I changed 1135 stock signals this week with 1066 being new DOWN signals.  Long time followers will know that I have only done such a big move a handful of times in the past 5 years.   The most similar recent example was on January 12, 2009 when I gave the First Warning Of 2009.

“could get ugly”??????   The market declined 25% in the two months after I wrote that post.   You have to decide whether it’s relevant this time around.

This week was a big move for HEDGEfolios.   But it was not a big move for the stock market in general.  We are only off 1.5% from Friday’s close.  Most people would not look at 1.5% as a big move, especially in a market that has increased 60% in 7 months.

However, my work is not based upon evaluating the index moves or many of the other things you hear from the experts that appear on financial entertainment.   To me, it is relevant to see 1/3 of the stocks I cover rolling over at the same time, and even if that means that many of those stocks are only declining by a percent or two from a recent high.

Small moves can become big moves if they happen simultaneously.

PLEASE PAY VERY CLOSE ATTENTION TO YOUR PORTFOLIOS.

In 2007 and 2008, the bullish spinmeisters used to love to tell everyone how S&P earnings were not really so bad if you just took out Financials.   So now that the same people are busy reporting how wonderful S&P earnings are and how high the percentagage beat rates are over ridiculously bad analyst estimates, I doubt I’ll hear much about excluding financial results, especially when we have removed the mark-to-market pressures and companies like Goldman Sachs are delivering big “profits.”   If it’s appropriate to take out anything that makes numbers look bad when the economy looks bad, how about we take out numbers that look good when the economy supposedly looks good?   Given the supposed reversal of “fortunes” in the financial sector and the 100% increase in oil in 2009, please make sure to evaluate S&P Earnings Ex-Financials and Ex-Energy.

Prices for most stocks may not be as high as they were when I first started blogging negatively about the market in 2006, but it certainly feels like we have come full circle given the commentary I have been hearing lately.

Here is a sample list of the topics that filled my posts when the market was last in La La Land:

• Excessive ridiculing of bears
• Obsessing about breaking through some arbitrary Dow level
• Being overly impressed with the lack of any meaningful pullbacks during the rally
• Sensationalizing the amount of bears as proof of bullish contrarianism
• Saying how many investors have missed the rally and cannot wait to get in
• Mythical “Cash on the Sidelines”
• Wall of Worry
• Hype of analyst upgrades and price targets
• Fascination with buybacks
• Hype of the last Private Equity deal
• Speculation about the next Private Equity deals
• Merger and Acquisition Mondays
• Believing quarterly results from financial stocks
• “Well capitalized” banks
• Cheering prospects for low Fed interest rates
• Weak dollar being great for stocks and especially, large caps due to their high percentage of international revenues
• Ignoring 75%-100% increases in oil prices
• Saying the worst is behind us

Check your memory banks or look through my old blog archives or view old articles / videos from mainstream financial media.   How many of the items I just mentioned do you find in 2006 and early 2007?   How many of them have you heard in the past month?

We have come full circle.

Please take the time to read this post from Yves Smith of Naked Capitalism.  Yves is one of the few bloggers I find valuable and I encourage you to read her content whenever you can.

If you were confused or wondering about my earlier post called “10 Guys In A Room”, that is my general opinion of many stocks in this market.  There appears to be a great need to not sell stocks and let them inflate on light volume just because of all the positive momentum that’s available.   And that’s fine.  But let’s just call it like it is.  Let’s not pretend that a stock or group of stocks or the majority of stocks are worthy of inflated valuations.  There’s a euphoria associated with feeling richer or feeling smarter…that’s just natural.   But when that leads to arrogance or ignorance, we get humbled pretty soon.   As I suggested in the “10 Guys” post, it’s not required that long investors believe a stock is great.  In fact, it’s possible that many of them actually believe it’s a piece of crap and as long as two situations persist, there is a disincentive to sell.  The first condition is that they believe the stock will head higher and the second is that they believe there is a sufficient supply of investors who want to get in.  When prices decline and buyers are not as abundant, there will be a massive rush to exit.   You don’t need to be the first guy out.   Just…..don’t be the last guy in.

Lower prices in early March were indicative of poor health in the markets.   And during the “recovery” to DOW 10000, higher prices are “proof” that asset prices are healing, if not healthy.   Right?   Isn’t that the common wisdom that floats around the media and markets?

Personally, I think associating prices to conditions is a ridiculous and dangerously ignorant concept.

By this logic, house prices and the housing market was at its healthiest on or about December 2005!

If today’s high stock prices are a sign of good health, then were stocks the healthiest they have ever been on October 9, 2007?  Where they healthy in April of 2000?  Were they healthy in September of 1929?  If the S&P suddenly jumped 500 points in the next week, would you be convinced that we immortally healthy?

And of course, the people that love to throw around the idea that higher prices mean healthier assets or markets try to only apply this notion to the asset classes they want to hype and spin.  For example, I doubt you’d agree that higher prices equal health if you were talking about oil.

