Dollar and U.S. stock markets should fall

Note that a movement to the fixed-income side was tending to the very short end in February because of risk aversion. Purchases of longer-term notes and bonds and of Agency paper fell dramatically, in part because of the subprime flap, but also because of the universal expectation the Fed’s next move will be to cut rates, making long-term paper the unwise choice, and making the capital inflow seem “hot.”

Hot money is money that can exit on short notice. So what about the argument that other markets (such as the DAX) are rising more than the U.S. market and their currencies are rising against the dollar, too — and therefore the dollar and U.S. stock markets should fall? This is a fallacy of composition that assumes the size of the pie is fixed. That one is rising doesn’t mean the other must fall when the
total amount available is rising.

The allocation is dynamic, and in other ways, too. At some point, the one that is rising relatively less will start looking good compared to the one that has just become fully priced. So far, the yen may be the key to the Japanese stock market, but the U.S. dollar is not the key to U.S. stocks — although the time may come when it will pay to be aware of the long-term trend away from U.S. leadership in global equity markets and the threat of diversification.

When you read a press report that U.S. stocks are going to fall because of the dollar, or the dollar is going to fall because of falling U.S. stocks, take it with a grain of salt, or maybe a spoonful. When it comes to intermarket relationships, it pays to be skeptical.