Friday, September 28, 2012

The Problem With Rules of Thumb

Click on the Graph for a larger view.

The problem with rules of thumb is they work thumb of the time.

Consider, one of the old rules of thumb on market evaluation is based on the Price/Earnings ratio (P/E) of the market. Historically, this number averages out around 16. If the current P/E is over this number, it is probably not a good time to buy. If the P/E ratio is lower than 16, it is a good time to buy. Some pundits extend this logic to individual stocks, although in many individual situations a P/E of 16 is not significant. Small new companies with a steep growing curve will have much higher P/E ratios. Banks and large established companies will typically have much lower P/E ratios.

In an article entitled The Rule of 20 Equity Valuation Method, Dennis Ouellet looks at a more meaningful variation on this theme. Over the past 80 years, the market P/E less the rate of inflation varies between 15% and 25%, averaging about 20%. When this number drops very far below 20%, a blind monkey could pick winners from a list of stocks. If the number gets up towards 25%, sell everything. The evidence the article presents successfully demonstrates this method produces better results than just looking at market P/E without considering the rate of inflation.

What does this method tell us about the current situation? There are some problems. Just exactly what P/E should we be looking at; the entire market, the S&P 500, or the stodgy old Dow? I would consider the Shiller P/E ratio the most useful. It is currently at 22.5. Way over 16. Less 3% inflation we are looking at a rule of 20 P/E of 19.5, a number much closer to the historic norm.

There are other rules of thumb. For example some people look at various payout numbers. The average dividend on the S&P 500 is barely over 2%, near a historic low point of just over 1% prior to the dotcom crash of 2000. The historic norm is about 3.5%. This rule tells me it is not a good time to invest. A number like this would be screaming sell, but the Federal Reserve Bank and the Treasury are dumping money into the economy at an unprecedented rate. This drives down dividends as investors turn from bonds and invest in riskier stocks for higher returns.

(The Dow Jones Industrial Payout + The Rate on 3 Month T Bills) divided by 2 is called the Payday Indicator. Currently this number is running about 1.25%. This indicator tells me it is a very bad time to do anything.

But I still have to do something. Some of my investments, such as my retirement account at work are on autopilot. Essentially, with maybe a once or twice a year tweak, I am dollar averaging over an extremely long time frame, 27 years. This seems to work OK with an age appropriate diversified mix of stock and bond funds.

Personally, I am looking at After Tax Corporate Profits as a Percentage of GDP. That number is around 8.8%, near the abnormal and probably unsustainable historic high of about one year ago, 9.8%. By the way, those numbers were read off a graph by eyeball.

Corporations have benefited from low interest rates. They have refinanced their old debt at the new lower levels, outsourced jobs to foreign countries, and invested in automation to replace their American employees. This has been very good for their bottom line, but I think that number will continue to decline. Since the price of a share of stock is ultimately based on future earnings (which are pretty difficult to predict with any accuracy) and I believe earnings are headed down, I am not buying much. As readers of this blog know, I believe age appropriate stock holdings for someone of my age (61) should run between 40% and 55% of an entire investment portfolio. Because I believe the market is overvalued, I am near the lower number in that range.

But then if I really knew what I was talking about, I wouldn’t be working for the Federal Government. Time will tell whether I am right or wrong.

One more thing, “Let’s be careful out there!”

Saturday, September 22, 2012

Some Practical Job Search Advice

I have always wanted to believe in fairytales. I have found J.R.R Tolkien mesmerizing since I was in Junior High School. I have also found that in this material world fairytales seldom come true. One of the fairytales currently in vogue, particularly in new age circles, runs like this.

1)Find your passion.
2)Match your passion to your job.
3)Immediately love your life.

There is a Christian variation on this teaching that has always made me feel rather guilty and inadequate as a believer.

1)Find God’s perfect will for your life.
2)Follow God’s will to your perfect job.
3)Immediately love your life.

However, that is not the way I have actually lived my life. Nobody ever seemed willing to pay me to pursue my passions or God’s perfect will for my life. After working in American factories for nine years, I looked around and made the following decisions. Working as the night superintendent at a saw chain factory was not any kind of life that a sane person might want to live. I liked machines and machines liked me. Working as a mechanical engineer in a Government research center seemed like a pretty good way to earn a decent living. After watching layoffs and factory closings the security offered by a Government job seemed like a pretty good idea.

