Benefits of  U.S. stocks – and does the exchange rate affect your gains?

I’ve been advising Canadian investors to include U.S. stocks in their portfolios for more than 30 years. I continue to recommend them today. The U.S. stock market offers the widest variety and highest investment grade of companies to invest in of any country in the world. It also offers a wider selection of growth opportunities for those companies to pursue, in North America and around the world.

For our Portfolio Management clients, our general preference is to invest one quarter to one third of their holdings in U.S. stocks and the remainder in Canadian stocks.

Many major financial institutions recommend investing in North America. Some also recommend investing outside North America, especially in developing nations. They say that countries outside North America also offer great opportunities, and they may be right in some cases. They note that foreign investing offers an additional chance for diversification. This may be true, but we see it as irrelevant. Our view is that North America offers all the diversification that you really need.

Many promoters of emerging-market investing are also motivated at least in part by a conflict of interest.

By offering imported investments in their home market, they can earn higher profit margins than they get with domestic investments alone. That is, they make more money by promoting foreign investments. Investors may not make any more money, but they undoubtedly face more risk.

We have occasionally offered favourable advice about a handful of high-quality foreign stocks in the past few decades, while mentioning the added risk. But we’ve stressed our view that the U.S. and Canadian markets provide all the investment opportunities that you need to succeed as an investor.

Of course, the Canadian market offers opportunities that beat those available in the U.S.—in bank stocks, in the Resources & Commodities sector, and in specialists like CAE Inc. But Canada has nothing to compare with, say, Alphabet, Microsoft, McDonald’s and any number of other household names.

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Neither too hot nor too cold

Some investors say they agree with our view on U.S. stocks in principle, but they disagree with our timing. They think the U.S. dollar is just too high at present levels—too hot, you might say. These folks seem to think that the natural foreign exchange rate between the U.S. and Canadian dollars should be around parity.

This year, the U.S. dollar has traded at around one-third higher than the Canadian dollar. Way above parity! In fact, the U.S.-Canada exchange rate has not been anywhere near parity in the past decade.

The U.S. dollar has mostly stayed between $1.20 Cdn. and $1.46 Cdn. since the start of 2015. It’s now around the middle of that 8-year range.

Since 1971, the U.S. dollar has stayed between $0.94 Cdn. and $1.60 Cdn. It’s now around the middle of that 52-year range.

Timing is worth a look. But if you make it the deciding factor in your investment decisions, it’s apt to cost you money, in the long run if not in the short.

“Has-been” U.S. dollar has a long life ahead

A lot of foreign governments share the view that the U.S. dollar is overvalued.

In March this year, in a meeting in New Delhi, the representative from Russia revealed that his country is spearheading the development of a new currency. It is to be used for cross-border trade by the BRICS countries: Brazil, Russia, India, China, and South Africa. (Potential recruits include Iran, Syria and North Korea.)

I put this ambition on a par with the claims of cryptocurrency promoters. Some of them still predict that cryptocurrencies will take the place of the U.S. dollar.

Foreign countries have been muttering about the unfairness of the U.S. dollar’s dominance of world financial markets since the 1960s. The muttering has grown since then, but nothing much has come of it. According to Foreign Policy magazine, “By one measure, the U.S. dollar is now used in 84.3% of the world’s cross-border trade—compared to just 4.5% for the Chinese yuan.” My response: so what?

We’ll say more about the U.S. dollar and related issues in the future. For now, hang onto your U.S. stocks.

What the U.S.–Canada exchange rate means for your U.S. investments

The Canadian dollar has been up and down lately against the U.S. dollar. I was recently asked this question by a member of my Inner Circle: “The Canadian dollar has been up and down lately against the U.S. dollar. When buying a U.S. stock, would that stock then have to rise 34% to cover the exchange rate before I realized any gains? Thanks.”

The short answer is no. $1.00 U.S. equals $1.34 Canadian. You get back the exchange differential when you sell. If the U.S.–Canada exchange rate is about the same as when you bought, you’ll only lose the cost of the trade, perhaps 1%.

The thing is that using Canadian dollars to buy U.S. stocks involves two transactions. You sell your Canadian dollars to buy U.S. dollars; then you use the U.S. dollars to buy the U.S. stocks you want.

The first transaction—the conversion of Canadian dollars into U.S.—may cost you 1% or more of your Canadian funds. The second transaction—using your U.S. dollars to buy U.S. stocks—will involve a second commission charge, like any stock trade. It will vary with the broker who handles it.

The outcome of your U.S. stock purchases will depend on two independent factors. The first is the rise or fall in value of the U.S. stock, in U.S. dollars. The second factor is the value of those dollars when converted back into Canadian dollars.

If the value of the U.S. dollar rises in relation to the Canadian dollar while you hold a U.S. stock, then you’ll get more Canadian dollars back when you sell than if the exchange rate had remained the same.

On the other hand, if the value of the U.S. dollar falls in relation to the Canadian dollar while you hold a U.S. stock, then you would get fewer Canadian dollars back when you sell than if the exchange rate had held steady.

Is it worth investing in U.S. stocks or other international investments?

Uncertainty over the direction of the U.S.-Canada exchange rate may seem like a risk factor. However, the U.S. market offers investment opportunities that simply do not exist in the Canadian market; the Canadian market also offers investment opportunities that the U.S. market lacks.

We see holding U.S. stocks in your portfolio, and thereby gaining U.S. dollar exposure, as a long-term plus. The two currencies go through random daily fluctuations. But in the long term, holding stocks from both sides of the border is a valuable form of diversification.

Institutions that deal in foreign securities say the same thing about investing in other countries. However, the stock markets and currencies of Canada and the U.S. are among the most prosperous and stable in the world. When you invest in less stable/less prosperous foreign markets, there’s always a risk that the foreign stocks you buy will drop in price in the local currency, and that the local currency will go down even more.

When both drop, it can leave you with a much larger loss.

What has your experience been with investing in U.S. stocks? Did the exchange rate influence either your decision to invest or the amount of your gains?