Why Do Investors Bet Against Central Bankers?

One of the most interesting trends in recent years has been the ‘shorting’ of various assets, particularly of stocks and currencies. For those not in the know, ‘shorting’ basically means an investor borrows a stock, sells it, and then plans to buy it back at a lower price so that he can make a profit. Thanks to the rise of the ‘short-term-seller’, more people than ever are experiencing the advantages of shorting. During a pandemic, with the fear of infection rising, more people are looking to take a short position on stocks, and with Central Banks around the world printing money and cutting interest rates, it is a great time to be in the market.

On the surface, shorting stocks seems like a safe bet. After all, the U.S. economy, as we know it, wouldn’t exist without the role of stock market in creating prosperity. Thanks to companies like Amazon and Google, which is now valued at nearly $1 trillion, and trillion-dollar corporations like Apple and Microsoft, the U.S. stock market has seen unprecedented growth. In fact, as of March 31, 2021, the S&P 500 is up 16% from its March 2020 low, and almost all major indices are showing positive gains.

Even more impressive is the fact that the U.S. stock market still has a large amount of underperformers. A large number of investors are enjoying great success by shorting these underperformers, and many successful short-sellers have attributed their winning streaks to ‘reading’ the behavior of the markets and figuring out the best timing to make short-term investments. This is also known as ‘technical analysis’. While it is always fascinating to follow the behavior of stocks and other financial assets as they rise and fall over time, knowing how to utilize this information can help investors profit from the market. As the old saying goes, ‘the trend is your friend’ – you just need to know how to utilize it correctly.

Now, let’s bring this analysis to currencies for a moment. Many investors believe that the best way to profit from the global economic crisis is to bet against the U.S. dollar (USD) and other fiat currencies, particularly against the Chinese yuan (CNY), considering the country’s massive government intervention in the economy. The dollar has seen unprecedented weakness in the last few years, with most major currencies, including the Japanese yen (JPY), surging in value against the greenback. The situation is similar for the Chinese yuan, which has appreciated by nearly 70% against the U.S. dollar since March 2021.

What’s The Difference Between Currencies And Stocks?

Now, let’s take a step back and see how these two market extremes behave. First, we’ll start with a broad overview of the differences between stocks and currencies before diving into their specific behaviors during different market conditions.

An important distinction to make is that stocks and currencies are not the same as one another. Stocks are simply shares in a company, and as a result, they are not always representative of the whole economy. For example, when you purchase a share of Apple stock, you are not necessarily owning a piece of the whole company – only a small fraction of it (based on your purchase price).

This means that, while Apple’s success is certainly good for shareholders, it does not mean that the economy as a whole is doing well. It is a common misconception that owning a share of Apple stock means you are automatically invested in all of its operations, including its research and development, which often leads to overly optimistic profit predictions and, subsequently, disappointing economic results. Stocks, as a broad category, are more than just corporate shares – they can represent entire industries, trends, and even countries. This is not always the case, however, as many stocks are simply a representation of a single industry’s performance.

This point is particularly important when considering the unprecedented rise of the ‘micro-cap’ stocks over the past few years. It is extremely difficult to accurately predict the behavior of these stocks, as they are generally less traded and follow very specific trends, such as the performance of the Nifty microcap index, which is up 229% since March 2021.

Currency Trends Predict Stock Market Moves

Just as with stocks, the performance of different currencies can be highly unpredictable. While most people think of the dollar/yen pairing as an ‘appease’ or ‘inverse’ relationship, with the Japanese currency appreciating against the greenback, it is important to keep in mind that this is not always the case. The situation is similar with most other major currency pairs, including the Swiss franc (CHF) versus the dollar, the euro (EUR) versus the yen, and the pound (GBP) versus the dollar.

It is well-established that major currencies have significant impact on the overall performance of the stock market, with strong dollar/weak yen, for example, often resulting in higher equity prices. In fact, there are many examples of how currency changes affect the market, ranging from the Spanish property crash in the 1990s to the global financial crisis of 2008 to the present day. During these periods, it is not unusual for the dollar to appreciate against other major currencies and for stocks to rise alongside it.

Watch The Trend, Not The News

An important distinction to make is that while many people, particularly financial commentators, focus on short-term news (such as the current rate of inflation or the national debt), it is more important to look at the trend, not the news. As we’ve established, most currencies and stocks rise and fall based on broad macroeconomic trends and news events, which can be heavily influenced by short-term psychological pressures, such as fear or greed, as well as outdated information, incorrect data, and the like. All of these factors can make it very difficult to accurately predict the mood of the general population and, as a result, whether or not an economy will boom or crumble – it usually depends on a lot more than just the news.

With all of this in mind, it is important to keep in mind the following four Ps of intelligent investment:

  • Prevention
  • Prediction
  • Profit
  • Practical