How China Could Wreak Havoc On Stocks?
This shouldn’t come as a shock. But the American public loves Donald Trump. It’s why he got into office in the first place.
And I must admit, there’s something very alluring about Donald. Whether you agree with him or not, he says what he thinks.
Yes, he spends a little too much time on Twitter. And yes, he tends to take comments a little too personally.
But it does seem that he genuinely cares about the American people.
What you might not know is that ‘Strong Donald’ even has fans in China. Each time he lands in China, legions of admirers come to see the straight-talking politician.
But Donald’s ‘American First’ mentality hasn’t won many points with China’s leaders.
This is not to say Donald doesn’t get along with China’s president Xi Jinping. But on certain issues, the two don’t see eye to eye.
And if push comes to shove, it’s within China’s power to wreak havoc on the US economy, spreading panic among investors worldwide.
Steady as she goes
At the start of last year, everyone was happy. Analysts were predicting another stellar year for stocks.
Their tune quickly changed as soon as stock prices fell.
Clearly most analysts are just following the herd. Doing otherwise would leave them exposed if they’re wrong. So they stick close to one another.
You can thank bond yields for the recent stock declines around the world.
While they might not be the most exciting topic, bonds are incredibly important. That’s because they offer a fairly secure return — the AAA bonds do, at least.
So if you know you can get a guaranteed 3% return on your money in bonds, the only reason you’d be in stocks, real estate or cryptos is because you think you can do a lot better.
For a long time, bond yields were declining. Central bankers were buying bonds (which pushed yields down) as the economy was taking a turn for the worse.
As a result, more money was pouring into the system. And because secure returns were so low for so long, investors got impatient and piled their money into alternatives, like stocks, pushing prices up.
Take the example of the US Federal Reserve. They’ve said they want to increase interest rates. All they’re waiting for is inflation to pick up.
Once inflation picks up, the Fed will slowly unload their US$4.5 trillion balance sheet, sucking money out of the system.
Of course, anyone can affect the price and yield of US bonds. Granted, they have to be big enough. But it’s usually the Fed that gets the blame for large movements in the bond market. They’re the ones with trillions to deploy. In fact, they have an unlimited supply of money to buy and sell as many bonds as they’d like.
The only thing investors are hoping for is that they don’t offload bonds too quickly. Doing so could suddenly spike bond yields, causing investors to panic and creating huge losses in other assets.
That’s why so many investors are fixated on US inflation right now.
But even if inflation rises steadily and the Fed takes the same caution with selling bonds, US bond yields might still skyrocket if China decided to do some damage.
China holds bond yields in its hands
The Fed is by far the biggest seller and buyer of US bonds.
The next biggest is China.
In 2017, China continued to increase their holdings of US bonds. The country now holds US$1.18 trillion worth of US bonds and notes.
Bloomberg wrote last week:
‘China remains the largest non-U.S. holder of debt followed by Japan, whose holdings fell for the fifth straight month in December, to $1.06 trillion after ending 2016 at $1.09 trillion.
‘China’s Treasury holdings are coming under extra scrutiny after a signal earlier this year that America’s largest creditor may be easing bond-buying amid rising trade tensions.’
It’s still not clear if China will start selling US bonds. In fact, it could be that China can’t help but buy more US bonds.
As an exporting nation, China earns hundreds of billions in foreign currency, particularly US dollars. Over time, they’ve piled up trillions in USD.
What can they do with all these dollars?
Well, the only market liquid enough to take such sums is the US bond market. So it’s easy for China to simply trade piles of US dollars for long-dated, low-yielding US bonds.
It wouldn’t be that hard to imagine China offloading debt to stick it to the US if their relationship breaks down.
While it’s been labelled as ‘fake news’, last month stories circulated surrounding China potentially slowing or even halting US bond purchases.
‘The Chinese officials didn’t specify why trade tensions would spur a cutback in Treasuries purchases, though foreign holdings of U.S. securities have sometimes been a geopolitical football in the past.
‘The strategies discussed in the review don’t concern daily purchases and sales, said the people.
‘The officials recommended that the nation closely watch factors such as the outlook for supply of U.S. government debt, along with political developments including trade disputes between the world’s two biggest economies when deciding whether to cut some Treasury holdings, the people said.’
And while it could be untrue, I wouldn’t put it past China to accept losses and show the US who the real economic superpower is if push comes to shove.
So what can you do if the second largest US bondholder goes haywire?
Reduce losses as much as possible
Reduce losses as much as possible.
It’s probably one of the most important rules when investing. It’s why Warren Buffett only has two rules:
- Don’t lose money.
- Don’t forget rule #1.
And that’s exactly what you should try to do if US bonds rise dramatically — try to reduce losses as much as possible.
This might mean selling a portion of your holdings now and waiting for stocks to decline further from here.
Asset managers around the world are looking forward to higher bond yields. For many of them, higher yields can’t come quickly enough.
As uncertainty and volatility kicks up, this is really the time for stock pickers to shine.
It’s time for you to shore up some cash to profit from the bargains to come.
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