Why your favorite foreign-stock mutual fund is such a weakling this year: Blame Europe and the euro

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The $146-billion, three-year deal to bail out Greece had the desired effect on government bond interest rates in Europe on Monday, mostly pushing them lower.

But if the goal was to boost the depressed euro, currency traders weren’t buying it: The European currency slumped anew against the dollar. That is deepening this year’s losses for U.S. investors in European stocks -- which may be why your favorite foreign stock mutual is performing so poorly.

The bailout plan put together by the euro-zone countries and the International Monetary Fund will give Greece low-interest loans to meet its near-term debt obligations.

With the aid package removing the immediate risk that Greece would default on its debt, market yields on the government’s bonds fell sharply Monday: The yield on two-year Greek notes tumbled to 10.28%, down from 12.72% on Friday and the recent peak of 15.91% last Wednesday.

The rescue also lessened concerns that investors would balk at buying bonds of Portugal, which like Greece has been struggling with a yawning budget gap. The market yield on two-year Portuguese government notes fell to 3.66% from 3.82% on Friday and 4.92% last Tuesday.

Among Europe’s debt-challenged countries, however, Spain is the biggest worry because of the size of its economy. And Spanish government bond yields were up slightly Monday, with the two-year note yield at 1.97% versus 1.92% on Friday.

The euro, meanwhile, fell to $1.321 from $1.331 on Friday and traded as low as $1.315. The euro has slumped nearly 13% against the dollar since the end of November, when the European currency was worth $1.51.

[Update on Tuesday morning: The euro has plunged anew, falling to a one-year low of $1.30 as European markets slide again.]

The conventional wisdom is that the euro’s weakness Monday reflected fears that the debt crisis isn’t over, and that investors will again drive up yields on bonds of countries saddled with huge budget deficits, potentially forcing another round of bailouts.

“A lot of people fear the market is going to turn on Spain and Portugal,” said Kathy Lien, head of currency research at GFT Forex in New York. That could send capital fleeing Europe, further depressing the euro.

What’s more, the deep budget cuts already forced on Greece, Spain, Portugal and other European countries obviously won’t help the cause of economic recovery. A weaker economy typically means a weaker currency.

There also is a widespread suspicion that Germany, a huge exporter, probably would be fine with a further decline in the euro because that would make its goods cheaper abroad.

“The path of least resistance remains a lower euro,” said Marc Chandler, currency strategist at Brown Bros. Harriman & Co. in New York.

Still, with so many traders betting on another drop in the euro, contrarians might be tempted to expect a rally instead.

Even a stable euro at this point could help the performance of popular foreign-stock mutual funds, many of which are heavily invested in European shares and thus have been held back this year by the currency’s fall.

Consider: The German stock market is up 3.5% this year measured in euros, but is down 4.6% measured in dollars (because a weaker euro translates into fewer dollars). The French market, down 2.7% this year in euros, is off 10.4% in dollars.

The average foreign-stock fund is up just 2.1% this year, compared with a 7.5% gain for the average U.S. stock fund, according to Morningstar Inc. Europe and the euro don’t get all the blame for foreign funds’ lagging returns this year, but they’re at the top of the list of culprits.

-- Tom Petruno