News of progress in negotiations between China and the United States, as well as a temporary reduction in tariffs imposed by each country, has rapidly shifted the sentiment in global markets.
But negotiations are a delicate process, and it’s important not to become complacent.
So, how can we continue to protect assets through portfolio rebalancing, remain alert to new trading opportunities, and where should our focus lie?
International investors will be important at the margin since they account for 18% of U.S. stock ownership.
As will be the strength of the U.S. dollar, which has retreated 5% in the last six months and has led to an emerging premium for U.S. bonds (thus commanding higher yields and potentially leading to higher interest rates).
But, at least in the short term, the tarnish on America’s reputation is unlikely to threaten the greenback’s reserve currency status since central banks hold almost $7 trillion worth of dollars in reserve, almost three times as much as euros.
Furthermore, the $28 trillion Treasury market is the world’s largest and most liquid. In comparison, there are only $1.4 trillion in German government bonds outstanding.
How the U.S.-China tariffs work out this year is the million-dollar question.
Both sides have come to the negotiating table, and both have significant leverage.
But negotiations will likely take time, and even with concessions, there will be considerable collateral damage and trading opportunities.
One likely group that will suffer is American multinationals. A considerable number of these consumer giants, such as Nike (NKE), Tesla (TLSA), Intel (INTC) and Starbucks (SBUX) have over 20% of sales revenue coming from China.
The American market represents only about 14% of Chinese exports, and China’s roughly $20 trillion economy will be hurt but able to adjust to a loss of some of the $550 billion in exports it sent to the U.S. last year.
Chinese stocks are outperforming this year, and many have little international exposure, such as Luckin Coffee (LKNCY) and Chinese automakers, which sell virtually no cars in the United States.
Financial service companies will also likely avoid tariff issues such as American Express (AMEX) and Visa (V).
What cards can China play in this high-stakes diplomatic poker game?
China’s central bank holds roughly $760 billion in U.S. Treasuries.
China has some $6 trillion of foreign exchange assets, if you include the holdings of state-owned banks.
As it did with Boeing (BA) before reversing course earlier this month, China can place American companies on restricted lists or order that Chinese companies not receive goods or services.
China can also push back by restricting highly valuable commodities like rare earths, threatening critical inputs for American military hardware.
According to the Defense Department, an F-35 fighter contains around 900 pounds of rare earth materials, and strategic submarines need more than 9,200 pounds.
Given the sensitivity of negotiations and their critical importance to U.S. military capabilities, I’ve recently added a position in Cabot Explorer that will benefit from intense U.S. efforts to become more independent in strategic materials such as rare earth processing. To learn about that company, subscribe to Cabot Explorer today.
