How China Could Make U.S. Stocks Soar

With the debt ceiling debate still dominating the financial news, concerns about what China might do with its massive holdings of U.S. Treasury securities have faded into the background. But regardless of whether the U.S. defaults on its debt now or kicks the can down the road, one analyst thinks that China should do what millions of individual investors have done with their portfolios: gotten out of low-paying Treasuries and into U.S. stocks.

Risk-free no more
China has the largest Treasury holdings of any foreign investor, with almost $1.15 trillion as of April. Yet the emerging-market country has been willing to accept record-low yields on those investments. Even worse, with the Chinese yuan floating against the U.S. dollar, currency appreciation has more than wiped out any interest that China received on those Treasuries. The dollar has lost almost 5% of its value against the yuan in the past 12 months.

In that light, former Morgan Stanley chief Asia economist Andy Xie argues that stocks represent a much better investment for China. Although broad-market indexes haven't yet reached new highs, the total earnings of S&P 500 companies eclipsed the former 2007 record high last year, and profits are set to rise another 17% this year.

Better bets?
The funny thing is that if a now-anticipated downgrade of U.S. Treasury debt actually happens, then Treasuries would have a lower bond rating than several top-rated companies. Four companies -- Microsoft (Nasdaq: MSFT  ) , Automatic Data Processing (Nasdaq: ADP  ) , ExxonMobil (NYSE: XOM  ) , and Johnson & Johnson (NYSE: JNJ  ) -- have AAA ratings for their debt. Standard & Poor's has said that a government downgrade would force the ratings agency to reevaluate corporate debt ratings for companies that are sensitive to deep cuts in government spending, but none of these four seems at risk by that standard.

Owning corporate bonds, though, would limit China's upside just as much as owning Treasuries. By contrast, buying shares of those companies would give them income in the form of dividends, as each of those four companies has a yield of more than 2% right now. More importantly, it would also give China the potential to enjoy rising share prices.

Continuing a trend
It wouldn't be the first time that Chinese institutions have put money in U.S. stocks. Over the past couple of years, China Investment Corporation, a Chinese sovereign wealth fund, has made several big investments in North America, including in General Growth Properties (NYSE: GGP  ) , Penn West Petroleum (NYSE: PWE  ) , and Howard Hughes Corp. (NYSE: HHC  ) .

Expanding China's reach into the U.S. would certainly come at a political cost, but from an economic standpoint, it makes plenty of sense. China has sought resources around the world, and with newly discovered shale gas, extensive coal deposits, and vast agricultural wealth, the U.S. has plenty to offer the growing country.

Of course, politics does in fact play a major role in such a move. In many past instances, the U.S. government has blocked attempts by China to buy what government officials ended up claiming were strategically important assets. For instance, CNOOC, which the Chinese government owns, took huge amounts of pressure when it tried to take over California oil company Unocal. Eventually, Unocal merged with Chevron rather than trying to overcome negative sentiment.

Acknowledging what is
The reality, though, is that China already has huge influence over matters that are essential to U.S. national security interests. Its debt holdings allow it to create a financial crisis for the U.S. simply by choosing whether and how much to invest in Treasuries at any given point. It's hard to see how letting China invest freely in U.S. stocks could give it any more power.

With resource-rich economies like Canada and Australia doing well under China's influence, maybe it's our turn. By promoting U.S. stocks -- the most valuable assets the nation has to offer -- as a potential Chinese investment, investors could end up seeing their wealth soar even as the Treasury crisis reaches new heights of trouble.

If China's going to buy dividend stocks like J&J, maybe you should, too. To get 13 smart stock ideas, let the Fool send you its free special report on dividend stocks, with no further obligation.