Talking Points

One of the jobs of the financial advisor is to "see it before it becomes obvious." All too often, an investor will wait for a sign of confirmation before venturing into an investment recommendation. We have witnessed it many times. You may be familiar with the study on investor behavior that found "that while the S&P 500 has returned 8.35% over a 20 year period ending in 2008, the average equity investor earned just 1.87%, which was less than the inflation rate of 2.89%. Bond investors fared no better. They earned returns of just 0.77% compared to 7.43% for the index." [1] One of the most glaring examples of investors seeking confirmation is the fact that 85% of money invested into technology mutual funds occurred after January 1, 2000.[2] In addition to the shortcomings experienced in the financial market, it is refreshing to see that we are not alone. I recall the story of the gentleman in central Florida that discovered a 30-foot python living under his front porch. To reach the length of 30 feet, one must wonder just how long the snake had resided there and how many small animals went unnoticeably absent before the discovery was made.

An important issue that is receiving surprisingly little attention today is the campaign for China to de-link its currency from the United States dollar. Since 1997 China has received the benefit of a "linked" dollar by creating an export driven market that kept its finished goods priced artificially low to the US consumer. To maintain this link, as US consumers continue to acquire newly produced Chinese goods and pay with legal tender US dollars, China in turn had to purchase something of ours to maintain equality. As it is well documented, they are not buying very many of our manufactured goods. What they are buying is our debt. Today, China holds more US Treasuries than the US Treasury holds in US Treasuries.

In my attempt to keep the complicated less so, it should come as no surprise to anyone that China has no desire to de-link its currency and it is pretty much widely accepted that if they did it would appreciate anywhere from 25% to 40%[3] (which would have a negative effect on Chinese exports to the United States). A revalued Chinese yuan or Renminbi (the same as saying dollar or greenback, respectively) that appreciates in value (China is the only country in the world to experience GDP growth of 9%+ for over 25 years in a row - just one reason why the currency is undervalued) would make their goods more expensive to the US consumer, but more importantly, it would make US goods cheaper for the Chinese consumer. Hence, the problem. What is true for US manufactured goods will be true for their massive US Treasury holdings as well. An appreciated yuan equates to a depreciated US Treasury that is held in China. So it would make sense, if you were China and holding roughly $877 billion in US Treasuries, to unwind at least some or most of that position before you de-link your currency. And that is exactly what China has been doing. Over the past four months China has been a net seller of US Treasuries.[4]

What is "back of the newspaper" news today will be front page, mainstream news tomorrow. Our job, as stated earlier, is to see it, and make our clients aware of it, before it becomes obvious and secondly to act on the information. The fact that China is a net seller of US Treasuries and that 29% of US sovereign debt comes due in the next 12 months [5] should make all of those investing in US fixed income give pause for just a moment.

Just like the man that discovered that 30-foot python living under his front porch, one must believe that the discovery of this carnivorous reptile would have been better revealed when it was still at a more reasonable length of, let's say, 3 feet rather than 30. For grins, one has to imagine that the conversation that led to the snake's discovery went something like this:

"Honey, have you seen the dog?"

"Honey,...?"

Our job is to see it before it becomes obvious!