Yesterday, the S&P 500 Large Cap index rose 10.8% from the open to the close.

I looked to see how the HEDGEfolios Universe of 3,333 stocks performed.   Assuming my usual equal weighting and a long-only portfolio, the gain would have been 3.8%.

Given the allocation of UPs and DOWNs at HEDGEfolios and the equally-weighted portfolio, the actual performance here was approximately 2.3%.  Note that 67% UP signals times 3.8% is 2.5%, so it was pretty much what I would expect.

But back to the index reporting.  To say the least, it was extremely biased by the market-cap weighting of its components.

• An equal weighted S&P 500 Large Cap index would have had a gain of 7.2%.
• An equal weighted S&P 400 Mid Cap index would have had a gain of 5.9%.
• An equal weighted S&P 600 Small Cap index would have had a gain of 4.2%.

Unless your portfolio was perfectly weighted to the index, your results would likely vary widely.  Even if you had bought the SPY on the open and sold at the close, it would have given you a 7.4% gain.

Comparing your performance to the index is a good tool but the comparisons between your portfolio composition and the benchmark need to be considered.

We all have principles and beliefs..as investors and as humans.   These principles and beliefs guide our behaviors and under most conditions, we are very confident in them.  And yet, this confidence is often unearned.   It is real easy to have a belief and when the results of acting on that belief turn out to meet our expectations it tends to reinforce our views of what is right and wrong and what works or doesn’t work.  It isn’t always necessary for the results to be satifactory or what we want, they just need to fall within a range of expectations that we find reasonable.

However, it is only in times that our principles and beliefs don’t work that we find out whether we truly believe in them or not.

If you are a fundamental investor….  if that was your guiding principle in investing and has worked within a range of expectations for many years, the past two months have been especially difficult.  If you are a technician and rely primarily upon a set of indicators to guide your investment decision making, the past two weeks have been especially difficult.   The same can be said for thematic investing, or macroeconomic investing or buy-and-hold or just about any principle or belief that has worked well for you.    The past few weeks and months have been unlike anything most of us have ever seen.

I have gone very bullish over the past three weeks from 31% UP signals on October 6 to 33% DOWN signals this week.  Prior to today’s 11% move, that bullishness was not rewarded.  In fact, last week HEDGEfolios declined 4.7%, the worst weekly performance I think it has ever had during the 6 years I have been doing this.  As of last Friday’s close, only 37% of the 3338 stocks I cover had winning signals and of the 1500 or so UP signals I gave the previous two weeks, 85% were wrong with an average loss of 16%.

More than a few people have asked me what I saw to encourage me to go bullish.   And more importantly, why I was not changing the recent signals back to DOWNs since I was so horribly wrong.   The answer to those questions was the same:  my principles and beliefs about investing that have guided HEDGEfolios over the past 6 years.

Was I questioning those beliefs and principles over the past few weeks?   YES, and when I looked at the stocks again this week, I questioned them again.   And the answer was to have faith.  Sometimes that’s all you have when everything you think you believe in is not working.

If this troubling period is causing you to question your principles and beliefs and led you to sacrifice them or make decisions contrary to what you thought was right, you need to evaluate whether you really believed in them in the first place.

Last Sunday night I commented that I had never seen a market that presented itself in such a dramatic manner.   The results have given me a reference point to recognize something like that if it ever reappears in my lifetime.  Personally, I hope I never see it again.

While the S&P 500 declined 18%, HEDGEfolios managed a 5% gain due to the fact that I was positioned so heavily to the downside with only 31% UP signals.

This weekend has been a very difficult analytical process, but maybe not in the way you might expect.  I have spent hours and hours going over the technicals.  Usually, I only go through all the charts one time and then just repeat the stocks I expect to change signals.  This weekend, I have completed 2 passes on over 3300 stocks and am taking this break to write this post prior to going through them one more time before the open.

What am I looking for?  Considering that I have been so hedged to the downside there is only one thing for me to do.  I am spending all my time with two main ideas….what not to go bearish on and more importantly, what to go bullish on.  I tend to be proactive, and not reactive.  Have you ever perceived that I was panicked?

As you may know from reading my portfolio management articles, I don’t place much emphasis on being a contrarian for the sake of being a contrarian.  I have been bearish in times (like April to July 2007) when it was really painful to do so.  Click here and here and here for some samples.  When I am different than market sentiment, it has simply come from what I have seen that differs from others and not because I am just trying to follow those goofy sayings like “be greedy when others are fearful….be fearful when others are greedy.”   I never understood the timing of that.  Seems to me people were fearful two weeks ago and one week ago…. so being greedy at the start of last week didn’t turn out to be so wise.

When I looked at the charts over the past two days, there was much devastation and yet, I also saw much more positive than I did the previous week.  When I did the fundamentals, even using my more conservative approaches, I saw quite a few stocks trading at unbelievable prices.    For example, when a company has more cash than its market cap and has minimal debt, you really need to give it deep consideration.  I have been called “Mr. Sunshine” by some of my closest friends and as you know, it wasn’t because I am always so optimistic!  Right Charlie????  However, even someone like me can give credit where it is due or see a few positives on negative days.

HEDGEfolios will likely miss part of a massive turn - I have a habit of sacrificing returns for confidence in longer term direction.  I am taking things one stock at a time as I always do.  It’s really easy to stay negative or to finally bail out if you’ve missed all the warning signs over the past few months.  In this business, you get rewarded for being rationally proactive whether that means increasing your downside hedges over the past two months or going in the other direction as you see real reasons to go long.  I am not advocating that you do what I do unless that means you are working your ass off.  Do your homework.  In times like this, do more homework.  Then when you cannot take it anymore, please take a break.  Spend time with your family or go for a walk or just do something that makes you happy.  Then….do more homework.

