Grow Your Portfolio the Intelligent Way

Paying Tribute to a Great American Educator

If you grew up in the 1970s or 1980s, or if you raised children during that period, you probably know all about “Schoolhouse Rock.”

I know as a child growing up in the post-Nixon-turmoil era, I learned a lot about how government works by watching the Saturday morning television hits, including “I’m Just a Bill” and “The Preamble.” I also learned how math works: “Three Is a Magic Number” and “Ready or Not Here I Come.”

Yet my favorite “Schoolhouse Rock” episode is “Conjunction Junction.”

Not only did the jazz/blues-driven tune teach me all about a part of speech, BUT it did so in a fun AND memorable fashion AND it helped me put together sentences as a youth. Neither dull NOR boring, “Schoolhouse Rock” was the bridge between often-boring learning at school AND fun learning at home OR at a childhood friend’s house.

If you know the melody, I doubt you’ll be able to read the following lyrics without humming along:

Conjunction Junction, what’s your function?

Hooking up two boxcars and making ’em run right.

Milk and honey, bread and butter, peas and rice.

Hey that’s nice!

On Saturday mornings, the three-minute long Emmy Award-winning musical vignettes of “Schoolhouse Rock” (1972-85) educated children about math, grammar, science, history and finance. Tom Yohe and George Newall were the original creative forces of the series. 

Credit: ABC PHOTO ARCHIVES ©1979 American Broadcasting Companies, Inc. 

I bring this subject up because on Monday, the world lost Bob Dorough, the creative force behind “Schoolhouse Rock.”

Dorough wrote the music and the lyrics for most of the episodes, including all of the multiplication series, my cherished “Conjunction Junction” and one of my other favorites, “Lolly, Lolly, Lolly Get Your Adverbs Here.” The pianist and composer died April 23 at his home in Mount Bethel, PA. He was 94.

While I didn’t know Bob Dorough personally, his work touched my life, as it touched the lives of countless others in my demographic and far beyond.

The way I see it, when someone who touches your life dies, I think we owe it to their memory, and to ourselves, to acknowledge their importance. Doing so connects us with each other and with ourselves and our place in the world. And though I felt sad to hear about Dorough’s death, I also felt a profound sense of gratitude for what he gave me.

What he gave me, and what he gave the rest of the world, was the mental stimulation needed to discover, learn and think about different aspects of reality in a fun, accessible and eminently memorable way.

It is for this achievement that I think we should celebrate Bob Dorough, as well as the other composers who worked on “Schoolhouse Rock,” as truly great American educators. By doing so, we can let the rest of the world know how important the role of a truly good educator is and how much inspiration they can provide.

On a personal level, I like to take the approach that learning about markets, the economy and the virtue of capitalism and its philosophic underpinnings should be a fun journey into this corner of reality.

That’s why you often will see my writing infused with song lyrics, quotes from great literature and quotes from philosophers, poets and even pop culture figures. It is the integration of these various elements that help to make the sometimes-arcane details of fundamental and technical equity analysis both understandable and entertaining.

In some ways, you might say I try to pay tribute to Bob Dorough in everything I write in my e-letter, articles and my investment advisory newsletters, all of which can be found at www.JimWoodsInvesting.com.

So, if you want to be reminded of just how fun education can be, or if you just want to spend a few minutes putting a smile on your face, then do yourself a favor and watch a few “Schoolhouse Rock” episodes.

Not only will it send you back to your youth, it will help you celebrate the achievement of a great American educator.

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ETF Talk: Leveraged Inverse Fund Profits If the Dollar Rises and the Euro Falls

Investors interested in protecting their assets during volatile market conditions may want to look at currency-based exchange-traded funds (ETFs), such as ProShares UltraShort Euro (EUO).

EUO is more than just a short investment that bets against the rise of the euro. It is correlated with twice the inverse of the performance of the euro against the dollar, so if the euro/dollar balance shifts in favor of the dollar and the euro falls in value, the fund is intended to produce positive returns equal to twice the magnitude of the change.

For investors confident the euro will go down, this investment could be lucrative. In general, leveraged ETFs like this one are intended as short-term trades. Since the euro vs. dollar is a zero-sum game, any thought of holding this fund for the long haul might be unwise, especially since it is a leveraged fund that is designed to move twice as much as with an unleveraged trade.

Keep in mind that the pricing of this fund will be affected by the value of the dollar. As a result, if the euro were to weaken, compared to a basket of global currencies, but the dollar did as well, this fund would produce flat returns.

The euro has performed well compared to the dollar during the most recent 12 months, so EUO has fallen by about 20% in that time. The fund currently is priced a few percentage points above its 52-week low and its expense ratio is 0.95%.

The ProShares fund company cautions that due to the compounding of daily returns, EUO’s returns over periods other than one day likely will differ in amount and possibly direction from the target return for the same period. These effects may be more pronounced in funds with larger or inverse multiples, such as EUO, and in funds with volatile benchmarks. ProShares recommends that investors should monitor their holdings in its funds as frequently as daily. 

