The last time I felt so annoyed with the market was in late 2006 and through July of 2007.   I encourage you to read through my archives if you cannot remember.   But here is a sample from February 2007 that sums up a few of my current frustrations.

As I mention in that piece, it’s important to know what your trading biases are and the weaknesses of your style.   Some of my trading challenges from when I wrote that post over 2 years ago are still with me today and the biggest has to do with technical breakouts.   Personally, I don’t feel like it’s possible to permanently remove my weaknesses (with stocks or in life) but instead, I spend a lot of time making sure I am able to identify them when they pop up and stay focused on managing their consequences.

So this week, as I went through the charts I continued with the painful process I began after Labor Day…giving UP signals to stocks that either broke through or were about to pierce big resistance levels.  Many of these signals were only a few weeks old and I hate having to reverse something so quickly, especially when the technical analysis pattern is the one I struggle with the most.  Regardless, it is what you have to do.   Here is a snippet from another 2-year-old post about Exiting At A Loss.

Many investors have big difficulties admitting when they are wrong. I do too. What makes it easier for me is being objective about the prospects for being less wrong going forward. Capitulations occur out of desperation. Exiting a position at a loss is not the same as capitulation if you are focusing on what will happen to the stock next, not what happened to the stock in the past to cause the desperation

Whenever breakout patterns conflict with my personal view of the market’s risk profile, I struggle.   When you couple those factors with the ridiculous fundamental valuations and ignorance of macro economic realities that I believe exist, it’s over the top for me.   However, it is always important to remember that no one gets to decide what is right or wrong about stocks or markets.  They will do whatever they want regardless of your assessment.   So I made about 500 signal changes that I find to be absurd and I look forward to reversing them (very quickly) if and when reality ever sets in again.

I am not a fan of index investing for 100% of anyone’s portfolio.  I like the idea of using index ETFs to rapidly increase or decrease exposure to equities but that’s about it.   Obviously, there are merits to index investing (such as diversification and transaction cost avoidance) and if you are the type of person that really likes to do no better or no worse than the market, then I guess index investing might be the thing for you.

John “Jack” Bogle is the father of index investing and the founder of Vanguard and according to CNBC, an investing “legend”.   Overall, I find him to be a very brilliant guy…so it’s really painful to listen to the first minute of today’s CNBC interview.   Click here.

Okay, so Bogle says…”Nobody should buy a stock.   Nobody should buy a bond.”   WOW!!  Of all the stupid things that are said on CNBC….this ranks right up there and coming from an “investing legend” it’s even worse.

If everyone took Bogle’s advice, there would be no stock market.   If nobody bought a stock and if nobody sold a stock, there would be no index.   There would be no index investing.  If nobody bought a bond, there would be no bond market.   In short, if everyone (the opposite of his “nobody”)  followed Bogle’s comments, there would be no finance.

Maybe you might interpret Bogle’s “nobody” reference to mean no individual investors.   So are you really going to leave the entire stock market and bond markets to mutual fund managers and by further specification, only index fund managers?   That’s absurd as well - just consider how they have done over the past 10 years.

At HEDGEfolios for the past 6 years,  I have consistently done what Bogle the “legend”, says nobody can or should do.  I have tried to show you it’s possible to take either long or short positions on 3,000 to 4,000 stocks and outperform the index.   So you won’t hear me tell you that “nobody should buy a stock.”  I’ll leave that up to the investing “legends.”

Since November, I’ve heard quite a few market technicians (or at least people pretending to be experts on technical analysis) suggest that multiple retests of the 820 (or 805 if that is what you prefer) support level on the S&P 500 means that it is more likely that these levels will hold.

I disagree with the theory that many retests at a given level ensure that it is a sturdy bottom.  I’ve criticized talk about triple bottoms in the past when the S&P was at 1400 and don’t feel any different now that we have lost 40%.

I agree that successful retests are important and yet, so are failures.   If you have 5 successful retests over 4 months that does not mean that the sixth retest will not fail.

It only takes one failure of a “strong” support level to wipe out your belief in all the times it held.

Regardless of whether we bounce off 820 again, what have all the “successful” retests given you?

Until a support level holds and a resistance level is broken the next time we rally, don’t get too optimistic.

I am not talking about currency investing.  I am talking about investing in a stock because of the value or direction of the dollar relative to other currencies.

