In terms of stock market analysis, I don’t do a lot of things the way you are “supposed to do them” - I’ve spent a lot of time creating my own theories and refining them. When it comes to measuring or sensing stock market volatility, I do not follow the VIX. Call me crazy but I prefer to look at the action in the 3405 stocks I cover every week to determine how volatile they are rather than an index based upon options activity in the S&P 500. There are many ways to measure volatility - I’ve created my own methods rather than relying on something I don’t find either intuitive or accurate.

During an average week, the HEDGEfolios database typically has about 300 signal changes in a universe of stocks that now sits at 3405. While some weeks are approximately 50/50 on the new UPs versus new DOWNs, an upward trending market will tend to be closer to 75% new UP signals and conversely, a downward trend will have a 3:1 ratio of new DOWN signals. When volatility picks up - the total number of signal changes at HEDGEfolios may jump to a number like 500 which I consider to be extreme and the ratio of new UPs to new DOWNs will exceed 5:1 which is also extreme.

In very rare circumstances, I have seen two distinct conditions.

The first is High Volatility one week in one direction followed by a reversal with High Volatility within the next two weeks in the opposite direction. That has happened precisely three times since I started tracking this data in January 2005 - I mention the week followed by the HEDGEfolios bias in parentheses.

1. 2/12/2007 (bearish), 2/20/2007 (bullish) and 2/26/2007 (bearish) Prior to the Asian…Carry Trade reversal….Dollar/Yen market selloff.
2. 5/29/2007 (bearish), 6/4/2007 (bullish) and 6/11/2007 (bearish) Prior to the beginning of the credit crisis selloff.
3. 2/25/2008 (bullish), 3/3/2008 (bearish), 3/10/2008 (bearish) and 3/17/2008 (bullish) Prior to the Bear Stearns Bailout rally.

I most recently wrote about this increase of volatility (as I measure it) on March 2, 2008 and again on March 13, 2008 - the day before the Bear Stearns problem was revealed.
The other volatility condition occurred during the past two weeks where I saw High Volatility measures in the same (bearish) direction on two consecutive weeks. On June 23rd, I changed 675 stock signals with a ratio of 10 new UPs for every 1 new DOWN. That was extreme but this week was even more noteworthy. I changed 807 stock signals with 633 new DOWNs vs. 174 new UPs. In the past 6 years that I have done HEDGEfolios, I have never done something so extreme two weeks in a row. During the past month, I have changed 1961 signals with 1651 new DOWNs and 310 new UPs.

I know this may be tough to follow because it is not traditional and anecdotal observations that rarely occur are very tough to evaluate. I get that. My work is not traditional so it is easy to disregard. On June 3rd, I mentioned a rare instance of Divergent Signals in the ETF signals and tried to warn that this typically signals a major market reversal. Other than a few readers of this blog, it was disregarded. Now I am making this new observation. Do what you want with it. I don’t need to tell you that the market is volatile - you already know that whether you watch the VIX or not.

However, the key element of volatility using traditional methods like the VIX rests on the reversal at extremes in a contrarian indication such as buying when the VIX exceeds 30. This is a very dangerous concept and I do not advocate for its use.

I never liked that approach so I do my own thing and look at each stock, the turnover in each and how the composite of all signal changes indicates the market volatility. As for the timing of market reversals, I primarily rely upon this anecdotal data and the HEDGEfolios Timing Indicator. If you look at it, you’ll see that the HF Bearish (red line) has never been so high and you might notice that my indicator went Bearish on June 9th.

On June 9th, the VIX opened at 23.56 and on Monday of this week, it opened at 24.25 with very little changes during those 3 weeks while the market fell 6% over the same time period. What did the VIX tell anyone? And yet, I am sure that the VIX lovers and experts will find a way to mention how great it is when stocks finally head higher, especially if that happens shortly after the VIX hits an extremely high reading.

