HEDGEfolios stock performance for 2007 year-to-date (through 07/31/07 close) was up 13.95%.

Over the same time period, the S&P 500 index was up 2.63%.

At the end of July, the HEDGEfolios universe consisted of 3,685 stocks.

Commentary: July ended with a significant erosion of stock prices and due to my consistently bearish stance, HEDGEfolios actually advanced during the month. On 7/31/07, 63% of the symbols had DOWN signals vs. 37% UP. While the focus is on credit concerns, there are other headwinds facing stocks inclusive of record highs on oil, weakness of the US dollar, risks to consumer spending, etc.

Past results:

• 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.

The Cockroach Theory says that when you see one cockroach, you have to assume there are a bunch more hiding in the walls waiting to come out. Tonight Bear Stearns is notifying investors that it has a third hedge fund that is in trouble and it is halting redemptions. Unlike the other two devastated funds, the $850 million Asset-Backed Securities Fund is unhedged and they say it will not suffer from forced liquidations or seized collateral, by lenders or investors.

However, the damage is potentially worse for the markets for the same reasons that it is being spun as not as bad. First, halting redemptions to stabilize a fund indicates to me that investors have lost confidence in Bear Stearns - a leading financial institution. So you may think that halting will prevent a meltdown by selling assets into a weak market, but the desire to pull out is very concerning. More importantly, the fund supposedly has only a small percentage of exposure to subprime - as low as 1% of the fund assets. That may make you feel better if you myopically focus on this as a subprime issue. But taking the bigger picture, you have to wonder how could a fund focused on Alt-A and prime mortgages be in trouble. The “containment crowd” has been denying the mortgage crisis by trying to isolate this as solely a subprime issue. I cannot count how many times brilliant people have said that subprime problems will not or is not migrating to higher quality borrowers. How many cockroaches do you need to see before you question that belief? AHM was one creepy-crawly-critter today. CFC was another prehistoric pest last week. I suspect tonight’s BSC disclosure will put this myth to rest.

And what is the remedy? When we first acknowledged the problem with subprime, Congress contemplated a bailout. Lenders were encouraged to restructure loans and be nice to the borrowers who supposedly were taken advantage of by predatory lenders. Congress also put the pressure on the Fed for their failure to prevent this mess. If we finally admit that this is bigger than subprime, then what do we do? It’s hard to contain cockroaches and it’s hard to prevent them and it’s hard to crush them.

I was looking for a rally today and I got it….at least until it disappeared.   I hate being wrong and I was wrong about my expectation for a short term rally starting today.  When I look at the market action from the last week - today was the worst, Friday was second and Thursday was the best.  Now I know you are going to tell me I got the math wrong and that the declines were biggest on Thursday, then Friday, then today.  But what I am talking about is the interpretation of the moves.  There was significant selling going on today from the gap up open until it broke down this afternoon.  I have been critical of the short sellers and while I still think they have sucked for many months, today was impressive.    If they did some covering, they did it well.  Meanwhile, the bulls were dumping shares.  So if you are a bear and I offended you…don’t hold your breath for an apology - just do your thing.   Today was a great opportunity for the bulls and they screwed it up.

Meanwhile, I gave more new UP signals than DOWNs this week.  As I hinted in my previous post, I took last week as an opportunity to “cover” some signals that I thought had been sold out.  And I didn’t overreact by dumping a bunch of stocks that had already suffered.  With today’s action, it appears that I might have been too optimistic for a relief rally.  We’ll see….

I’ll probably miss the rebound rally - whether it happens today or in the near future and especially if it starts in the middle of the week. As I wrote yesterday, the slope of the decline during last week’s selloff was not what I was looking for and I am expecting a rally towards at least 1510 on the S&P 500 whenever it decides to show up. Today’s positive earnings and lack of negative economic data is giving the bulls a chance to benefit from the weak conviction of short sellers and it will be the first real test to see whether they are going to take their short term gains or whether they are going to maintain pressure on the stocks. If they give in, I suspect we may see The Mother of All Short Covering Rallies.