Over the past several years, fund managers, stock research firms and the media have often suggested that you should invest in stocks based upon their percentage of international operations and try to play the currency effect.  Meanwhile, I said that the weak dollar is a stupid reason to invest in stocks and I still say it. The theory went that a high percentage of foreign operations means that the company would benefit during a weak dollar period.  Of course, this concept went a long way to try and generate buying for large cap stocks and specifically humongo multinationals that had underperformed for many of the previous 6 or 7 years.  Did I mention that many of the brainiacs pumping this idea to the masses were managing funds that were heavily loaded with multinational stocks that had been hurting their performance?

First off, currencies are an asset class on their own whose values are largely determined by complex domestic and global macroeconomic factors.  If you want to invest in the dollar I think you should consider investing in the dollar and not some proxy in equity form.  Note that I have consistently cautioned non-experts from trading currencies.

People are/were  so hung up on this they almost give the impression that there is no better reason to buy stocks than a weak dollar. The idea that the multinationals benefit greatly because sales accelerate when our cheapass dollar makes their products more competitive and more appealing to international purchasers is not a new idea. Secondarily, the dollar exchange rate does increase the earnings due to currency translation effects. I get the theory.  Presumably, these effects would allow a stock to have improving fundamental valuation metrics and allow for higher stock prices.

So what’s the problem with me? There is a difference between theory and reality.  Equities and the decision making process for building and managing a portfolio are much too complicated to just blindly pick multinationals over stocks that are purely domestic.

When the broad statements about buying multinationals are mentioned, do you ever hear which specific currency pair they are discussing?  I never did.  I just heard the “weak dollar” as if they were referring to the US Dollar index which is a basket of currencies, not specific ones.  So what does “weak dollar” mean exactly?  Weak dollar relative to what?   What if it is the Canadian dollar and not the Euro or Yen or whatever.  Does it matter which currency pair?  Does it matter whether the company actually does business in a country with a currency that appreciated more dramatically than some other currency?  What percentage of total revenues and cash flows came from each currency?

If the general theory was accurate, then wouldn’t you expect that as the dollar was crumbling over the past 6 years that the multinational stocks would have done extremely well. HMMM!  The reality is that the stock prices of many multinationals declined dramatically and consistently from February 2002 when the US Dollar Index last peaked.

Since the beginning of February 2002 through today’s close, here are the performance figures of relevant indices.

• US Dollar Index declined approximately 36%
• S&P 500 Index increased 4.9%
• Russell 1000 Index (large cap) increased 9.2%
• Russell 2000 Index (small cap) increased 44.4%

Okay, so Russell’s small caps stocks as a group have done about 4 times better than Russell’s large caps.  So when does the payoff come in the form of higher stock prices for the large caps?  I thought that the fund managers and others promoting this concept were interested in stock performance.   Did they get higher revenue growth than small companies?  Some did.  Some did not.  Are we measured on whose sales go up faster or are we measured on whose stock prices go up farther and faster?  Were the multinationals more profitable in their international operations?  Most certainly were.  Are we measured on who has the most profits or better currency translations or are we measured on whose stock prices go up farther and faster?  I love sales growth, I love diversification in geographic sales, but if the stock prices don’t respond, it is not impressive.

While the large cap vs. small cap indices had clear disagreement with the weak dollar theory, not every stock worked out that way.  Certainly, some small stocks did worse than other small stocks from 2002 until now and some small stocks did worse than multinationals.  But that is always the case.  Each stock has its own issues.  The percentage of international revenues and earnings is just one variable and after looking at the data, I found no evidence that showed performance that was uniquely attributable to one percentage or the other of foreign operations.  For each stock that did well, I could find another that did poorly with roughly the same foreign component.  For each stock that did well, I could find another that did equally well without having foreign revenues.  Lastly, the same stock went up and down pretty significantly several times while the dollar weakened rather consistently during the same period.  If the dollar was such an important reason to invest, it should have been a reliable method…it was not.

For the record, now that some people have begun suggesting that the dollar has bottomed and is heading higher, I am hearing that investors should reverse the previous theory and buy small stocks that have a low percentage of foreign operations.  As you might imagine, I find this logic to be about as poor as the weak dollar argument.

I am not suggesting that multinationals are good or bad investment decisions or that small caps are good or bad decisions.  All I am saying is that the dollar’s weakness or strength and its direction is not a reliable indicator to help you pick stocks.