I went back to school, earned my engineering degree, got my job, and (as they say) the rest is history. There is a price to pay for not following your dreams and passions. Somehow I feel as though I have done a pretty good job of living someone else’s life. On the other hand a stable, secure, interesting job has allowed me to be a faithful, though certainly not perfect husband and employee these many years.

In fact, I followed the alternative advice offered by Ramit Sethi in “Follow Your Passion is Bad Advice. Do this instead.”

1)Identify a Target Lifestyle (not a target job)--How much money do you need to live the life you want to live? My wife and I wanted to live a comfortable middle to upper middle class lifestyle.

2)Find a Supporting Job Amongst Many Such Jobs--Being a 20th Century industrial man, my mind was pretty limited to opportunities in major manufacturing corporations or the Federal Government. That is where I did my job search.

3)Train a Rare and Valuable Skill--Once I found my job, I worked to improve my skills as project manager, as the branch expert on industrial processes, and in the area of contract management.

4)Leverage Your Value to Move Towards Target Lifestyle--Well I have paid off the mortgage, enjoyed vacations in Hawaii and such places, paid cash for new cars, and now it looks like I will be able to retire with some measure of comfort and dignity. Guess it worked.

The author believes achieving mastery in your career will lead to passion. He states that, “Feeling passion for your work is a great goal, but identifying a passion in advance, and then matching it to a job, is not a consistently replicable way of achieving this goal. The better strategy is to work backward from a target lifestyle, pick a supporting job, cultivate a skill, then leverage your value. If you study people who really do love their careers, you’ll find that most used some variation of this strategy as the foundation for their happiness.”

As I have said before, it has been over 27 years since I did the job search thing. My knowledge and experience in this critical area is out of date. From my research Ramit Sethi’s blog, I Will Make You Rich, seems to have the best variety of practical tips to find a job, at least on the websites I have explored. He is young, urban, and edgy. At times some of my more genteel readers might find him a bit offensive, but I think if you are looking for a job or know someone who is looking for a job, he is well worth your time.

Read the original and watch the video

Follow Your Passion is Bad Advice by Ramit Sethi

Sunday, September 16, 2012

Ask Your Heart

Ask your heart, “Does this make me more awake? Does this make me free?”

My mind is a very imprecise instrument for perceiving and understanding reality. I have all sorts of biases that color my decision making processes. Even when I manage to confront an inconvenient fact, I would rather explain it away than question my underlying world view. I react emotionally to my environment rather than studying and understanding the world that surrounds me. Some of this is a good thing. If one of my ancestors heard a rustle in the bushes she thought might be a tiger then stopped to investigate the reality of her assumption, I wouldn’t be here writing this blog. On the other hand we are in the middle of a presidential election campaign. I am inundated with lies, exaggerations, and misrepresentations packaged by the best expertise money can buy to take advantage of my fears and prejudices.

There is a way to look deeply into what is, but it is not always easy or natural. I belong to various groups. I work at a defense laboratory. I attend a conservative Protestant American Church. Since I live in Maryland, I must register my party affiliation if I ever wish to vote in a primary. I am inclined to believe that people who generally agree with me must be pretty smart, so I am more likely to believe their answer to a question quite disconnected from their area of expertise.

Psychologists tell us we form group loyalties over quite trivial distinctions. Then we base how we interact with others on the basis of these loyalties, rather than looking for the truth.

We all suffer from what is termed with the Dunning-Kruger effect. I tend to over rate my own competence. Surveys indicate that over 2/3 of Americans graduated in the top half of their high school class. Hmmm… Worse 50% of high school varsity football players believe they have a shot at the NFL. The truth is more like 1 out of 3,000 college football players will make it to the NFL.

If I like a person, I am more likely to think he is right, no matter what the subject. Truth exists where it is found. Someone I dislike may possess knowledge that I need. If I am unable to hear the truth because I don’t like the speaker, it is my loss.

I interact with a universe. Unconscious assumptions I make about nature color my decisions and my understanding of reality. The well known Franciscan author Richard Rohr observes:

Life is hard.
You are not that important.
Your life is not about you.
You are not in control.
You are going to die.

I am not the center of the universe, yet I persist in believing that the universe “owes” me something if I make decisions on the basis of my own prejudices and assumptions. The flip side of this insidious shortcoming is the belief my bad fortune is always unjust, but that when something bad happens to my neighbor, they deserved it.