For investors looking for a way to profit from short-term swings in currency values, ProShares UltraShort Euro (EUO) could be worth including as an investment that is not dependent on the rise of the stock market to produce a profit.

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In Search of the Bull’s Demise

I read a whole lot of analysis about the market every week. Lately, much of that analysis has been overwhelmingly bearish. In fact, I’ve read more bearish analysis over the past couple of months than I’ve read over the past two years.

This makes sense, of course, given the swoon in stocks and the ramped-up volatility that has slammed markets in Q1. So, what’s at the core of this bearish thesis? What is the main thread these analyses have in common, and how should investors look at it?

To answer those questions, I’ve enlisted the help of my favorite macro analyst, Tom Essaye, Editor of the Sevens Report. The following guest editorial was written by Tom and edited by me for this publication.

When Will the Fed End the Bull Market?
By Tom Essaye

There’s been a lot of bearish analysis coming my way of late. Most of that analysis assumes that the yield curve is telling us the Fed is about to commit a “policy mistake” and choke off the recovery — and end this bull market.

Now, in general, I agree. At some point, the Fed will hike rates too high (like they always do), and that will choke off the expansion (like it always does) and end the bull market. But what all this bearish research I’ve been reading has been missing is a compelling answer to the question of when this will happen. Most of the research says it’s soon, but none of it does a good job of backing up that assertion with facts.

So, lacking that answer, I went in search of it, and the historical truths I found about curve inversions and the end of bull markets was surprising — and it universally implies that while this bull market may end for any number of reasons in the short term, history strongly suggests that it will not be because of a “Fed policy mistake” or an inverted yield curve (at least not in the near term).

Before I get into my findings, I want to be clear that yield curve inversions have a perfect history of predicting recessions, and they are signals that should be heeded by all investors. However, knowing the yield curve is forecasting a recession isn’t the hard part.

The hard part is knowing when to get out of the stock market, and that’s what I’m trying to address here, because history shows us that the penalty for getting out too early is very stiff in the form of missed returns (e.g. 1998, 2004/2005).

Fed “Policy Mistake” Fact One: Yield curve inversions don’t mean immediate ends to rallies. On average (going back to 1980), the S&P 500 peaks 10 months after the yield curve first inverts. The shortest period of inversion to peak was three months (1980-1981) while the longest period of inversion to peak was 19 months (1988-1990). The yield curve hasn’t even inverted yet, so based on this historical precedent, the proverbial “end-of-the-rally” clock isn’t even ticking yet.

Yield Curve Inversion Fact Two: There has never been an economic downturn when real interest rates are negative. Right now, real interest rates are still negative. Real interest rates are the Fed funds rate (currently 1.625%) minus the year-over-year core Consumer Price Index (CPI) rate (currently 2.10%). So, 1.625% – 2.10% = -0.475%. Takeaway: The fact that rates are negative strongly implies that the Fed has not raised rates too far.

In fact, according to some JPM research I was sent, there has never been an economic downturn started when real rates were below 1.8%. Now, I admit that we’ve also never come out of a near decade of 0% rates, so perhaps that 1.8% will be lower this time. But the point still is that based on historical metrics, the Fed is not close to hiking rates “too much,” and thus halting the recovery.

Yield Curve Inversion Fact Three: The S&P 500 has rallied in every rate hike cycle since 1980 (where I stopped my research). The smallest gain over those hiking cycles was 4% on three separate occasions (’80/’81, ’94/’95, ’99/’00). The biggest return is this current cycle, 29% from December ’15. Clearly, that corresponds to the pace of which rates are being raised (the more quickly rates rise, the lower the returns for stocks).

So, this research implies that, on a very simple level, equity investors should remain fully allocated until the first “Fed pause” that signals the end of the hiking cycle and, barring a big surprise, we’re not close to that.

Now, knowing that inverted yield curves signal a looming recession isn’t the hard part. The hard part is knowing when to get out of equities and when to get more defensive, and that’s the answer I’m trying to find here.

Going forward, based on my analysis, I am looking for three specific signals to tell us when it’s time to get out of stocks (for medium- and longer-term investors):

  • Positive Real Interest Rates (the closer to 1.8% the more cautious)
  • An actual yield curve inversion (that starts the clock)
  • The first “pause” on the rate-hike parade

Those three signals (generally speaking) should, according to history, tell us when it is time to prepare for a bear market in stocks — and none of those indicators have been elected at this point (or are close to being elected).

Finally, I believe my research only demonstrates that a Fed policy mistake/inverted curve won’t end this rally near term. That does not, however, mean something else can’t end it, including trade wars, military conflicts, political disasters, etc. So, I will remain vigilant to any macro threats, but for now, a Fed policy mistake/inverted curve is not a near-term concern.

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On the Fruit of Knowledge

“The roots of education are bitter, but the fruit is sweet.”

— Aristotle

Although always wise in his observations, it’s interesting to ponder whether Aristotle’s theory of education might have been a bit different had he grown up with “Schoolhouse Rock.”

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.

 

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