I love equally-weighted portfolios because I like treating each stock the same.   Keeping HEDGEfolios an equally-weighted portfolio requires me to focus on each stock as if it is the only one that matters.  I don’t place more importance on a stock because of how popular it is compared to a small cap company in the same industry.  I see no difference between Microsoft losing 10% and Google losing 10% so there is no reason why I would find a difference between Intel gaining 10% and AMD gaining 10%, even though AMD’s size is about 3% of INTC’s market cap.  The best way for me to make sure the equality perspective finds its way into my portfolio management style is to keep each stock with the same weight in the HEDGEfolios universe.

As a result, the market cap weighting of the S&P 500 index and the stock price weighting of the Dow are not methodologies that I appreciate.

Most investors and fund managers focus on concentrated portfolios and there is a ton of research that will tell you that is the right way to go about it.  That may be good for them, but it is not good for me.   As I have stated repeatedly on this site, you need to figure out who you are as an investor and know what you believe in and then conduct your portfolio management accordingly.

Compare the performance of hedge funds or mutual funds with concentrated portfolios and unequal positions to the performance of HEDGEfolios and ask yourself whether equally-weighting is a stupid idea.  In my opinion, it is stupid if you believe in concentrated portfolios.  If you are more like me, then it might make sense for you.

Here’s an example of how it could work:   Let’s say you start a portfolio construction with $1 million in cash.  Equally-weighting each position in your initial portfolio is easy, but as time goes on, it is impossible to maintain those positions exactly.  As you exit a specific stock, the remaining positions have varying balances and depending upon your gains and losses, taking a new position will never be able to match existing ones exactly.  My preference is to use an average by dividing the total market value of your portfolio by the number of positions you want to hold.  If your portfolio started with 100 positions of $10,000 each and you sell a stock that has appreciated to $12,000, the position I would enter after that would be the lower of $12,000 or the portfolio market value divided by 100.  As a result, any excess cash would be held in reserve to cover for the shortfalls in any future losing trades and the ability to get close to equal weighting when you enter the replacement position.

There are two portfolio management issues that make equal weighting of portfolios problematic.

The first is transaction cost effects.  You need to make sure that the number of positions and the value of your investable assets results in a position that will not be wiped out by trading commissions.  That amount is something you have to determine but I worry about any round trip commission that would exceed 1% of the position size.

The second concern is liquidity.  If your equal weighting means that your trade will comprise too high of a percentage of average daily volume of that stock, you really need to determine the incremental cost of bidding it up on the way in and the difficulty of getting out.  Obviously, if your equal weights result in small positions of highly liquid stocks, it is not likely to be a problem.  A few years ago, a trade I made represented approximately 10% of the total volume in that stock that day.  It was costly and I never made that mistake again.

Lastly, I always look at it this way.  I spend the same amount of analytical effort on each position.   If you have a position that represents a disproportionate amount of your portfolio, do you spend that much more time on it?

Position sizing is a large determinant of overall performance.  Winning big on something that represents a large portion of your portfolio may feel great, but the opposite can be devastating.  Equal weighting of positions is a significant component of why HEDGEfolios has significantly outperformed the index each year since I started - it works for me because it is consistent with who I am as an investor and the other elements of my portfolio management.   Make sure that your position sizing matches your own style.

It’s tempting for many people to do thematic investing.  Listening to smarties appearing on financial entertainment and it’s almost impossible to miss.  Sometimes it’s addressing macroeconomic themes like slowdown or recession and you get treated to how smart it is to be “defensive”.  Note that I don’t intentionally go defensive.  Similarly, when the economy starts to pick up, you might hear about “early cycle recovery” picks.  Note that I don’t intentionally go aggressive.

Over the past few years, we’ve been treated to some fun themes….like buying ethanol stocks because President Bush and Congress supported it (oops) and the bird flu trade buying stocks that would help us deal with pandemics (oops) and the terrorist trade buying stocks in security companies (oops) and the Katrina trade buying stocks in plywood, shingles and other home construction supplies (oops).

Themes are all about fads.  Often, other than the guys talking about the theme and why these stocks make them sound so smart, the strategy has no basis in sound investing.  This is about speculating and trading, not investing.  You really need to evaluate how well thematic bets actually work out and make sure you are paying attention for when the fad fades or isn’t mentioned by a gazillion other smarties on tv.