If you are successful using the VIX or any other common volatility measure, I encourage you to keep doing it. If you are like me and think the VIX is a waste, then I encourage you to come up with your own methods.

One of the reasons I believe in an equally-weighted portfolio was exhibited with the performance of HEDGEfolios yesterday. Unlike the S&P 500 which declined 3.1%, the equally- weighted HEDGEfolios universe of 3414 stocks declined 1.0% from the open to the close. Part of the reason for the smaller loss was the fact that I have 29% DOWN signals - not 100% long as the index assumes. If HEDGEfolios had been 100% long, it would have lost 2.3%.

I understand the benefits of concentrated portfolios and the effects of market cap weightings. However, at times these strategies have their downsides and you can look at yesterday to figure that out. Small and Mid Cap stocks did better and so did indices with a large number of constituents.

In normal weeks, I spend very little time analyzing the strategies that I use for my portfolio management. If there isn’t much that sticks out, I just practice my normal analytics. It’s one of those “if it isn’t broken, don’t try to fix it” moments. However, weeks like we just went through - the extreme and really painful ones - are full of information. These are the times I use to evaluate what works and what doesn’t. Portfolio construction - long vs. short - diversification - position sizing - concentrations - betas - value vs. growth, large vs. mid vs. small cap, etc. All that stuff is there for you to learn from this week. I know yesterday may be something you’d like to forget or prefer just to enjoy your weekend without reliving the painful trading if you were net long. If you were net short, maybe you feel like smelling the roses and relaxing for a few days. However, regardless of how you were affected by the past week, I strongly encourage you to analyze everything you can.

HEDGEfolios performance differentials have come from using weeks like this to learn. Some times, I notice a few things that are in conflict with techniques or portfolio management concepts that I believe in. It causes me to challenge myself and think about trying something new. Other times, I reinforce or refine what I am previously doing. Regardless, it’s a great opportunity - take it.

A friend of mine was telling me today about his frustration with one of his positions that went bad. He suggested that it had so discouraged him from trading that he was going to stop participating in the market. Don’t give up. If you love trading, don’t give up. Go ahead and take a break. Spend some time evaluating what went wrong and what you could have done to make the trade work out. Unfortunately, sometimes that analysis is useless. Sometimes there is nothing you could have done and the position is overtaken by events. But time away from the market is definitely worth it and you should never trade with a lack of confidence or love for the pursuit of profit. If you find the time off was better without trading, then go ahead and stay away. On the other hand….we all have bad performances but just like a child that falls off his bike, it’s important to get back on - Don’t give up!

With few exceptions, I am not impressed with fundamental analysts and their estimates of revenues or earnings or their recommendations or the timing of their upgrades and downgrades or their price targets or whatever else they spend their time doing. I am impressed with how much money most of them get paid to do those things with whatever accuracy the market seems to tolerate. To be fair, I suspect the analysts have no use for me either so let’s call it even. I am comfortable with a head-to-head comparison between my performance on about 3500 stocks each week over the past few years and their performance on maybe 10-20 stocks they covered “in-depth” over the same time period.

That would take a lot of work so let’s just take the easy way out. Let’s be objective and consider some of the main catalysts for market action over just the past week.

• Was GE’s miss GE’s fault or the fault of analysts who had not lowered their estimates during the quarter?
• Was GOOG’s beat because of superior results at Google or because analysts had lowered their estimates too much?
• Was C’s miss on EPS okay because their revenues were about $400 million higher than analyst estimates or because analysts had expected $20 billion in writedowns and the company only marked them down by $12 billion?

I always get a little crazy when the market responds to earnings data. Seriously, if investors are fundamental only and believe in this mess, they deserve to get their asses handed to them. Just pick any stock that has more than a handful of analysts. Look at the dispersion of estimates and then consider the average that gets reported. Lately, there is such a huge difference between the high and low estimate that the average is a very statistically odd number. I really enjoy the occasions when a company meets the analyst estimates. So when a company misses or beats, what is it really missing or beating? Are we rewarding or punishing the company for its earnings performance or are we rewarding or punishing the company because the analysts sucked in either direction. Don’t even get me started on their idiotic price target announcements or the timing of their upgrades and downgrades. They can do all of this and be terribly wrong - unfortunately, investors still respond to it and that’s why it’s important.