As we watch the world and our own mental activities, look deeply into your own heart. Examine your motivations and your operating assumptions. When you find you are making decisions on the basis of fear, ignorance, or greed, be merciful; forgive yourself. Then look deeply into the truth of the situation. You can tell when you are headed in the right direction. The truth will always make you more awake. The truth will always make you free.

John 8:

[31] Then said Jesus to those Jews which believed on him, If ye continue in my word, then are ye my disciples indeed;
[32] And ye shall know the truth, and the truth shall make you free.
[33] They answered him, We be Abraham's seed, and were never in bondage to any man: how sayest thou, Ye shall be made free?
[34] Jesus answered them, Verily, verily, I say unto you, Whosoever committeth sin is the servant of sin.
[35] And the servant abideth not in the house for ever: but the Son abideth ever.
[36] If the Son therefore shall make you free, ye shall be free indeed.

Thursday, September 13, 2012

Have I Got a Deal for You

“I bought and sold FB shares as a TRADE, not an investment. I lost money. When the stock didn't bounce as I thought/hoped it would, I realized I was wrong and got out. It wasn't the fault of the FB CFO that I lost money. It was my fault. I know that no one sells me shares of stock because they expect the price of the stock to go up. So someone saw me coming and they sold me the stock. That is the way the stock market works. When you sit at the trading terminal you look for the sucker. When you don't see one, it's you. In this case it was me.”
Mark Cuban

The buildings that line Wall Street are filled with people who are smarter than me, richer than me, more informed than I will ever be, and probably a lot of them are prettier than me. Don’t forget there are sharks swimming in that ocean and they are looking for a meal. If a genius billionaire like Mark Cuban can be taken to the cleaners, don’t think you can outsmart the street.

That doesn’t mean you should hide your money in mason jars. It just means you need to understand your own motivations and limitations. In an excellent article by Barry Ritholtz 10 Ways for Dealing with the Sharks on Wall Street the author examines some recent examples of people who thought they were sharks only to discover they were in fact, dinner for the real sharks. Greece successfully disguised their bad financial condition from their partners in the Euro zone through a complex dollar/yen swap for Euros. It netted Goldman Sachs, the engineers of this deceit, $600 million dollars! It netted Greece national bankruptcy. A San Diego school district attempted to avoid financial responsibility by issuing bonds that make no payments for 20 years. They pay 6.8% tax free rather than 4.1% that was available at the time. Over the course of 40 years this folly will cost the taxpayers nearly $1 Billion for a $105 Million loan rather than $300 Million for a normal loan. In both instances politicians were attempting to avoid responsibility until after they were retired at the expense of the future. The sharks were only too happy to help them on the road to ruin. After all the deal makers got their money up front.

Always examine your own heart. If you trying to pull a fast one on the world, the chances are you will lose. Just ask the folks that took out liar loans during the real estate bubble.

Take your time. Collect good information. Understand unless you happen on a bit of inside information, the institutional investors have more knowledge than you do. The institution can and does hire the best accountants and attorneys money can buy. Seek out wise counsel, preferably someone who will not benefit from your decision.

Keep it simple. If you don’t understand something don’t buy it. The insurance company pays their lawyers big bucks to write those incomprehensible 40 page annuity contracts. All those clauses are not there for your benefit. Those contracts exist to protect the interests of the company.

Ask who gets what from whom and when do they get it. This is true of financial products sold by commission salesmen, but it is also true of more complex traps for the unwary. Think about the current student loan mess. The university can raise the price of their service because there is a large pool of federally guaranteed money to pay the university no matter what they charge. $40,000 a year is no longer limited to the Ivy League. The university gets their money, up front, in cash no matter what they charge or whether the student graduates or fails. The banks are guaranteed a wage slave for a decade or more. Student loans are not discharged in bankruptcy. The student is guaranteed nothing, not a job, not even a degree.

Barry Ritholtz ends his article with a observation that is so good, I have used it as a stand alone quote. “There is no free lunch: Repeat after me: There is no free money, no riskless trade, no way to turn lead into gold. If you remember no other rule, this is the one that will save your hide time and again.”

Psalm 131:

[1] LORD, my heart is not haughty, nor mine eyes lofty: neither do I exercise myself in great matters, or in things too high for me.
[2] Surely I have behaved and quieted myself, as a child that is weaned of his mother: my soul is even as a weaned child.
[3] Let Israel hope in the LORD from henceforth and for ever.