I recommend that you work on finding good stocks first and then figuring out whether they are getting a boost from a theme that might last for a while.  Coming up with a theme and then trying to find stocks that fit that theme is not a good idea.

I fully expect that the SEC will extend the ban on short selling (if nothing else to give it time to allow more companies to petition for coverage).  Regardless the reason, I expect the ban to be renewed at the last minute.  But when is the last minute?

I am looking forward to seeing the long-only crowd fall all over themselves to bail on stocks that have rallied 30-100% by squeezing the shorts last week.  How many minutes before the ban expires will it take to see the profit-taking begin?  How long will it take to see the profits disappear?  How long will it take to see people taking losses?  How long will it take before the longs realize that the shorts are not there to provide liquidity and short covering demand?

If you are long a stock that has benefitted greatly from the government’s manipulation, I hope you know when to get out 1 minute before everyone else begins to get out.

If your perspective on performance runs from the daily open to the daily close, here is what you got this week:

• Monday           S&P500 -4.65%
• Tuesday          S&P500 +2.13%
• Wednesday      S&P500 -4.46%
• Thursday         S&P500 +4.27%
• Friday              S&P500 +3.46%

If your perspective on performance runs from the weekly open to the weekly close, here is what you got this week: +0.33%.

HEDGEfolios only changes signals at the open of each week.  For all the critics of my laid-back style, this week exemplifies why I do what I do the way I do it.

How did HEDGEfolios actually do this week given that I went into this volatile period with 56% UP signals?

From Monday’s open to Friday’s close, HEDGEfolios was UP 1.9%.

In 2006 and 2007 when the markets were hitting record after record, many financial gurus were advising everyone to buy international and to pump up their portfolios with 20-50% of foreign stocks and ETFs.  They made a ton of money doing that.  The advisors did at least.  Maybe some traders did too depending on when they got in, but as for long term investors still in those positions, I doubt they are holding big gains or gains at all.

Please take a look at this research from Bespoke from September 17, 2008 (before the bailout).

I wrote this piece back in 2006 trying to warn people that international investing had its risks.   I don’t feel much different now than I did back then regardless of how far the markets have declined.

Finance theory known as MPT suggests that putting international stocks in your portfolio reduces your risk while increasing returns.

I am not a fan of this theory which was proposed about 50 years ago when the data supported the concept that international markets are not highly correlated or perhaps, negatively correlated.  In the past, many of the markets currently trading all over the world did not exist and the information flow around the world was nothing like it is now.    We live in a very global economy with very integrated capital markets and just evaluating the past 5 years you’ll see that directionally, the US markets are highly consistent with foreign markets.  What you can see is that when the US goes up a little bit, the foreign markets go up a lot and recently, (per the Bespoke research), when the US goes down 20%, many other markets do as bad or worse.

It’s real easy for financial advisors to push a program that makes them money, especially when it is “supported” by finance theory that has been accepted as the truth for decades.  When it doesn’t work anymore and clients lose, it’s time to separate the facts from the theory.

Times of panic are great opportunities to evaluate yourself, your financial advisors, commentators, media etc.  I’ve mentioned this in the past during tough times and I think it is worth saying again.

The next hours and days will show people’s true colors.  Information will be offered as fact one minute and found out to be fiction the next.  Supposedly smart people will be advising others to do some really stupid stuff.  Others will be promoting an agenda that appears to be oblivious to everything that is going on around them.   Others will be silent because they said stupid crap a few days or weeks ago that will make them feel embarrassed.   Others never had a freaking clue to begin with and I just hope they stay quiet.

Not everyone will be wrong in what they say and do during this crisis.  Some bright people will present themselves as a contrast to all the morons.  It should be easy to identify the good and the bad.

I expect panic and I will be sitting back and evaluating it.  The time to have positioned yourself without panic was weeks ago.  If you cannot help yourself and panic, I understand that…it’s part of human nature.  I’ve been working really hard on Getting Centered for over a month since I started seeing some early warning signs (search backwards through my posts…I am not going to provide links to my prior comments).  My work is largely done.  It’s one of the great luxuries I have with my methodologies and investing style to be able to use any market event to learn rather than react.

So if you are able to join me and have positioned yourself as well as you can, pay close attention to what is said and by whom if we have panic.  Then compare it to what they said or advised you to do or what they didn’t say or didn’t advise you to do over the past few weeks and months.  Give credit where it is due and hold people accountable for doing a poor job.