10 guys are in a room.  To get into this exclusive club that can only hold a maximum of 10 occupants, all you have to do is own the same stock as the other guys.   For the past 6 months, there have always been more than 10 people trying to get in.  2 go out. 2 new ones come in.  After a while one of the new guys whispers to the other and says, “I think this stock is a piece of shit.”   The second guy says, “I agree but it keeps going up so I am not selling.”  A third guy overhears their whispers and quietly joins in the convo saying, “YOU DON’T NEED TO WHISPER, EVERYONE IN THIS ROOM BELIEVES THIS STOCK IS GROSSLY OVERPRICED.” 2 guys go out.   2 new ones come in.   One of the 2 new guys had left the room a week ago and decided to come back saying, “I had to pay a higher price, but I am glad to be back!”   The other guy says, “Why did you leave the first time?”   The returner says, “I couldn’t stand knowing the stock was a piece of shit but it keeps going up so here I am.”   2 guys go out.  1 new guy comes in.   The other 8 look at him and say, “Hey Buddy, we’ve never seen you in here before, have we?   The new guy says, “Nope, this is the first time I could get in so I bought both shares from the 2 who just left.   I had to outbid the 8 other guys that were trying get in.”  A few seconds later, how many are left in the room?

Three weeks ago, I asked you to Justify The Extreme stocks in your portfolios.  I even went further and provided a list of 165 symbols that were a small subset of the stocks that I felt were at heightened risk of declines.  Note that I have rarely pointed out individual symbols on this blog but thought it was time to make an exception.  Remember, this list was a result of both fundamental and technical analysis and at the time, I had a mix of UP and DOWN signals on these stocks.  That is still the case.  I have UP signals on stocks I hate and I have DOWN signals on stocks I love.  Hopefully you understand that I am more concerned about what the market likes or doesn’t like than what I personally think.  For those of you that are still confused about that concept, please get that figured out before you lose too much money trying to invest.

Since September 23rd (the date of that post), the S&P 500 declined about 4.5% until October 5th…has rallied about 4.5% since October 5th…and has advanced 0.5% overall.

So how has my list of 165 risky symbols done over the same time period…during the decline and during the rally and during the sideways move depending on what dates you use?

At the market’s worst point (on October 5th), 87% or 144 of the 165 were lower.  A short portfolio of all these stocks would have resulted in about an -8% loss.  70% of my list had declined more than the market decline with 48% losing between 9% and 36%.

Okay, so if you are still not impressed with my performance during the decline let’s move on to how these stocks have done now that the index is back to where we were 3 weeks ago.     61% or 101 of the original 165 stocks are still lower.   The same theoretical short portfolio would still have a loss, but only about -3%.

The original post’s main point was to encourage you to justify your positions, especially on stocks that may have advanced dramatically despite having crappy fundamentals or stock charts that are unsustainable.  My list was an example to highlight stocks that I thought would do significantly worse than the index during a decline.  I think the results proved that out (albeit over a short time frame).   The stocks may not be the same the next time around but the concept I am proposing will be the same.   There are always extreme stocks that pose significant risk to your portfolio.

It’s important to note that many of these stocks advanced much higher than the market’s 4.5% since October 5th.  That’s also a key point of this and the previous post.   These stocks are extreme.  Many of them have very high betas, a few do not have high betas.   Extreme stocks are great on the way up.   As long as you can justify their existence in your portfolio and as long as you can be honest with yourself about the risk they pose to your performance on the way down, you are fine.

HEDGEfolios year-to-date stock performance for 2009 (through 09/30/09 close) was up 76.85%.

Over the same time period, the S&P 500 index was up 17.06%.

At the end of September, the HEDGEfolios universe consisted of 3,147 stocks.

Commentary: September provided gains of 3.57% for the S&P 500 and due to an average of 60% UP signals during the month, HEDGEfolios underperformed by only advancing 2.11%.   Over the last week, HEDGEfolios started positioning once again towards the center and ended at 59% UPs.   There have been several times since March where I have mentioned getting less bullish or marginally bearish and yet, each time, the market rebounded very quickly.   So I’ll repeat this once again…..until the buy-on-the-dip strategy fails and previous support levels are broken, I do not expect a significant retest of prior lows.  Regarding fundamentals….I am not comfortable with the valuations being placed on almost 1000 of the stocks I cover.  As I mentioned recently, there are an abundance of stocks who have rallied very far without any historical earnings, many of whom still do not have any forward earnings estimates for the coming 12 months.  But it seems no one cares.   Analysts who have been terribly wrong about earnings during 2 years of this crisis are now raising estimates.   In the past 2 quarters, investors supposedly cheered beating ridiculously lowered estimates and lately, they are cheering the analysts optimistic earnings revisions which tend to convince everyone that the future is brighter and valuations are reasonable.   You have to decide on a company-by-company basis whether a stock is fundamentally and technically sound.   As we go forward, macro factors that have been propped up by government interventions will show their true colors.   It has been enough to just try to ignore our underlying economic problems and be happy about less bad results or higher stock prices.   I doubt that can persist much longer.

Here is a chart showing the performance of HEDGEfolios vs. the S&P 500:

Prior Years’ Performance:

• 2008, HEDGEfolios performance was +30.51% vs. -38.47% for the S&P 500 index
• 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.