Europe's debt crisis has many American investors closely watching the euro. Since the euro can impact U.S. investors, Americans should be aware of the euro's worth.
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Chuck Butler, president of EverBank World Markets and author of The Daily Pfennig, explained that if the euro is trading around $1.2950 (as it was on May 9, 2012), 100 euros would be worth $129.50. If the euro falls 1 percent, the resulting value in dollars would be $128.21.
Here are several ways that the state of the euro can affect American investors, according to Tom Anderson, chief investment officer for Boston Private Bank & Trust Company.
U.S. Holdings of Euro-Denominated Investments
American investors tend to hold investments in both U.S. and non-U.S. stocks, and Anderson says a weaker euro relative to the dollar can reduce the value of U.S. holdings of euro-denominated investments, such as European stocks or international mutual funds. If the dollar strengthens versus the euro, there will be a negative impact on the international holdings of U.S. investors.
If the euro increases in value verse the dollar, this too will affect U.S. investors. Butler explained that as long as U.S. investors have European investments in the local markets, denominated in euros, a decline in the dollar, "allows them to gain in the value of their investment, and to offset the loss of purchasing power that the decline of the dollar brought to holders of dollars."
According to the Carnegie Endowment for International Peace, Europe consumes 20 percent of U.S. exports, while the U.S. holds almost 40 percent of Europe's foreign assets.
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Anderson says a weaker euro relative to the dollar reduces the competitiveness of U.S. exports to Europe, which could have a negative impact on the U.S. economy. However, he says this is less of an issue because of increased momentum and strength of the U.S. economy.
Albert Lu, managing director and chief portfolio manager of WB Advisors, said, "If the euro rises relative to the dollar, some businesses may experience a short-term increase in earnings whereas others may experience the reverse."
Owning non-dollar denominated assets may adds another layer of risk that requires more monitoring by investors. Alan McKnight, the director of global investment strategy at Balentine, said taking on currency exposure adds the risk that movements in the currency can influence the overall value of the asset regardless of the underlying characteristics of the asset. To illustrate this point he offered an example: "An investment in a German stock that is held in euros would be hurt by a weakening euro regardless of the underlying fundamentals of the company," such as cash flows and the balance sheet.
Butler, on the other hand, argued that adding non-dollar denominated assets to a dollar denominated investment portfolio, "diversifies the portfolio and reduces the overall risk to the portfolio. Treating currencies as a separate asset class diversifies a portfolio by having different pricing mechanisms, and a low correlation to the other assets in the portfolio."
Investing in so-called American depository receipts (ADRs) or investing in U.S. subsidiaries of foreign firms (which are traded in dollars) both have risk. By not owning local market and currency stock, one does not have an adequately "diversified portfolio with an allocation to non-dollar denominated investments," according to Butler.