As poor-performing economies of Europe continue to contract, the European Central Bank (ECB) just announced that it will use all available means to increase inflation and stimulate the economy. This means the ECB will initiate programs that will lower interest rates, which makes the Euro currency less attractive to investors. So this latest ECB announcement caused the Euro to fall to its lowest level in a year against the U.S. dollar.
Economies and central bankers around the world move interest rates and currency values that you must consider when purchasing foreign stocks. If a great company in Japan performs well but the Japanese Yen is falling in value, then that currency drop may offset any stock gain that you may have had.
There are two cases when currency valuations are not as important for foreign stock ownership, global commodities and global companies. In the case of commodities, for example, a company in Asia that refines oil, it is the single, global price of oil that will affect the company’s earnings more than the local currency. Since the company is selling an item at a global price, the ups and downs of the local currency have much less net impact to you as an investor. The second situation, global companies that operate on several continents and countries, they normally hedge the currency of sales to their domestic currency. So currency fluctuations happen slower over time as they roll their hedges over a year or more.
Anytime you find an attractive stock outside your home currency, you need to be aware of the potential risk of currency moves that could hurt your investment return.