For the record, I do believe analysts perform a useful function. Someone has to crunch all the numbers and it is a ridiculously difficult job that we should not really expect to have extreme accuracy. And as I have said, studying the investor reaction to these numbers is a significant portion of my work. But wouldn’t it be nice if the numbers would either be accurate and deserve the attention they get or at least, wouldn’t it be nice if investors would treat them accordingly when they are grossly inadequate?

What really concerns me though is the perception of a stock’s valuation metrics and for that matter, the perception of the market PE and anything else that allows commentators to proclaim how cheap things are. These crappy analyst estimates that have about as much accuracy as economists’ forecasts and yet, what they put out is half of the ratio that investors are conditioned to reply upon. Chief among this absurdity is the Forward PE ratio that is foisted upon us and even more dangerous is its derivative, the PEG ratio, which gives us a double dose of analyst estimate danger. I believe in the “P”, that’s entirely accurate at all times. But the Forward EPS? How many of those were accurate when you bought stocks 1 year ago? How realistic was the earnings growth rate?

Let’s look at C back then….

What was the opening price per share of Citi on April 2nd, 2007? $51.31

• What was the Forward PE if you bought into Citi on April 2nd, 2007? 11.4 - Sounds cheap! Doesn’t it?
• What was the Expected Earnings Growth Rate? 9.6% - Wow, a PEG ratio of about 1.2. Sounds doubly cheap!
• What was the Dividend Yield? 4.2% - Fantastic and besides, they’d never cut that dividend. Right? Wrong!

So one year later on April 1st 2008, the price was $22.61 and the trailing 12 month PE was 33.6. OOPS! That’s quite a bit off from the 11.4 projected last year. But don’t fear, today’s Forward PE based upon the analyst estimates is only about 8. Sounds cheap! Doesn’t it?

I am not suggesting that investors should ignore analysts. On the contrary, if you are going to invest based upon the fundamental expectations they provide, I want you to not ignore the reality of how right and wrong these estimates turn out to be. Analyze the analysts. If you pay attention to them, do more than just look at the average of the extremes. Figure out which analysts get close to actual results and which ones do it consistently each quarter. Then, calculate your fundamental variables based upon the good analysts and place more emphasis on these numbers when deciding what to buy or sell. It will take a lot more work, but good investing takes a lot of work.

There are good analysts and there are bad analysts. It’s up to you to analyze the analysts.

Two weeks ago, I gave 628 new DOWN signals and only 21 new UPs. That was the most extreme negative or positive move I have done in the past 5 years of HEDGEfolios by about a factor of 2. It was a very tough one because 449 of the new DOWNs were signals that I was wrong about. Typically, 68% of signals at HEDGEfolios are closed out as winners so it wasn’t so easy to have a week where I changed course with 71% being wrong.

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.

On the night I made these decisions, I hinted at what I had seen when I wrote about When Bottoms Drop Out and I voted Bearish at the Ticker Sense poll. I think this was the only time I ever changed my vote on the poll before publishing the signals and timing indicator at HEDGEfolios.  I thought it was extreme enough to violate my policy and earlier that night, I was a bit more ominous when I wrote this:

During the 5 or so years I have been doing HEDGEfolios, there have been three times I have thought the market was at risk for an imminent and serious decline. August 16th, 2007…January 21, 2008…and today. The previous two times, the Fed showed up with surprise cuts the next day.

The dramatic reversal I saw in the charts a few weeks ago had to do with my belief that many stocks trading near their individual support levels had made decisive moves lower. I call that a bottom dropping out. That eventually played out in the days that followed as we hit new lows. I was off by a week, but Bernanke did eventually show up with a new bailout tool.

