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European investors in US equities have been dealt a double blow as a slide in the dollar compounds losses on stocks, ending a “virtuous cycle” of share price and currency gains during Wall Street’s recent record run.
The slump in US stocks this year has confounded a widespread bet that Wall Street would continue to outperform. But an accompanying slide in the dollar has magnified the pain for foreign investors, ending a pattern where currency gains tended to offset some of the declines.
The blue-chip S&P 500 is down nearly 4 per cent in dollar terms so far this year, but more than 8 per cent in euro terms.
This has reversed a self-reinforcing cycle whereby European investors piling into US stocks had helped to strengthen the dollar, improving the returns from unhedged stock bets and encouraging them to allocate more, analysts said.
The dollar has strengthened over the past couple of decades against its major peers, with the latest burst of strength at the end of last year.
“It’s sort of a virtuous cycle that you have had for a long time and now that is turning the other way,” said Peter Oppenheimer, chief global equity strategist at Goldman Sachs.
“The US market has fallen more and because the dollar has fallen, when you translate that back, the impact is worse.”
In the final quarter of 2024, investors drove US stocks to record highs on tech optimism and hopes for a boost to corporate profits from Donald Trump’s tax-cutting pledges. The S&P rose 2 per cent in dollar terms, but almost 10 per cent in euro terms.
But the dollar has dramatically reversed this year as investors upend their assumptions on the impact of Trump’s protectionist policies. Previously, investors had anticipated high trade tariffs would boost US inflation and hurt growth elsewhere, pushing the dollar upwards and the euro towards parity with the greenback.
Since mid-January, the dollar has weakened as investors fret over US economic growth while Europe’s promises on higher defence spending breed optimism on the continent.
Some detect a deeper shift in how dollar assets are perceived. The dollar has been widely viewed as a haven in times of stress, often strengthening when bad news hits global stocks. That has encouraged overseas investors to pile into Wall Street stocks without paying to hedge their currency risk, because the dollar acted as a shock absorber during a sell-off.
“The risk-reducing properties of unhedged dollar exposure have played a key part in portfolio allocation over the past decade”, said Deutsche Bank analyst George Saravelos, adding that this is “now changing”.
This year’s US sell-off has led to similar losses for European investors as a much deeper Wall Street rout did in 2022, due to the shifting role of the dollar, he said.
If this “correlation breakdown” between equities and the dollar continues, European investors may think twice about loading up on US stocks without currency hedges, according to Saravelos.
Some are already shifting. Just over a fifth of European fund managers responding to a Bank of America survey this month said they were underweight US equities, the highest proportion since mid-2023.
A bigger European exodus could add to the pressure on US stocks, which tumbled into correction territory earlier this month.
“The downside risks to the S&P 500 as a result of foreigners selling are significant,” said Apollo chief economist Torsten Slok in a note this week, citing the overweight position that foreign investors had built up in US stocks.
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