Chart of the Week: Can Foreign Currency Changes Boost Investment Returns?

Foreign stocks are off to a roaring start in 2023, carrying momentum built during last year’s final weeks. Over the past three months, the MSCI All-Country World index ex-U.S., a measure of non-U.S. equities, has returned nearly 21%. By contrast, the S&P 500 has gained about 9%.

Wall Street has noticed: A recent Reuters poll of portfolio managers who oversee global strategies found that six out of 10 overweight foreign investments compared to their U.S. counterparts—the highest percentage since 2005.

After a decade of underperformance, is the stage being set for a sustained rally in overseas markets? We think so—in part because a weakening dollar is making foreign stocks more attractive than they’ve been in quite a long time.

Our chart of the week helps demonstrate the relationship between the dollar’s strength and the relative performance of U.S. and non-U.S. stocks. The blue line charts the relative performance of foreign stocks vs. U.S. stocks. When the line is rising, U.S. shares are performing better. The opposite is true when the line is dropping. You can see that the dashed line, representing the U.S. Dollar Index, moves in near correlation.

Over the past 25-plus years, a clear relationship has developed: As the dollar rises, U.S. markets outperform. In periods of dollar weakness, we can also observe the inverse—foreign stocks begin to outpace their counterparts.

Predicting the path of currency trends is nearly impossible. The important takeaway is this: After more than a decade of strong dollar performance and a shift in the foreign currency tides, a tailwind is improving foreign stock investment returns, and that wind may continue blowing.