This week, I gave more new DOWNs (158) vs. new UPs (103).  Then the TSLF spiked us higher and yet, nothing about Tuesday’s big rally has changed my mind.

Today’s “loss of Jobs Report” convinced quite a few people that the economy is either already in or soon to be in a recession. It’s amazing that with all the other data that has been around for months, suddenly this one report is all that it took to bring supposedly smart people over to the dark side. Maybe it was the proverbial straw that broke the camel’s back but I find this a little absurd and useless. In the past, I ripped on the market moving on the Jobs Report whether it was up, down or flat and whether or not the economists guesstimates were off by tens of thousands compared to the government’s initial guess that will be revised about 3 more times. So forgive me if I am not going to jump on the recession bandwagon just because this report was so crappy. Besides, I am not too excited about being potentially associated with some in the crowd that were so clueless until caving in today.

I felt the same way when many economists, politicians, “journalists” et al were denying that the economy was struggling. How many times did I have to hear the President and his crew say the “underlying economy is sound” before I realized it really hadn’t made a single impact on how I did my work with HEDGEfolios? Exactly Zero. I never said to myself, “Hey we are not in a recession so let’s go buy every stock.” And I won’t be doing the reverse. There are always stocks to buy and always stocks to sell every day whether we are in boom or bust. I know other investors conduct portfolio management based upon giant macro themes and seek out individual stocks that are supposedly recession proof. I hope it works for them and I am sure that they will probably be spending this weekend figuring out how to adjust their folios. As I’ve said before, I don’t go defensive. Hearing a consensus of economists announcing that this one Jobs Report seals the deal certainly doesn’t change my opinion about how to manage stocks. I have no idea how knowing we are in or not in a Recession will tell me exactly which stocks I need to buy or sell. Today’s action was not helped by the reality that our economy is struggling but there were many other factors that caused it to slide. Yesterday there were other reasons. Next week there will be other reasons. Those are the things I am focusing on.

I am declaring this my Recession Secession. I am simply not going to give any credibility to the idea that yesterday we were maybe not in a recession and today we probably are. So I am seceding from the Recession camp and leaving it to people who really care.

Many market participants spend a lot of time with sentiment indicators like the VIX or the Put Call Ratio or the Investors Intelligence Index. I look at them too, but I spend very little time on that kind of analysis. Call me unsentimental! I am not advocating that they should be ignored but they should not be overemphasized. They are just a few of the dozens of technical and fundamental variables that you should be using. Early last week, Dennis Kneale was ridiculing the “fraidy cats” as he likes to call them and quite a few other permabulls were suggesting that sentiment was greatly improved. I kept hearing how all the bad news was being ignored and the market was heading higher. So now that bad news is bad news again, we see the value in the previous assessment. Did sentiment change? I think the only sentiment that changed was the sentiment about sentiment from overly sentimental people.

I like Google - primarily for the utility of their product and the respect I have for the corporation’s pursuit of innovation. As for the stock, HEDGEfolios has had a DOWN signal since November 12, 2007 when it was trading at $657.74. To be fair, I have been very even-handed on my opinions for the likely direction of the stock. Since I first started covering GOOG in September 2004, I have given 14 signals - 7 UP and 7 DOWN. Only one of those was wrong with a loss of 10%.

Throughout this whole time, I have watched Price Targets on GOOG get ramped up and often in $100 increments. Two years ago, I wrote a post called Moving Targets - if you read it, you know I don’t do price targets and I have little use for them. They are great for hyping stocks, especially for high profile / high growth momentum stocks like Google. When you had Cramer or some analyst seeking attention by slapping big price targets on GOOG as it was heading higher, they got a lot of positive attention like the $985 target given at the end of October, 2007. But just consider where we are today on this stock relative to the targets. Click here for the current summary of GOOG estimates. Pretty pathetic.