Sunday, September 9, 2012


So many fail because they don’t get started – they don’t go. They don’t overcome inertia. They don’t begin.” Ben Stein

Our future has a deadly enemy, our inertia. It is hard to get started on major life changing programs, whether that might be saving for retirement or an exercise program. I need to start preparing the house for sale. After 25 years in a 40 year home, this will not be easy or inexpensive. My first efforts have not been all that productive. Either I am not ready to deal with strangers tearing my house apart or in one case, a recommended landscaper does not seem to want the work. Last week my 17 year old air conditioner decided it would be a good time to start leaking. That may turn into a $1,000 leak or a $3,000 leak. I have been told it will take several months to choose the correct course of action.

Some random thoughts (some from the Daring to Live Fully Blog)

Rest-sometimes we are just tired. After too much stress in other areas, a little rest will give you time to plan and regenerate your energy. This is also true after major life disruptions like a divorce or a death in the family. Don’t use this as an excuse to be lazy, but if you need a break, take one. Your physical health, mental health, and your energy level are one.

Small bites-The question is asked, “How do you eat an elephant?” The answer is, “One bite at a time.” Break up a gigantinormous task up into convenient bite sized tasks, no longer than two hours at the start of a major project.

Seeking congruity through Prayer-Often our problems start because our life is out of whack with who we are. If it isn’t working, spend some time in prayer, seeking a direction that fits your skills and dreams better than your current life. No, I am not suggesting you quit your job and move to Hawaii to wax surfboards on a part time basis.

Rewards-When you do something you don’t like that needs to be done, give yourself a little treat.

Punishment-When you don’t do something that needs to be done, deny yourself some little something, perhaps a TV show you enjoy.

Accountability Partner-Find somebody to keep you honest. In my case, I may never get an exercise program going outside of a structured program with an instructor, or perhaps a personal trainer.

Visualization-Spend some time imaging the possibilities of your new world, then remember, step by step, how you achieved your goal. This technique is frequently offered in books on self hypnosis. It works. Similar methods are used by Olympic athletes preparing for their events.

Reminders-Set out objects as reminders. Perhaps, tape your bank account statement to the refrigerator if you need to build an emergency fund. Or leave your walking shoes out where you can see them, if you need to be reminded to exercise.

Unfortunately, at some point, even with all the tricks and support motivational methods can offer, it is up to you to get off you butt and do something.

In the words of Mississippi John Hurt

You got to walk that lonesome valley
Well, you got to walk it for yourself
Ain't nobody else can walk it for you
You got to walk that valley for yourself

Monday, September 3, 2012

The Perfect Storm Labor Day 2012

In the movie The Perfect Storm the captain and crew of a fishing vessel make an imprudent decision to the return to their home port with a large catch rather than to run from a gathering storm and lose a lot of money. Two powerful weather fronts combine with a hurricane to produce one of the most dangerous Atlantic Ocean storms of the past century. When a gigantic rouge wave hits the boat, the good crew and captain are lost. As with George Clooney and his crew, the average American worker has been hit with the confluence of three enormous economic storms. All of them seem to be beyond the control of either the government or the ability of our financial system to absorb.

First over the past 20-30 years globalization has gutted manufacturing in this country. Free trade pretty well guaranteed the destruction of large scale industrial employers from high paying unionized jobs in primary steel mills to the low pay operations such as those found in the garment trade. The American worker is caught in a battle of wage arbitrage with employees who will work at near slave labor wages in the developing world.

Regulations, particularly environmental regulations, have shut down entire industries in this country, including the two factories where I worked many years ago. It is just easier to move your operations to a country where there is little in the way of environmental regulations or where a simple bribe will send inspectors off to bother someone else. Likewise the rising costs of benefits and taxes (local, state, and Federal) are contributing to push jobs offshore. Now foreign countries like China, have our physical plants (capital), their labor, and increasingly they are learning how to replicate our technology. We are in trouble.

I have written at length concerning the effects of automation and artificial intelligence in the American workplace most recently in:

The Robots are Coming

Automation is not going away. In fact it is combining with globalization. IBM is replacing computer programmers laid off in this country with programmers in India, the new back office of the world’s industrial combine. New York City famously contracted with an Indian company to process their parking tickets. And, Oh yes, now radiologists in India are reading your X-Rays on the Internet.

