When a currency is devalued how does it affect different investment classes (stocks, commodities, bonds,etc.)?

Sensei answered 10 months ago …

To answer this question you have to ask, "Devalued relative to what?" International commerce is affected by currency valuation but local transactions are unaffected. So, to the extent that you're only dealing with local product, devaluation should have no affect. The problem is that there is almost nothing you buy that doesn't have a foreign component in it. In other words, the affect of currency devaluation on any item is dependent on the foreign component.

For stocks, if XYZ is trading on the NYSE at $10, the devaluation of the US dollar will have no affect on the stock price if it is a purely domestic enterprise.

If it is a significant importer of its raw materials, its stock price will suffer. Why? Because its costs of production are increasing (since it needs more US dollars to buy the same quantity of raw material) while its revenues may be stagnant (if it cannot pass those costs on to its customers.) This will lower its profitability and consequently its share price.

If it is an exporter, its stock price should go up. Why? Because its revenues in foreign currency (say, the Euro) will generate more in terms of the local currency (the US dollar), thereby producing more "bottom line". Up here in the "frozen North", Canadian manufacturers were squawking for months over the increasing value of the Canadian dollar vs the US dollar (to over $1.07 at one point.) Most of our exports went to the US and those Canadian companies' revenues fell because they couldn't obtain the favourable foreign exchange conversion they were able to get when our dollar was only worth 62 US cents. (Yes, this is a temporary matter, but the fundamental issue remains.)

From a foreigner's perspective however, the situation is much different. That person is looking at the stock price relative to his currency. If XYZ costs him 7 Euro, he doesn't care what the US quote is. His only interest is, once he sells the stock, will he get back more or fewer Euro? In the case of an importing company, the stock price will fall in US funds, creating a loss. Worse for him because each US dollar is worth less in terms of the Euro. So he gets a "double whammy".

For example, assume a 10% devaluation of the US dollar against the Euro. He pays 7 Euro for a US$10 stock. The stock falls to $5. Had the dollar remained constant, he'd get back 3.5 Euro. But because of the devaluation, he'll only get back 3.15 Euro.

But if the company is an exporter, its rising profits (from the foreign exchange gains) will increase its bottom line and its stock price. If the stock price rises enough, the foreign investor may be able to overcome his foreign exchange loss when he converts his US dollar proceeds back to Euro. Using our previous example, if the stock price goes from $10 to $15, even after the devaluation, he'd get back about 9.45 Euro (instead of the 10.5 Euro he'd have gotten without the devaluation.)

With commodities, again, it depends. The US dollar is the world's "standard". Say a pound of commodity X costs $10. That's going to equate to 7 Euro (in our example.) If the US dollar is devalued by 10%, X will now cost $11. Does that make it more expensive? It depends. If you live in the US, the answer is, yes. 10% more expensive. But in Euro? It still costs 7 Euro a pound. So, when a currency is devalued, what happens to the price of commodities? It depends on whose currency is being devalued relative to whose.

Bonds are a different matter. A devaluation of the currency may signal to investors that the issuer may default on the debt, thereby increasing the perceived risk and forcing the price down.

On the other hand, countries can issue debt in any currency denomination they like. Israel, for example issues its debt in US dollars. So, if you see little risk in Israeli debt (and they have never defaulted on their debt - they have an AAA rating), if the US dollar was devalued relative to Israel's currency, its price would go up. Why? Because the lower risk would translate into higher prices in US dollars. Moreover, it is easier for the Israeli government to repay the debt because it takes fewer shekels to buy a dollar for repayment, thereby reducing the risk of default even further. So, while the value of US bonds would go down, the value of Israeli bonds denominated in US dollars would go up.

So, what happens to bonds on a currency devaluation? It depends on who the issuer is. But if it is the local issuer (the USA) issuing bonds denominated in local currency (US dollars), the value of those bonds will be discounted before maturity.