One of the big problems for using price targets is that they encourage you to buy when the stock slides. Take a listen to Cramer’s 11/14/07 explanation of how to buy GOOG on the way down and when you do, just know that the Michael Steinhardt he references is not me. For the record, I don’t advocate “averaging down” either.

The next time you hear a price target increase being hyped to encourage you to buy a stock, please consider this example.

There is a lot of talk about a “pennant” formation in the index charts. Since I can only stand hearing so much technical analysis bullshit, I have reached my limit. I rarely discuss detailed technical analysis with anyone or write about it on this blog. It’s just not something I like to do. I make exceptions when I feel that the media is intentionally or unintentionally misleading investors. First of all, non-technicians should shut up. Appearing on CNBC or Bloomberg does not mean they are experts on anything, much less technical analysis.

As it relates to the pennant formation, there are two types - bullish and bearish pennants. Listening to many of the supposed experts lately, you might be led to believe that all pennants are bullish. That is not the case. Typically, these are continuation patterns meaning that they follow the preceding trend. Expecting that this is a reversal pattern or something you see at the top or bottom of a trend is not a good assumption. If the market action from January 22nd until today truly is a pennant, then I am concerned. Remember the preceding trend over the past several months is down so a continuation of that is also down. Please read this article on bearish pennants and then read this one on bullish pennants. You decide which one is more relevant to the way today’s index charts look.

During the decline, there’s been a lot of portfolio management advice about “going defensive” through purchases of stocks that have held up well in the past during economic weakness or recessions. This is a common piece of “wisdom” that you can hear coming from really successful fund managers and investors. Good for them. You will not hear that from me because I don’t do it. If in my normal course of analysis whether we are in a boom or bust period of the cycle a stock looks like it is likely to head higher - I would be inclined to consider buying it. REGARDLESS OF ITS INDUSTRY. REGARDLESS OF HOW THE INDUSTRY HAS DONE DURING PAST PERIODS OF ECONOMIC WEAKNESS.

I really don’t like the idea that you should let the assessment of the economy by economists (or anyone else for that matter) tell you what sectors you should buy. Please remember how pathetic economists are at predicting the onset, severity or duration of a recession. It scares the hell out of me to think that investors buy stocks for themselves this way. It makes me feel even worse that professionals would do this for others.

I look at each stock on its own merits. Obviously, if demand is picking up for a company considered to be defensive and this “going defensive” strategy is the source of that demand, I am affected by it. As for looking at specific stocks because they are considered “defensive”, I just think that is dangerous.

Big Pharma used to be considered great “defensive stocks.” I look at MRK and most of the other names in this space and I wonder how someone would have felt buying them as recently as December when the economy already appeared to be slowing. What about other traditional defensive sectors / industries like utilities, food, beverages, tobacco, oil, etc. I know the market’s been tough lately(at least since December) on fears of the economy slowing (among other things), but pull up a bunch of stocks considered to be defensive and analyze how well they did as a group relative to the index. With a few exceptions, I see very few that did better than companies that are not defensive.

Defenders of the defensive strategy will probably tell me that it’s too early to judge. That’s an interesting point - the whole timing thing. So when do you get in? Typically for an investment like this to work out, you need to buy before everyone else does it. When was/is that? I remember hearing this advice back then or if it wasn’t at the end of December, then when is it? Is it now? Is it next month? Since few (none) of us can say for certain when a slowdown begins or ends until it’s obvious that it happened a few quarters ago, when exactly do you go defensive?

To me, this whole concept is problematic. Yet, I realize that experts in the industry and the media are fascinated by it. They are treated as if it’s so easy… so brilliant… so foolproof. Unfortunately, it’s none of those things. If you find a great stock that you think is undervalued and your technical analysis is encouraging and it happens to be considered defensive - good for you. If you find all those things and it isn’t “defensive” - good for you.