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Forex, Inflation, Housing and Making Order Out of Chaos

May 21, 2022

Forex, Inflation, Housing and Making Order Out of Chaos
In some past posts, I’d touched on Forex – the global market for trading currencies. What I hadn’t done, though, was talk about Forex about inflation or the downturn in the stock markets, primarily because until fairly recently, neither had been an issue but always had correlated behavior.
 
Now, though, with sky-high inflation and market unease in the U.S., as well as geopolitical conditions and ongoing challenges that continue to erode at a sustained global economic recovery, I thought now would be a good time to look at the correlations. We’ll also take a quick look at housing and, finally, share some insight into how to make order out of chaos.
 

Forex: What It Is, Why It Matters, and What Current Activity Tells Us

 
As briefly noted in the intro, Forex is the global currency-trading market. By daily dollar volume, it is, by far, the largest and most liquid market in the world: According to The Bank for International Settlements triennial survey (last reported for April 2019), Forex daily trading averaged $6.6 trillion, up from $5.1 trillion in April 2016. 
 
That’s $6,600,000,000,000 – for perspective, imagine about $20,000 trading hands between every single American, every day. On the most basic level, it’s imperative to have an open exchange of foreign currencies to enable international trade and travel. Forex also enables more complex investment strategies, such as forwards and futures.
 
But how do inflation, rising interest rates, and declining equity markets impact US and foreign currencies? As Investopedia breaks it down:
“Low-interest rates spur consumer spending and economic growth, and generally, they have positive influences on currency value. If consumer spending increases to the point where demand exceeds supply, inflation may ensue, which is not necessarily a bad outcome. But low-interest rates do not commonly attract foreign investment. Higher interest rates tend to attract foreign investment, which is likely to increase the demand for a country's currency.
 
The ultimate determination of the value and exchange rate of a nation's currency is the perceived desirability of holding that nation's currency. That perception is influenced by a host of economic factors, such as the stability of a nation's government and economy. Investors' first consideration in regard to currency, before whatever profits they may realize, is the safety of holding cash assets in the currency.”
 
The US dollar tends to be a solid investment for foreign investors of all sorts, largely because it’s valued and backed by our relatively stable and consistent federal government that is trusted by the population. And now, with interest rates rising, demand is further increasing. As Reuters recently reported (via NASDAQ.com), “The dollar climbed to a 20-year high on Thursday as concerns persisted that central bank actions to counter high inflation would crimp global economic growth, boosting the currency's safe-haven appeal.”

And as reported in The Wall Street Journal article, “Even the Foreign Exchange Market is Getting Kind of Crazy,”:
 
“The price swings are yet another sign of how prolonged inflation and global supply-chain shocks have wreaked havoc on financial markets in 2022. Rising interest rates, Russia’s invasion of Ukraine, and an economic slowdown in China have upended the usually calm foreign-exchange universe. The dollar has surged rapidly, and the WSJ Dollar Index, which measures the dollar against a basket of currencies, has gained more than 12.5% over the past year. The euro has slid nearly 14% against the dollar and the British pound has lost around 12% during the same period.”
 

As reported in The Wall Street Journal
 
There has to be a balance, though, because when the value of the US dollar increases and too much foreign currency flows into the US because of higher returns, this increases the buying power of the US dollar overseas and adds further inflationary pressures to our trading partners.  However, it decreases inflationary pressure in the US.
 
And it’s important to understand this as a part of the larger picture of our economic challenges and recovery.  For example, the impact is not unnoticed by other central banks and they potentially may make adjustments to their own interest rates as well as their own behavior in the forex markets buying and selling currencies to balance their own fiat.
 

Housing: Is Opportunity Knocking?

 
If you didn’t lose your home-buying funds in crypto or stocks (and I certainly hope that’s the case), now could be a better time for you to purchase a home.
 
I’ve long said that I see strong correlations between equity markets and housing – albeit, with a 60-90 day average lag time – and now that the markets have been sliding for several weeks, I think we’ll start to see the impacts within the next month or so. 
Already, we’re seeing evidence (anecdotal and otherwise) that sellers are lowering their asking prices quicker than in the past two years. As reported by GoBankingRates:
 
“While 2022 was the housing market’s hottest March ever, 12% of homes had a price drop during the four weeks ending April 3, according to Redfin. This likely has something to do with rising interest rates, which reached 5.27% for the week ending May 5 — the highest level realized since the early aughts.”
 
And with interest rates continuing to rise, competition will settle some. I predict that in some markets, we could see prices soften by as much as 10% and while this good news will be offset somewhat by higher interest rates, keep in mind that a mortgage rate of 5-6% is still a very, very good rate for the long term.
 

Make Order Out of Chaos

 
Some business and political leaders sow chaos – Elon Musk and Donald Trump are noteworthy examples. And since I just brought him up, I have to admit that I was recently wrong about Musk – or, more specifically, about Musk and Twitter. As a seasoned investor, I know that the markets will dictate pricing and I should have heeded my own knowledge and experience when it came to the whole Twitter escapade, too. I still believe that Musk’s deal will close, but I also believe that it will be at a not-insignificantly lower price than he first put out there.
Reminder to myself: Musk is a showman who sows chaos; the market is a self-correcting entity that will overcome his folly.
Others make an order from chaos and if you’re a frequent reader, you had to know that I’d point to Warren Buffett and Charlie Munger as the masters of that category. 
 
You can leverage that quest for order, too: It’s simply a matter of researching the right opportunities, buying them, holding them, and making a profit from them. It’s value investing at its most basic and it’s once again the reason that I hold Buffett and Munger in such high esteem.
 
I don’t know if it can be any clearer than this: Musk’s path to wealth is tough for anyone to emulate – and Buffett’s and Munger’s path to wealth is one that anyone can follow. 
 
They’re experts at reading the tape and are cleaning up when everyone else is busting to bits.
 

The Wall Street Journal, Feb 18, 2:43 pm
 
I always say that things come back, but they come back differently. So, yes, the markets will recover, they always do, but they’re not going to look exactly as they did before, which is why reading the tape is more important now than ever.
 
I also like to remind people that losses accumulate much more quickly than gains. 
 
Here’s why: I can’t tell you how many times I’ve heard people say that they’ve lost XX%, but they’re sure that they can make XX% back again.
 
But here’s the thing: There’s a mental mistake of thinking that a loss can be offset by an equal gain – for example, that a 50% loss can be offset by a 50% gain. If you lose 50% of an investment, you need to double it to make it back. If, for example, you invested $100 and now it’s worth $50 (a 50% loss), you now need a 100% increase (another $50) to get back to Square One.
 
So, what should you do now? 
 
It’s actually a great time to make moves, pivot to the value opportunities, and doesn’t get caught up in the illusion of the quick buck unless you really know what you’re doing and can afford to lose (let the lessons that others learned with this recent downturn be a lesson for you, too).
 
Make order out of the chaos and you’ll win.

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