There are still a few trading days left in the month, but May so far has been a good one for the TSP.
The C Fund is up just under 3%, the S Fund is up about 4.6%, and both the G Fund and F Fund are up a small faction of a percent. The I Fund is the odd one out, being down a bit under 0.9% so far.
The Importance of Currency for the I Fund
Since the I Fund mostly consists of stocks from Europe and Japan, the most prevalent currencies used by companies in the fund are the British Pound Sterling, the Japanese Yen, and the Euro. Their revenue and profits are made substantially in those currencies, and they pay dividends in those currencies.
When the US dollar strengthens compared to those currencies, all else being equal its bad for the I Fund, for American holders of those foreign stocks. And when the US dollar weakens compared to those currencies, the I Fund can have outsized performance for American investors.
For example, in 2017 the dollar substantially weakened compared to many currencies, including the Euro and Pound Sterling, which led to outperformance of the I Fund for that year.
But this month in May, the dollar strengthened by several percentage points compared to both the Euro and Pound Sterling, which has hurt the I Fund by a couple percentage points.
You can see the 2-year performance of the US dollar compared to these three currencies in the following charts:
Currencies Tend to Be Mean-Reverting
While strong local currencies (pound, euro, yen) benefit American holders of those foreign companies’ stocks in the short-term, it gets a bit more complicated over the long-term. And as long as there is no fundamental problem with a currency, they tend to at least partially revert to the mean over time.
For example, when a currency is very strong, it is more expensive for consumers and businesses in other countries to buy goods and services from that country with the strong currency. They can start to find better deals from other countries. Stocks from those countries can start to decline a bit.
Currency strength is built from several factors, including interest rates, inflation, budget deficits, and more. Right now, the fact that the United States is raising key interest rates while many countries are not, makes holding US dollars more appealing than holding most of these other currencies. That’s a strong tailwind for the US dollar to continue to strengthen, but it’s no guarantee since it’s just one big factor among many.
One of the benefits of holding domestic stocks and foreign stocks together in a portfolio is that they help balance each other out and reduce volatility. You don’t necessarily have to predict currency swings, and can instead hold a diversified collection of companies from multiple countries and ride out the waves.