Finally, some economists describe the current economy of the developed world in terms of a “Kondratiev Winter.” Nikolai Kondratiev was a Russian economist who studied long term economic cycles. A Kondratiev Winter occurs after major sectors of an economy reach saturation. That has happened in a variety of industries from steel to electronics. Even though prices are dropping, demand is not increasing fast enough to cover the sunk costs in capital. The onset of a Kondratiev Winter “Is characterized by a lack of good investment opportunities that leads to low interest rates. In the past, investments offering exceptional returns or low interest rates, or a combination, led to lowered credit standards which, in turn, created a speculative boom and high debt levels, followed by a crash and financial crisis.” (Wikipedia) Sound familiar?

Perhaps the most important feature of a Kondratiev Winter is an overhang of bad debt that strangles out productive economic activity. The governments of the developed world, as well as the average middle class American are facing an enormous overhang of bad debt. Nearly 1/3 of American homeowners are underwater. That means they still owe more on their house than that house is worth. The baby boom is desperately attempting to pay down its debt prior to retirement. This demographic tidal wave is also downsizing, getting rid of stuff, not buying more stuff. In past recessions the insatiable appetites of the American consumer rode to the rescue. Not this time.

This chart compares the growth of the population with the growth in employment and more importantly the growth in “covered employment” meaning jobs that provide benefits. What it is telling us is that most of the jobs generated during the last four years are low paying jobs without benefits or self employment or contract work that does not provide benefits.

The working class American is in trouble. The growing and unsustainable split between the richest Americans (top 0.2%) and the rest of the country has been discussed so much that no one is bothering to listen anymore. I am not worried about the 1%. The 1% includes some of our most desirable and productive citizens including medical doctors and successful small businessmen. I am a little worried about the 20%. This includes the white collar (managerial class) and the gold collar (technologists). These are the people who do the heavy lifting for the 0.2%. They have good paying relatively secure jobs. I work with a number of outstanding young men who hold bachelors and masters degrees in engineering disciplines. No matter what turns the economy might take, I think defense scientists with degrees and security clearances will be OK.

I am deeply worried about the future of the average man. Forty years ago a man of average intelligence with a high school diploma who was willing to work 40 to 50 hours a week could reasonably expect the income necessary to support a wife, a couple of kids, a house, and a car. This is no longer true. Even two incomes are sometimes not enough. I offered this prayer for those who seek employment back in 2009. It is needed more than ever.

A Prayer For Those Who Seek Employment

Sunday, September 2, 2012

How Much is Enough?

How much is enough? It is a question that each of us must answer in their own heart. There are two emotions that will lead us to a bad answer, fear and greed. They are not surprisingly the two emotions that most drive human behavior in the stock market. They are our enemies.

I am rapidly approaching a major decision point in my life, retirement. For many years I have been taking care of my money. Now it is time for my money to take care of me. Is it enough? I have run the numbers, many times, in a variety of retirement calculators. Even the most unfriendly and hostile of these programs tell me, “It is enough.” But my mind generates all sorts of “what if” scenarios. What if this disaster occurs? What if that law changes? What if? What if?

It is wise to count the cost. It is not wise to obsess. It is fear.

First John Chapter 4:

[18] There is no fear in love; but perfect love casteth out fear: because fear hath torment. He that feareth is not made perfect in love.

The second enemy is greed. How much is enough? I have read articles based on interviews with the rich. One man was unhappy because his yacht was only 150 feet long, much smaller than his neighbors’ boats. Apparently private jet envy is a real problem in this class. But really, are we any better. At what point does a stereo system or a motorcycle or the latest cell phone cease to be a source of pleasure? At what point do our possessions begin to own us, rather than the other way around?

Luke 12:

[15] And he said unto them, Take heed, and beware of covetousness: for a man's life consisteth not in the abundance of the things which he possesseth.

How much is enough? Of course the wise answer is, “Be happy with what you have.” Can you imagine how wonderfully simple life could be if we just wanted what we had instead of always wanting what we don’t have? I’m still working on it. When I achieve enlightenment, I’ll let you know.

Philippians 4:

[11] Not that I speak in respect of want: for I have learned, in whatsoever state I am, therewith to be content.
[12] I know both how to be abased, and I know how to abound: every where and in all things I am instructed both to be full and to be hungry, both to abound and to suffer need.
[13] I can do all things through Christ which strengtheneth me.