The new year brings new opportunities to boost your budget, and to accomplish this you need to keep an eye on currency inflation, the strength and position of the dollar, and look around for investments that promise possible earnings. To understand how to navigate in investment environment, even if you are an inter-currency trader, you need to familiarize yourself with the above relationships and how its analysis refers to market values. The following analysis is provided to identify potential investments worth further watching.
Inflation in the Spotlight
Inflation is one of the key factors affecting exchange rates. Last week and the economic calendar are full of registers of this macroeconomic indicator. How can it affect ratings in the near future? It depends. Let’s start with the fundamental things, that are interest rates and cash printing. If you analyze the current macroeconomic environment by yourself, both of these variables are present. We have had interest rate cuts for some time now (practically since March 2020), which practically all central banks in the world have applied.
This was to support economies during hard times by giving access to cheap loans. The second aspect that is related to inflation is quantity of money. At the present time, it is easy for us to say that there is a plenty of cash in circulation. We can look at it through a fundamental prism – fiscal stimulus. This resulted in a number of aid packages in the US and EU. In addition to low interest rates, countries decided to intervene more robustly, offering support in the form of real cash. I think we will observe this tool being used again pretty soon. In the United States, the size of the next package is still being negotiated. There are many indicators that a “richer” version of it will be voted through.
We have to keep in mind one more important detail. Namely, inflation targets. Central bank policy is based on certain guidelines. For example, consider the Federal Reserve. Recently, the bank assumed that the inflation target was 2%. If inflation rates were higher, it became more likely that the FED would raise interest rates to reduce the amount of money in circulation. Conversely, with inflation ratings at lower levels, the bank usually decided to lower interest rates to stimulate economy – more people reach for loans. Of course, one extreme rating did not immediately define significant changes in interest rate policy. Looking at the chart above, we can see two measures. The first, in blue, is U.S. inflation and the second, in black, is the change in U.S. interest rates. There are marked two episodes – a large drop in inflation (green) and a sequential rise in inflation (red). Both are indicative of what is mentioned above. Simply, the central bank must keep its hand on the pulse.
Frenzy of Printing Money
As far as printing money is concerned, the situation in the world looks equally interesting. Central banks have not yet had a period in their modern history when they printed new money so intensively. Just take a look at the graphic below, which shows the size of this increase.
As seen above, the European Central Bank has been particularly intensive in doing so. Nevertheless, the collective value of putting new cash into circulation is high. All right, but how does this relate to currencies? In general, the most important thing is the combination of these two factors together. We currently experience a low interest rate environment, so inflation is doing very well. In addition, it is supported by successive printing of cash by central banks practically all over the world. The risk of inflation is therefore growing. Banks will be forced to raise interest rates to reduce the amount of money in circulation – if someone is thinking about taking out a loan from a bank or fast online payday loan, it is worth deciding before the inflation rises. In theory, higher interest rates are good news for currencies, which encourages their appreciation. Just look at the following chart of the dollar index to interest rates.
The effect of appreciation (strengthening) is of course not seen immediately. A change in the interest rates does not have an immediate effect, and you have to take into account the time it takes for the market to react to these changes. Therefore, all interest rate increases and decreases are spread out over time. Nevertheless, higher interest rates (more expensive loan, but a higher rate of return on money deposits) encourage people to invest money in a currency whose bank maintains relatively high interest rates. The demand for it grows, which is reflected in ratings in general market.
A Taste for Cheap Currency
Why do central banks want to have a cheaper native currency? It is currently due to economic conditions. A cheap domestic currency primarily benefits exporters. Central banks are well aware of this, as a high level of exports is beneficial due to the improvement in the economic situation. Moreover, the more stable, “average inflation” was deliberately introduced in the USA in order to maintain the low interest rate environment for as long as possible. It has a positive effect on stocks (cheap loan with which to finance stock purchases). Of course, one of the reasons why the FED wants to create inflationary growth is because of the high national debt in the United States. The reason, od course, is simple. With higher inflation, the debt can be repaid with cheaper money.
Investing in 2021
We are entering a new year, a new decade and perhaps a new business cycle. Investors in 2020 received almost the entire repertoire offered by the stock market – we had a slump, bull market, undervaluations, overvaluations, crashes, euphorias, economic stagnation, a very high employment rate, which later turned into the highest unemployment rate in decades, sector rotation, dividend cuts for companies that previously raised their dividends year after year for several decades, etc. Last year provided a lot of experience – it showed fresh investors whether they can emotionally survive major downturns, and reminded more experienced ones that markets can also move in the opposite directions.
But that is all the past, we are interested in the future. How exactly the year 2021 will unfold – no one can predict that. We can only speculate based on the past events.
Moving on to the facts: we can divide 2020 into two groups of stocks, one that has suffered from lockdowns (e.g., companies in the travel sector) and the other which benefited from them (e.g., companies that gained from digitalization). In 2021, we are unlikely to have to fear renewed lockdowns – the vaccine is already around the corner, and it may significantly affect future perceptions of the threat that lockdowns tried to suppress earlier, i.e. I do not expect any more lockdowns.
Thus, the companies that gained the most in 2021 (these are mainly companies profiting from digitalization) may face difficulties in maintaining ratings in the new year. The pace of growth of financial results will be rather difficult to repeat and only those companies that will record the smallest decline in turnover growth (compared to the same quarter of 2020) will hold high. In particular, I will be watching stocks – DocuSign, Fiverr International, Nvidia, The Trade Desk, Shopify, Amazon (NASDAQ:AMZN) and Zoom Video Communications.
On the flip side, companies that suffered the most during the 2020 lockdowns but survived the “attack” on their business model may see above average growth rates in the new year (compared to the same quarter in 2020). Companies that I find interesting from this category are: The Walt Disney Company (NYSE:DIS), the Coca-Cola Company (NYSE:KO) and PepsiCo, Ross Stores (NASDAQ:ROST), TJX Companies and Booking Holdings.
I do not expect any major declines or a transition of the markets into a prolonged bull market – we simply have too many big players around, i.e., economic stimulus. Companies have the highest increase in cash in a very long time (at the same time debt has also increased, but less) – it may stand for a year of record number of acquisitions and low interest rates.
However, what the stock market has taught us over the past twelve months is that an investor must remain flexible and adapt quickly to new conditions.