The exchange rate is one of the factors affecting investment and the stock market in particular. In this article, we will briefly discuss the relationship between the decision to devalue the currency and the effect on the stock market.
The decision to devalue the currency can be expected or anticipated through the movement of the stock market, as studies around the world indicate that usually the devaluation decision may be preceded by unjustified losses for a period of up to a year before the decision and may continue for a quarter of a year after it before You start the reversal movement and make profits.
Does the decision to devalue the currency lead to a recovery in the movement of the stock market? The short answer is yes, but it doesn’t have to be profitable for all investors. The investor’s position on achieving returns or losses after the devaluation of the currency is affected by several factors such as whether the investor is local or foreign, macroeconomic indicators, and the financial position of companies. In a study conducted by “Global Financial Data” on all local markets in countries that have witnessed currency devaluation since 1980, the study cases were divided into three groups:
1. The stability or appreciation of the currency after the devaluation decision: the highest returns were achieved by the investor who built his investment position immediately after the devaluation decision.
2. A free fall in the currency price after the devaluation decision: In this case, the saying “patience is one of the most important principles of investment” is realized, as the investors who entered the market after the devaluation decision benefited and kept their position for a year, realizing higher profits than the first group.
3- Emerging markets before the downgrade: In this case, the downgrade decision is no longer of significant interest to investors.
Therefore, it is important to see the full picture of the market situation before and after the decision to devaluation in order to determine the entry and exit points and hedge against the change in the currency price.
When does the currency rate affect the stock price? Let us ask the question differently, why is the exchange rate not directly reflected in stock prices, as we find in commodities such as gold, for example? The answer to this question includes several aspects, the first of which is the total difference between the nature of commodity markets and financial instrument markets such as stocks, where the first is less liquid, more affected by inflation rates, and more vulnerable to changes. It also represents an in-kind commodity that can be physically acquired and consumed, unlike stocks, which represent a share in the ownership of companies. Likewise, the pricing of commodities depends on supply and demand, directly affected by the price of the local currency and the rate of inflation, while the pricing of stocks is related to the investors’ view of the companies’ financial position. Here, the importance of fundamental analysis of the company’s position appears to show how the exchange rate will affect the re-pricing of the company’s shares. To clarify,, if the company is completely local where all its expenses and profits are in the local currency, it is difficult to see a large variation in the price of its shares.
Other accompanying tools and variants: The exchange rate is one factor but not all. The full picture of the economy’s indicators should also be assessed. For example, did the devaluation follow other integrated procedures and investment flows after that to start an activity cycle? Or was the price move only partial and exceptional? Also, what is the nature of other accompanying monetary policy tools, such as interest rates? What is the direction of the monetary reserve curve before and after the decision to devalue the currency? What is the evolution of the country’s credit rating level? Answering these questions may pave your way to entering or exiting the stock market.
Conclusion: The local investor can achieve profitable returns after the decision to devalue the currency, taking into account the factors surrounding the decision. There are also some measures taken by major investment institutions and fund managers based on complete information, such as hedging against exchange rates, investing in blue-chip stocks, as well as diversifying between stocks and government bonds.
This was not written by Thndr and this is not investment advice, you should do your own research before making investment decisions.