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Trade War Escalates

Written by Briton Ryle
Posted October 8, 2018 at 3:23PM

If you were walking the streets of Memphis around 750 BC, during the 25th Egyptian Dynasty, and you asked somebody how the world came to be, that person might've told you that the god of craftsmanship had the ability to not only envision a perfectly crafted finished product but also call it into being. 

And so the world came into being as Ptah imagined things...

If you asked a Cherokee, he or she might've told you that in the beginning, there was only sky and water. One day, the water beetle that lived in the sky wondered what was below the water, so it dove in. After swimming around for a bit, the beetle grew tired and wanted a place to rest. So it brought mud up from the bottom of the water and built an island to rest on.

Creation myths are common across cultures and eras. All cultures have come up with some kind of story of how the world came to be. Because we humans have this burning desire to know why. Why did that happen? Why does this exist? 

It's never enough for something to just exist or happen. We've got to have a reason. Even a completely fabricated, nonsensical explanation seems to satisfy the need to “know.”

That's what I was thinking when I read the Bloomberg headline: “Bond Tumult to Hit Last Stock Market Pillar, Morgan Stanley Says.”

The gist of the article is that rising interest rates for bonds provide competition for stocks in terms of returns. Why take on the risk of owning Pfizer and its 3% dividend when you can get that same 3% from a 10-year Treasury bond? After all, the U.S. is not in any danger of failing a drug trial with the FDA...

There's a certain logic to this idea. And it even makes pretty good investment sense, at least if you don't think about it too much...

Bonds Won't Make You Rich

Morgan Stanley's chief U.S. equity strategist, Mike Wilson, wrote: “Given their lack of dividends and high valuations, high-flying growth stocks are arguably the longest-duration assets in the world... Therefore, it’s perfectly reasonable that they would eventually succumb to rising rates.”

Let me say this as simply and directly as I can: Stocks are not selling off because yields are rising.

There's no growth for bonds. They won't grow revenues over time. They won't raise their dividends (except in relation to a drop in price). Bonds are not going to make you rich. If Warren Buffett had bought nothing but bonds over his long career, he wouldn't be among the richest people in the world.

Bonds are just a loan. And when you buy a bond, you get the yield you get. If you're worth millions, then sure, lending a chunk and making 3% or 4% is a fine way to go. But for most of us, that 3% or 4% is never going to amount to much.

So why does Wall Street continue to pitch bonds as some kind of alternative to stocks? Glad you asked...

I think Wall Street uses bond yields as a kind of shorthand. Instead of saying, “Economic and/or stock market risk is rising,” they just say, “Yields are rising.”

Ultimately, it's the same thing. The truth is, the Fed's interest rate hikes don't have much of an effect on bond yields. Sometimes yields will actually drop after the Fed lays down a quarter-point hike. The reason yields rise is because economic risks are rising. 

Think about a bank offering a mortgage loan today. Wages are only rising moderately, but home prices are rising kind of a lot. The house you wanna buy is expensive, and you're not likely to be making a whole lot more money in the future. Is that an ideal scenario for a bank to lend you money? Not really...

But of course, everything has a price. There's always some rate at which the bank will be happy to loan you some money.

Right now, yields are rising for the same reason stocks are falling. It's because “economic and/or stock market risk is rising.”

Yep, Another Trade War Article...

Yeah, stocks are a little expensive. Sure, Italy's debt scenario is dicey. Fine, emerging markets have too much dollar-denominated debt...

But can any of these things lead to people buying fewer iPhones? 

Ehhh, not really. But there is one little thing that could make people buy fewer iPhones. One scenario where Apple misses earnings. Could it be... China???

It hasn't happened yet. And really, so far, it seems like China has been making a concerted effort to keep its share of the trade war off the companies that do a lot of business in China. It's easy to see why. China likes the investment that U.S. companies make there. They like the technology that gets shared... and stolen. 

But did you catch any part of Vice President Pence's speech on China last week? Wow. He basically called them criminals. And while he's pretty much right in many regards, this was not a diplomatic speech. Its goal was not to get China to come to the table and negotiate a deal. Pence's speech wasn't a jab. It was an uppercut. A verbal haymaker designed to knock the opponent out. Because this is a fight, a war. One the administration thinks it can win.  

After that speech, investors are now wondering how many times Trump & Co. can whack the hornet's nest before the bees come swarming out for a real counterattack.  

That's the worry for Apple. iPhone sales in North America and Europe are basically stable. Apple depends on China for growth. Same for Starbucks and GM. And if China's government decides to change course and unleash its citizens' boycott power on U.S. companies that do business there, Apple's share price can get crushed...

And if iPhones sales weaken, it's not just the semiconductor companies that will suffer. Think about all the pension funds that would suffer. Think about all the S&P 500 Index funds investors have been pouring money into. Think about poor Warren Buffett dropping a few spots on the world's richest list! The horror!

I know, I have a hard time going full-on doom and gloom. I always have to ruin it with some dumb joke.

But seriously, this trade war is about much more than the prices on a few goods. And this stock market sell-off is about much more than bond yields.

Time for Downside Profits?

Every bull market eventually hits the point where there is big money to be made in the downside. It seems to me this one is now one step closer to that point. Morgan Stanley pretty much just threw in the towel...

I haven't rolled out the downside trades to my Real Income Trader members just yet. Oh, I've got the trades lined up and ready to roll; I'm just waiting for one more thing to happen...

When we get the green light and the real trade war sell-off starts, nailing winning trades is gonna be like shooting fish in a barrel. Here's how you can join in.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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