Archives For February 2009

I sent the following email to one of my favorite authors, asking for an interview opportunity:

Mr. _________,

I have been a fan of your work for many years now. I was wondering if I could do a short email interview with you regarding the current economy and how people can cope with facing a layoff. If I sent you several questions, would you be able to answer them so that I could post them on my blog, I have done similar interviews with Larry Winget and other book authors. I would appreciate your help.


Jeffrey Pritchard – a personal finance blog

This was the response I got back (a week later):

Thank you, Jeffrey,

I don’t do interviews like this. They are not a good use of time for me.

Why don’t you read my latest book, “____________” and use that material for your blog.

Good luck!

I was disappointed. Not from the “no” answer but from the thought that such an interview on my blog is not a good use of his time. How could he possibly know that? I don’t have a huge readership but I’m not small either. What if just one reader read the interview, bought his book(s), became a fan, and told his friends about this guy? Would that be a “good use” of his time? Obviously he doesn’t understand the world of blogging and the power of word-of-mouth.

I would have much rather him responded with a simple, “Thanks for your interest but I don’t do interviews.” To me, that would have been the appropriate thing to do.

What do you guys think? Am I being too touchy? I asked my brother (who is also a big fan of this guy) his thoughts and he agreed with me.

There’s a new commission report (study) out about Americans and their driving. From the Wall Street Journal:

The government should make it a lot more expensive for Americans to drive and should install devices in cars that levy a fee for every mile traveled, according to a report being released Thursday by a congressionally chartered commission.

Among the proposals: raising the 18.4 cents-a-gallon federal gasoline tax by 10 cents, or 54%, and then indexing future increases to inflation. The study estimates that would cost American households about $9 more a month. The plan also calls for adding 15 cents a gallon to the 24.4 cents-a-gallon tax on diesel fuel.

Longer term, the study calls for shifting away by 2020 from a fuel-tax system to a technology-enabled system that levies taxes based on how many miles people drive.

I don’t know about you guys but last idea just gives me the creeps—a little too big-brotherish in my opinion. I like the per gallon gas tax better. At least with the per gallon tax, you can control it somewhat by buying a more fuel-efficient car. A miles driven tax would ruin that. Plus, I think it penalizes people who live in the country or parts of the country where driving is a necessity. I would be interested to know how much driving the people on the commission do.

I think if they want to do something like this then they should also tax taxi customers per mile and people who ride buses and subways. I mean let’s REALLY make it “fair.”

I just read an interesting piece by Jeremy Siegel that explains Standard & Poor’s methodology for calculating the earnings for the S&P 500 Index. The S&P 500 Index is a market-weighted index, which means that larger companies (based on market value) are a larger percentage of the index. However, as Dr. Siegel points out in his article, S&P does not account for earnings on a weighted basis:

Unlike their calculation of returns, S&P adds together, dollar for dollar, the large losses of a few firms to the profits of healthy firms without any regard to the market weight of the firm in the S&P 500. If they instead weight each firm’s earnings by its relative market weight, identical to how they calculate returns on the S&P 500, the earnings picture becomes far brighter.

A simple example can illustrate S&P’s error. Suppose on a given day the only price changes in the S&P 500 are that the largest stock, Exxon-Mobil, rose 10% in price and the smallest stock, Jones Apparel Group, fell 10%. Would S&P report that the S&P 500 was unchanged that day? Of course not. Exxon-Mobil has a market weight of over 5% in the S&P 500, while the weight of Jones Apparel is less than .04%, so that the return on Exxon-Mobil is weighted 1,381 times the return on Jones Apparel. In fact, a 10% rise in Exxon-Mobil’s price would boost the S&P 500 by 4.64 index points, while the same fall in Jones Apparel would have no impact since the change is far less than the one-hundredth of one point to which the index is routinely rounded.

Yet when S&P calculates earnings, these market weights are ignored. If, for example, Exxon-Mobil earned $10 billion while Jones Apparel lost $10 billion, S&P would simply add these earnings together to compute the aggregate earnings of its index, ignoring the vast discrepancy in the relative weights on these firms. Although the average investor holds 1,381 times as much stock in Exxon-Mobil as in Jones Apparel, S&P would say that that portfolio has no earnings and hence an “infinite” P/E ratio. These incorrect calculations are producing an extraordinarily low reported level of earnings, high P/E ratios, and the reported fourth-quarter “loss.”

I never thought about this before but Dr. Siegel’s way does seem to make more sense. Maybe they should do both—a market-weighted earnings and P/E ratio and a standard earnings and P/E ratio.

Although stocks seem cheap right now on a P/E basis, they won’t be as cheap if earnings continue to fall. For example:

Say you have a company that is trading at $20 per share and earns $2 per share, giving the stock a P/E of 10. Then lets say this company’s earnings drop 25% to $1.50 per share. If the stock price remains at $20 per share (it most likely wouldn’t if its earning dropped 25% but this is an example), its P/E would now be 13.3 or roughly 33% higher. Remember, the way to think of P/E is the price you pay for each dollar of a company’s earnings. So, with earnings of $2 per share and a $20 stock, you are essentially paying $10 for each dollar of earnings. Now that the earnings are lower, you are paying $13.33 for each dollar of earnings.

There’s no doubt that stocks look a lot cheaper than they have in the past but there are still risks out there. That’s why I think the best thing to do in this market is to dollar-cost average.

Your thoughts on Jeremy Siegel’s thoughts?

