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The Dollar Is Breaking a 20-Year Pattern

Here is something the U.S. market rarely forces investors to think about: for most of the past decade, owning U.S. stocks meant you were also long the dollar. That double exposure worked spectacularly. In 2025 and into 2026, it has started working in reverse.

The U.S. Dollar Index fell approximately 9.6% in 2025 – its worst annual performance since 2017 and the steepest first-half drop in over 50 years. By mid-2026, the picture had gotten more complicated. The DXY rebounded sharply in June, climbing back toward 101 after the Federal Reserve signaled growing support for rate hikes later this year. Around half of FOMC members now project at least one rate increase in 2026, and Fed Chair Kevin Warsh reaffirmed the Fed’s commitment to bringing inflation – currently running at 3.8% – back to target. That hawkish turn has kept the dollar firmer than many forecasters expected heading into summer.

Wall Street remains split on where the dollar goes from here. Bank forecasts for Q4 2026 imply DXY in the 99 range on average, with some banks targeting levels in the low 90s and others holding near 100. That is a historically wide spread, reflecting deep disagreement about the Fed-ECB policy path. What matters for investors is the longer arc: even with the recent bounce, the dollar ended 2025 roughly 10% below where it started the year, and structural pressures – persistent fiscal deficits, an overvalued currency by most purchasing power models, and a narrowing yield advantage over global peers – have not gone away.

What is interesting is what happens to international stocks when the dollar weakens. A U.S.-based investor holding foreign assets gets a currency translation boost when converting gains back to dollars. That mechanical tailwind drove international stocks to outperform U.S. equities by roughly 14.6 percentage points in dollar terms in 2025. The MSCI World ex USA index returned 31.9%. The S&P 500 returned 17.3%. The gap was not subtle.

It was not just one region. South Korea’s KOSPI surged 76% in 2025 – the strongest annual gain among all major global markets, and only the third such rally in the index’s 43-year history. Japan gained roughly 27%. Germany climbed 22%. The MSCI Emerging Markets index returned 33.6% for the year. These are not fringe numbers. They are bigger than what most U.S. portfolios captured, because most U.S. portfolios hold near-zero international exposure.

Slight tangent, but it matters: Korea’s run was not purely a currency play. Samsung gained 125% over the year, and SK Hynix nearly quadrupled. Those two companies now account for roughly 35% of the KOSPI’s total market cap. The AI chip boom was the real engine. The dollar tailwind just amplified the return for U.S.-based holders.

The valuation gap makes this more interesting, not less. Emerging market stocks were trading at a forward price-to-earnings ratio of roughly 13.4 at the end of 2025, against the S&P 500’s approximately 22.5 forward P/E as of mid-June 2026. Even after last year’s EM rally, the MSCI EM index still trades at roughly a 42% discount to the S&P 500 – wider than the long-term average discount of around 32%. That is not a small gap. And mean reversion in global allocation alone, given how extreme U.S. concentration has become, could sustain international outperformance for years regardless of the earnings trajectory.

Germany has embarked on a significant fiscal stimulus plan. Japan’s corporate reform wave is ongoing, with shareholder-friendly policies pushing capital returns higher. China’s tech sector is seeing renewed interest, with consensus EPS growth forecasts for MSCI China pointing to roughly 15% in 2026. And European banks – a traditional value sector – have outperformed the Magnificent Seven over the past three years, benefiting from ECB rates staying higher for longer and improving net interest margins.

The part that gets missed: dollar weakness is not just a currency story. It reshapes relative earnings power. U.S. multinationals with heavy overseas revenue actually benefit from translation effects – a secondary opportunity within domestic large-caps. But the primary beneficiaries are unhedged foreign equity holders, and most retail investors in the U.S. are not positioned that way at all.

Here is where things stand on risk. The dollar’s June 2026 recovery is real, and it could extend. If inflation stays elevated and the Fed follows through on rate hikes, the yield differential that once supported the dollar could reassert itself. Morgan Stanley estimated the dollar could lose another 10% by end of 2026 – but that call was made before the Iran conflict pushed U.S. CPI to 3.8% and forced the Fed’s hand toward a more hawkish posture. The recovery scenario is no longer hypothetical.

But the structural backdrop – fiscal imbalances, valuation differentials, two decades of extreme U.S. concentration, and foreign investors beginning to hedge their dollar exposure – does not resolve in a quarter. The question for investors is not whether to have international exposure. It is how long they can afford to wait before the cost of not having it shows up in their statements.