China’s Financial Sabotage
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Bullish seasonal trends brought no immediate relief. At its worst point, the S&P 500 fell another 2%.
And amid the bloodshed, a culprit quickly emerged: spiking bond yields.
The 10-year U.S. Treasury yield (blue line below) climbed to the highest rate since 2007… continuing a trend change four decades in the making.
(More on this chart at the end of today’s essay.)
When yields spike like this, it wreaks havoc on equity and debt portfolios alike. High, risk-free yields give investors little incentive to hold stocks. And long-dated Treasuries bought at all-time-low yields are sinking even deeper underwater.
However there’s another, hidden culprit behind the last couple months of falling stock prices…
This is just one of many factors causing volatility. But it’s far and away the most nefarious.
I’m talking about the biggest threat to America’s place on the world stage… its currency… and even its way of life.
Of course, I’m talking about China. But I’m focusing on the $40 billion in U.S. Treasuries it’s sold in the last six months, the $300 billion it’s sold since 2021… And most importantly, what you should do today to prepare for what could come next.
China’s Debt PurgeFirst, let’s take a look at the long-term chart of China’s Treasury holdings…
As you can see in the chart above, after a significant ramp-up from 2000 to 2011, China has slowly offloaded its U.S. Treasury holdings by about $500 billion. Being the second-largest foreign holder of Treasuries, this shift is significant.
But notice, the line steepens from January 2021 onward. More than half of China’s Treasury sales have occurred in just the last two years.
The reason for this is complex. Some evidence suggests China is attempting to distance itself from the West, both politically and economically.
After Russia’s invasion of Ukraine and the resulting sanctions from the West on Russia’s economy, there was a huge ramp-up in Russian trade with China. That could lead to a firmer alliance between America’s two biggest rivals. And that would be a big step toward making China’s currency, the yuan, a formidable competitor to the U.S. dollar.
This isn’t the only reason China’s selling Treasuries, of course. China’s slowing economy is driving capital out of the country, and that’s forcing drastic measures to dull the pain. Selling Treasuries in a prevent the yuan from deteriorating too quickly against the dollar.
That doesn’t seem to be working. The chart below shows the dollar is stronger against the yuan than it has been in 15 years.
But whatever the reason, there’s no doubt that China dumping U.S. Treasuries is adding to U.S. investor pain. China represents over 11% of the foreign Treasury market. The more it sells, the more kindling gets thrown on the raging yield fire… which will continue to weigh on stock prices.
But let’s zoom out for a moment and take a wide view of what a higher-yield world really looks like.
A New EraI want to return to that chart of 10-year Treasury yields from the beginning of this piece. Here it is again…
I told my colleagues here at TradeSmith last week that this could be the chart of the decade, and I stand by that.
This single chart may represent the ultimate trend change of our lifetimes. It could mark a new financial era that will look entirely different from what we’re used to.
In short, 40 years of low interest rates and low inflation could soon be replaced with just the opposite. This would invalidate the playbook that investors the world over have relied on for just as long.
Everything you learned about investing would change.
It would require a complete reframing of how we look at financial assets. Investor behavior would have to change, too.
This environment would urge a much harder look at what sort of assets are actually worthy of investment. And it would be the starting gun in a mad dash toward safe, inflation-beating yield as a larger overall chunk of an investor’s portfolio.
And yes, a change in the global reserve currency, possibly ceding to China, is not off the table.
All these changes, and many more, are what this simple change in trend implies.
I, along with everyone here at TradeSmith, aim to help you prepare for these changes in every way we can. And should none of it occur… it’s all the same to us. End of the day, your wealth and prosperity are our top priority.
As an investor, you must be mindful of how these forces affect the broad market. And since the broad market benchmarks are heavily weighted toward the largest-cap stocks, you should consider very carefully how much of your portfolio is allocated to them.
With yields high and climbing, it’s become more important than at any time of the past half-century to focus on healthy, capital-efficient businesses that pay a strong and growing dividend. Rate-sensitive sectors, like tech and other growth sectors like crypto, could face headwinds in this environment.
Stocks that present a good value, with a price-to-earnings ratio relatively cheap compared to their industry peers, are a key filter of where you should place your chips right now.
Of course, we at TradeSmith are here to help you find stocks just like these… and use trading strategies to help you grow and protect your capital under any market environment.