We looked at a few details behind lagging small-company stock returns last Thursday. Today, I thought I'd do the same for foreign stocks.

Once again turning to Bespoke Investment Group for a pretty illustration of the trend, here's a chart showing "the spread between Domestics (S&P 500 companies that get at least 90% of their revenue from the United States) and Internationals (S&P 500 companies that get at least 50% of their revenues from outside of the United States). As the dollar trends up, the domestics begin to outperform, with no foreign revenues to be hurt by declines in overseas currencies." 

Their article goes on to illustrate this relationship by comparing Altria and Phillip Morris International. For those not up on tobacco company details, these are basically the same company — same tobacco products and brands — only Altria serves the US market while Phillip Morris International serves foreign markets. Not surprisingly, as the dollar has rallied, Altria (US customers paying in dollars) has rallied while Phillip Morris (foreign customers) has been flat. When those foreign currencies get converted to stronger dollars, they result in fewer of them.

The same thing is happening with most foreign funds. As their profits are converted from foreign currencies into dollars, the stronger dollar diminishes those returns. Not surprisingly, then, returns from most diversified foreign funds have been substantially lower than U.S. stock funds over the past few months.

For example, Morningstar shows the average US small-company stock fund has lost between 3.9%-4.8% over the past three months. However, the average foreign small/mid-cap fund has lost more: 5.5%-6.7%. An even greater disparity exists among large-company stock funds: gains of 6.0%-7.1% for the average US funds, but losses of 3.9%-4.7% for the foreign large-cap funds.

For more on the recent dollar strength, see Austin's post on gold last week, or my earlier post from a few weeks ago.