May 3, 2004
It's Dark, and We're Wearing Sunglasses
John P. Hussman, Ph.D.
hussmanfunds.com
Last week, the Market Climate for stocks slipped decidedly into the most hostile condition we define – extremely unfavorable valuations, unfavorable market action, and hostile interest rate trends.
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If China tightens monetary policy (and given its strong central control, it has much more effective tools to do this than the Fed), it must also allow interest rates to rise domestically. Yet that sort of tightening is completely at odds with a policy of holding down the value of the yuan, which is already under heavy pressure to revalue. As a result, we are probably very close to the time when China will finally, and possibly abruptly, allow a revaluation of its currency. The result would not be a strengthening of the U.S. dollar, but a weakening. Nominal yields, not real ones, would be pressured higher in the U.S., because rapid accumulation of Treasury securities has been the mechanism by which the Chinese have suppressed their currency valuations and supported the dollar. Meanwhile, the rapid inflow of capital to the U.S. would be cut short, resulting in much greater weakness in gross domestic investment than the markets seem to envision.
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