Does a Weak Dollar Hurt Foreign Stocks?

When you read in the news that the dollar is "weakening," that means it's losing value in relation to other currencies, such as the euro, the British pound or the Canadian dollar. Say you're visiting Europe and you want to buy a bag of chips that costs 1 euro. You check the exchange rate, and you discover that 1 euro is the equivalent of $1.25. So you swap $1.25 for 1 euro at the currency-exchange desk at your hotel, and you get some chips. Two days later, you're hankering for more chips, but you discover that 1 euro now costs you $1.35. The dollar has weakened against the euro, meaning it takes more U.S. money to buy the same amount of euros. Now imagine that instead of chips, you're buying stocks.

Currency exchange rates fluctuate for many reasons, but in very general terms, they tend to reflect the relative condition of national economies. When the U.S. economy is going gangbusters, the dollar will be strong against currencies from places where the economy is sputtering. Similarly, when the U.S. economy is in a rut, the dollar will be weaker compared to the currencies of countries where things are perking up. What this means for stocks is that if the dollar is weak against, say, the euro, that suggests strength in the European economy. A strong European economy is good for European companies, which will tend to increase share prices for those companies.

If you already own foreign stocks, as many investors do, either directly or through mutual funds, a weak dollar will boost the returns of those stocks. Say that you buy 100 shares of a French firm, Compagnie Zut Alors, for 10 euros apiece. If the current exchange rate is $1.25 per euro, your 1,000 euro investment is worth $1,250. Now say the dollar weakens, so that 1 euro is equal to $1.35. Even if the share price of Zut Alors stays exactly the same, at 10 euros, your 1,000 euro investment is now worth $1,350. You've "made" $100 simply by watching the dollar weaken.

Dividends are cash distributions of company profits, and foreign companies pay them just like U.S. firms do. A weak dollar makes those dividend payments more valuable to a U.S. investor. Say you own one share of a Japanese company, Osaka Heavy Industries, and that company plans to pay a dividend of 50 yen every three months. When the first dividend date rolls around, the exchange rate is 100 yen to the dollar, so the first payment is worth 50 cents to you. Three months later, the dollar has weakened, so that $1 buys only 90 yen. Now Osaka's 50 yen dividend payment is worth about 56 cents to you.