The role of currency changes on equity returns is often significant
In many years and in aggregate the U.S. $ has appreciated substantially versus most other major currencies. When the dollar rises against things like the Euro, the returns for U.S. investors in European stock markets are lower than they are in the local currency. For instance, if the Swiss stock market appreciates 10% in the local (e.g. Swiss market) but the Swiss franc (CHF) declines 5% relative to the U.S. $, the return for an investor who purchased in U.S. $ would only be 5%. Thus far this year, there has been a reversal in exchange rates across most major currencies. In other words, this former headwind is now a tailwind for U.S. investors. The chart below shows the change in currencies relative to the U.S. $ thus far this year as of early June.i
To be clear, we don’t know what lies ahead with respect to currency movements relative to the U.S. $. Much will depend upon the outcome regarding U.S. tariff policy, as well as things like GDP growth here and abroad. There are other determinants of stock market returns here and abroad. Some of the most important are: 1) the change in GDP for each country and 2) whether profit margins for underlying publicly traded stocks increase or decrease. Often, the most important factor in any specified period is whether valuation (e.g., the PE ratio) has expanded or contracted. During periods of expansion, price gains exceed growth in underlying earnings per share (EPS) and vice versa. Circling back to currency value, when the dollar appreciates, it gives us more purchasing power. A trip abroad can seem like a real bargain as the dollar goes further. On the other hand, a strong dollar can make U.S. exports more costly to consumers in other countries. Said differently, there are two sides to the currency coin.
We never profess to know what lies ahead for economies and markets in the near term. Nevertheless, we believe that U.S. large cap (e.g., the S&P 500) stock returns could potentially be appreciably lower over the next 3, 5 or 10 years than what we have experienced since the market’s bottom in March 2009. Further, we would not be at all surprised if international stock markets (both developed and emerging economies) might be appreciably higher in the future than we have experienced in recent years. The chief reason being valuation multiples for the U.S. and international markets. At present, the U.S. PE multiple (especially for large cap growth) is high relative to historical norms. International market valuation metrics are much lower on an absolute and relative basis. Either way, we remain steadfast in our belief that diversification is a prudent way to navigate the unknown future. Please see a surprising chart in an endnote – European stocks have been providing ballast for over 3 years.i We expect to experience headwinds and tailwinds in economies and markets in the years ahead.
Since the GFC, and especially in recent years, vast sums of money have flowed into U.S. equity markets from U.S. and foreign investors alike. The investment flow into U.S. equites has been robust and it provides ballast which in turn translates into greater flows. It is similar to what happened in the Japanese market in the 1980s. Investors across the globe added aggressively into Japanese stocks in that period. The pendulum swings far on the upside when flows are strong. However, if and when, momentum shifts, the downturn can be severe and can be exacerbated by ever increasing outflows. That's precisely what happened from the U.S. market highs in early 2000. The ensuing downturn also travelled further than most investors could have imagined.
In summary, we don't know what lies ahead over the near term. Nevertheless, we believe a sea change in market segments is not only possible, but we believe likely. It's the nature of cycles. Markets get too expensive on the upside and unduly cheap on the downside. To believe that these swings are a relic of the past but won't happen in the future requires a belief that somehow history’s lessons are irrelevant, and that investor behavior is now decidedly different. We think that is a risky bet.
W. Richard Jones, CFA
Partner, Harmony Wealth Partners
i The chart below is from JP Morgan’s Guide to the Markets from May 30, 2025. It shows the equity performance in various markets expressed in local currency and U.S. $. As you can see, the YTD differences in returns are significant and because the U.S. dollar has weakened against most major currencies, returns in U.S. $ are generally higher than in local currency. This contrasts with most years since the GFC as generally the U.S. $ has strengthened. The other thing worth noting is in the chart in the top right. As I shared in a prior letter, Japan accounted for the largest share of global stock market value in the late 1980s. At that time the U.S. share was only 28% compared to 40% for Japan. Recently the U.S. share hit 65% and Japan’s has fallen to just 5%. All other major markets and regions are 12% or less of current global market value. If the U.S. share recedes, the increase in other countries’ individual and aggregate share will mean that those markets have generated higher returns. We believe that could be the case so, we want to continue to have meaningful ownership of equity markets outside of the U.S. That said, we also expect to have an allocation of at least 50% in U.S. equities in our aggregate equity allocation.
Source: JPMorgan Guide to the Markets as of May 30, 2025
ii 
Sources: Charles Schwab, Macrobond, S&P Global, MSCI as of 6/02/2025
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