I need to get back to mine.  There are only 9.5 hours left before the opening bell.  I am going to spend them on my new effort to move towards Getting Centered.  I don’t call crashes or rallies.  I leave that up to other people that seem to be doing far worse than HEDGEfolios but spend a lot of time appearing on television to say how smart they are.

I am taking this one stock at a time and while some are improving, they are not all improving enough to warrant signal changes.   For the ones that do look good to me, I am going ahead with the changes just as I have done when the market was euphoric and I was going negative.  I expect the difficult market to continue, but I have been leaning heavily in the negative direction for weeks and I don’t think it is wise to continue at the same pace.

Newsletter #2 to be emailed tomorrow.  It’s going out once and only once.  I’ll be sending it to anyone that has emailed me before the release.  If your request is late, I will put you on the list for the next one, if there is a next one.

I know I am setting up incorrect expectations that since I am doing the newsletter two weeks in a row that one will be coming out every week in the future.  Two in a row is random.

UPDATE:  IF YOU RECEIVED NEWSLETTER #1, YOU DO NOT NEED TO REQUEST ANY FUTURE NEWSLETTER.

Regardless of volatility or whether the market went up or down over a given week, I usually do not notice anything out of the ordinary.   It’s always tough, so a particularly rough week does not confuse me or rise to the level of concern.

There have been less than 5 weeks in the past 6 years I have been doing HEDGEfolios that I saw something I have never seen before.   On those occasions, I made mention of them on the blog and said that I had no idea what they meant at the time, but I was watching them to see what happens so I’ll recognize it if the situation ever reappears.

This weekend looking at the charts and doing my fundamental work was one of the 5 weeks of confusion.  In fact, if I had to rank them, this was the worst.

Stocks that looked great for months, now look like crap.  Stocks that looked strong last week, now look like crap.   Stocks that had started to find support or head higher, now look like crap. In summary, the top fell out and the bottom fell out at the same time.  Strong stocks got weak, and weak stocks got weaker.

I am not a supporter of the capitulation theory that says you need to see a capitulation to find a bottom.   Commentators like Pisani have mentioned the “C” word almost every time they want to call a bottom and they have been wrong.   So since I don’t call bottoms or crashes or capitulations or things like that, I am not suggesting last week was a capitulation.   I am not suggesting that we are set up for a crash.  All I am saying is that I have never seen anything like it.

Of the 1443 UP signals I had going into last week, 669 of them declined by more than 10%.  It is rare for me to get hammered like that.  Of the 1910 DOWN signals I had going into last week, 1026 declined by more than 10%.  More than half the stocks I covered declined in excess of 10%.  If you are an optimist, you might want to call this a capitulation event.  I just call it devastating and since many of these stocks just started to fall last week, I have a tough time assuming that the slide began and ended that quickly.  What catalyst do you see for a positive reversal?  Another $700 billion government bailout?  Another Fed rate cut?  A bottom in housing?   Strong retail sales?  A great earnings season?

The S&P 500 declined about 9.4% last week.  Many people commented about how bad this was.  Usually when they say stuff like this I think they are exaggerating or maybe I even see the opposite.   This time though…IT WAS SO MUCH WORSE IN MY OPINION.

Newsletter #1 to be emailed tomorrow.  It’s going out once and only once.  I’ll be sending it to anyone that has emailed me before the release.  If your request is late, I will put you on the list for the next one, if there is a next one.

Good luck this week, I expect it to be unlike anything I have ever seen.

UPDATE 2:40 PM ET 10/06/08   I have emailed out the newsletter.  A few have been bounced back to me.  If you did not get the newsletter and you can provide me with another email for me to try, I’ll do that.  If you feel that I should have sent you the newsletter because you took the time to request it at an earlier time/date, then send me proof of your prior message.

HEDGEfolios year-to-date stock performance for 2008 (through 09/30/08 close) was up 28.86%.

Over the same time period, the S&P 500 index was down -20.55%.

At the end of September, the HEDGEfolios universe consisted of 3,354 stocks.

Commentary: HEDGEfolios was able to advance approximately 3% during a month that saw the S&P decline about 8%.  Throughout the month, HEDGEfolios had weekly moves that ranged from +1.9% to -0.9% and from September 22nd through the end of the month, it varied no more than 30bps.  Compare that low volatility to the massive swings in the indexes.  On August 11, 2008, HEDGEfolios was sitting at 80% UP signals.  For the past few months I have been advocating moving towards a very neutral position and ended the month at 43% UP signals.

Prior Years’ Performance:

• 2007, HEDGEfolios performance was +21.78% vs. + 3.55% for the S&P 500 index
• 2006, HEDGEfolios performance was +25.54% vs. +13.62% for the S&P 500 index
• 2005, HEDGEfolios performance was +19.99% vs. + 3.00% for the S&P 500 index
• 2004, HEDGEfolios performance was +31.19% vs. + 9.00% for the S&P 500 index

Disclaimer: Nothing in my performance quoting is intended as an advertisement or in any other way meant to encourage anyone to subscribe to HEDGEfolios. These performance figures have not been audited or verified by an outside party and are NOT in compliance with the CFA’s AIMR Performance Presentation Standards. They don’t net out any transaction costs such as commissions or management fees and are not a total return calculation as I do not include dividend yields or any compounding factor. These performance figures cover a hypothetical portfolio of the entire HEDGEfolios stock universe with an equal weighting of each security. The calculation is simply the cumulative total of all gains and losses from the signals during the period in question.