By Eric Fry
When foreign economies recover from a bust, their stock markets usually boom. But that’s not all… Their currencies also boom. They soar in value against the U.S. dollar.
This phenomenon is not simply a curiosity; it can be a big-time moneymaker. The combination of rising stock prices and a rising currency can produce supercharged gains for a dollar-based investor.
The past is full of many such examples. This week’s chart shows just a few of the most memorable ones…
In each example, a foreign stock market delivered gains of about 500% in U.S. dollar terms. And in each instance, a large percentage of the gains came from the local currency’s appreciation against the value of the dollar.
One truly remarkable aspect of this effect is that it does not simply add currency gains to stock market gains; it compounds the combination of the two to produce an even larger total return.
As powerful as this phenomenon can be, it often confuses investors. So let me simplify it with an example I’ve used in the past…
For illustrative purposes, let’s say $100 would buy 100 Indian rupees on the day you decided to invest in the Indian stock market. So you exchange your $100 for 100 rupees and invest those funds.
After one year, the Indian stock market has doubled and the rupee’s value against that of the dollar has doubled, such that each rupee is now worth $2, rather than $1.
In this scenario, your gain is not the sum of your 100% stock market gain and your 100% currency gain – i.e., 200%. Instead, your gain is 300%!
Here’s why… The 100 rupees worth of stock you purchased would be worth 200… and 200 rupees would now be worth $400 – or a 300% return on the original $100 you invested.
The chart below shows a real-world example of a currency’s power to supercharge returns…
Between May 2004 and May 2008, the Brazilian stock market gained 810% in U.S. dollar terms.
Less than half of that gain (358%) came from the stock market’s performance in local currency terms. The rest came from compounding appreciation of the Brazilian real against the value of the U.S. dollar.
A repeat performance is underway in Brazil right now.
Over the last two years, the iShares MSCI Brazil Index ETF (NYSE: EWZ) has produced a total return of more than 180% in U.S. dollar terms. A big chunk of that gain has come from the appreciation of the Brazilian real against the value of the U.S. dollar.
The MSCI Brazil Index is trading 40% below its highs of one decade ago. If the index simply returned to that level, it would deliver a gain of 150%.
I’d call that a good start.
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Source:: Investment You