I saw this post over on the FatWallet forums:

I recently read a thread about a person wanting to purchase a home. Almost all of the posters told the OP he was not financially ready. This made me wonder what everyone thinks of my situation, as I am under contract to purchase my first home.

My info:
27 yrs old
Credit score of 780
employed as an engineer
$53,000 annual salary
Take home pay is about $1200 every two weeks, contributing 15% to 401k
approximately $50,000 cash
$3,000 Stocks
$19,000 401k
$0 credit card debt
only debt is $24,000 on truck with payment of $453. Trucks value is about $30k
Currently living rent free with parents ( this needs to change )
Purchase price of home: $130K
20% down so loan amount is $104k
Mortgage payment will be about $580
Taxes are $1700/ yr
I also have several thousand dollars in other easy to sell items such as silver, guns, and ammo.

Here’s a link to the thread.

Wouldn’t it be nice if everyone was this prepared when they bought a house?

According to my math, his house payment plus taxes equal about 30% of his take home pay. This is reasonable and should become a smaller percentage of his net pay due to future raises. Not a bad starting point.

The only thing that sticks out to me is the that the mortgage payment and the truck note will take up 43% of his take home pay, which seems like a lot. He’s fortunate that he will have a nice cash cushion of $24,000 when he moves into his house ($50,000 – $26,000 downpayment). Let’s hope he doesn’t have to eat through it as he adjusts to homeownership. Trust me, there will be lots of unexpected expenses popping up.

I wish him well.

Remember the other day when I posted about Sam Stovall’s book, , and his 7 rules of investing? At the time I wrote that post, I had not yet seen his book. Well, yesterday I read browsed through the book at Barnes & Noble and got some clarification on his point number 2, which was “As goes January, so goes the year.”

I had originally assumed that Stovall meant the market’s January performance was a good barometer for the rest of the year. That doesn’t appear to be the case—at least not from my experience. Well, it turns out that Stovall does not say that in his book. Instead, he says that the performance of the sectors of the S&P 500 Index during the month of January is a good predictor for the year’s market performance. (NOTE: I did not purchase the book so I’m going from memory here.) He then went on to explain that purchasing exchange-traded funds of the three best-performing sectors of the S&P 500 during the month of January and holding them the rest of the year, the investor stands a good chance of beating the market.

That may be true, but…

It didn’t work last year. Check this out:

The three best-performing sectors of the S&P 500 Index during the month of January, 2008 were:

S&P Sector Performance - January 2008

Now here’s how those same sectors performed the following eleven months ranked in order of performance (not including dividends):

S&P 500 Sector Performance - Feb - Dec 2008

Granted, Stovall does not claim that his strategy is guaranteed to work. Rather, he claims that it works more times than it does not work. Last year was just bad all around so I wouldn’t take those results too seriously. That said, I’m becoming skeptical of all these plans for “beating the market.” I write about them a lot because I like to research them and see how they work. However, even if a strategy works, once it is adopted by lots of people, it fails to work and we all start looking for the next big idea. Like Solomon says, it’s like chasing after the wind.

I plan on doing some follow-ups on the book. Even though I’m skeptical, there are some interesting things in it. I just haven’t purchased it yet and hate paying full price at the book store.

To be continued…

Okay, we have talked a lot about the current economic crisis and what caused it. Now let’s look to the future with the today’s Question of the Day:

When do you think things will return to normal?

By “normal,” I mean the economy starts growing again and people start putting money back into the stock market.

I have this nasty feeling that it’s going to be a long time before we get out of this mess. Several readers have mentioned the real threat of inflation due to the fact that our government is basically printing money in order to get stimulate the economy. That’s not good news. So my guess is that we are looking at 2-3 years before things return to normal (and that’s being optimistic).

My strategy now is to keep doing what I’m doing. Adding to our retirement accounts on a continuous basis and ignoring the account balances because all they do is make me sad.

So what about you? When do you think things will turn around? What have you heard or read?

Sam Stovall (remember him?) has writtten a book on investing titled The Seven Rules of Wall Street: Crash-Tested Investment Strategies That Beat the Market* (remember Sam?). Kiplinger’s interviewed Sam about his book and asked him about his seven rules. I haven’t read the book so I’m not sure the reasoning behind some of Sam’s points.

1. Let winners ride, but cut losers short. This is much easier said than done. Sam’s thoughts seem to go along with what James O’Shaunessy says in his books.

2. As goes January, so goes the year. Is this really true?

3. Sell in May and then walk away. If everyone does this it ceases to work.

4. There’s no free lunch on Wall Street. I’m pretty sure this has do with fees.

5. There’s always a bull market someplace. That was harder to find in 2008 as every asset class seemed to be down last year.

6. Don’t get mad, get even. The Kiplinger interview asked him about this one and this was his response:

The S&P 500 is weighted by market capitalization, meaning the larger the company, the greater the impact. With the S&P equal-weighted 500 index, every stock is equal. A portfolio based on that index, which you can construct using exchange-traded funds, gives you the safety of holding stocks of larger companies, but with the higher returns of mid-cap and small-cap indexes.

Of course the flaw with the equal-weighted index (from what I’ve read) is that it’s more expensive to maintain since there are more transactions involved with rebalancing. I think it would be better to just add a small and midcap index to S&P 500 Index or just buy the total market index (yeah, it’s still cap-weighted but has exposure to the small and midcap classes).

7. Don’t fight the Fed. I’m going to check out the book to find out what he means by this one. The Kiplinger interview is too short in my opinion.