If it sounds like I am cavalier about missing rallies, in this case I am. I don’t play the volatility game very well and prefer to focus on a mix of fundamentals and technicals that attempt to smooth out whipsaw actions. Last week in the middle of the hysteria, I made relatively few new downside bets - not because I am a permabull - but because I already had 64% of the HEDGEfolios universe pointing in this direction. However, I did take the opportunity to change a few DOWN signals to UP - especially if they held up well last week or if they were participating in an acquisition. Just as I didn’t “react” to last week’s decline, I am not going to react to a big rally. My signals are based upon what happened last week, so whatever occurs today or the rest of this week will be considered when the trading week is over. I may miss a few points in either direction, but I also avoid the turnover costs and stress that often cause investors to make poor decisions.

When you are going through volatility in your portfolio, it is the best time to evaluate your asset allocation, diversification, and portfolio beta. Check your feelings. If last week was too painful for you, I suggest that you look at your portfolio and address these issues. If there is a rally, check your feelings again - did you feel regret over selling last week and did you wish you had loaded up? Your answers will give you insight into the portfolio management decisions you need to make to ensure that it fits with your investor profile.

To the extent that I miss the eventual rally, it really is not part of the longer term approach at HEDGEfolios. I have no idea how to analyze the data of a rally in advance. So I choose to wait for the trading info to determine whether its quality and breadth is worthy of a response. Jumping in front of an anticipated rally is all about speculation.  I am less concerned about missing the next rally, than I am about avoiding the next selloff.

Naming market technical indicators is an art form and two of the most dramatic names are the Hindenburg Omen and the Titanic Syndrome. “Oh, the humanity!” Both of these supposed market topping technical indicators have given off rare signals in the days and weeks prior to the selloff we are experiencing now.

I don’t track these things but when they get mentioned I take a few minutes to evaluate their merits. So if you feel like spending some time reading about them, here’s a discussion of the Hindenburg Omen and one that is specific to the Titanic Syndrome. Like most technical indicators, you will have to evaluate for yourself whether you believe in what they are saying. False positives are abundant in technical analysis and just because these went off recently does not mean they are correct this time. Have fun with them or if you don’t like these, make up your own.  There are a few disasters that still don’t have a technical indicator named after them.

Last week, the Yen had it’s largest appreciation relative to the US dollar since the end of February. If this continues, you will certainly be hearing a lot of discussion on the Yen Carry Trade and the correlation between the Yen’s move and our stock market. When we had the last go around on this complex discussion, I was very critical of the crappy explanations that were being offered up and given credibility by being mentioned on CNBC and Bloomberg. You can read my thoughts on the Carry Trade here and the Yen/S&P 500 correlations here to see how I differed with the prevailing wisdom offered by others.

While I am sticking to my thoughts from those articles, there have been a few important changes to discuss why I am more concerned this time. In my opinion, the global capital markets in February were not conducive to a real unwinding of the carry trade. There were minimal reasons for investors to return capital to Japan due to the interest rate differentials. However, with the widening of credit spreads and some signs that Japan may be raising rates, I am paying more attention to this situation. Just note that Japan is still very fragile and any rapid changes to the Yen will present serious challenges to their export driven economy.

With Short Interest at record levels prior to last week’s decline, there is a good probability that we will see the Mother of All Short Covering Rallies when the selling abates. The only way I see to avoid this is for the current decline to assume a flatter downward slope over a sustained period. As I have previously written, the shape of last week’s decline is not what I would expect to start a bear market.

Based upon the volatility in this market and the tremendous amount of bullish mentality that built up over the past four years, I am expecting an eventual rally that will take us back to at least 1510 on the S&P. Right now, I don’t see it forming, but will let you know when I do.

The short sellers have been pathetic for a long time. With the added positions that probably got piled on during last week, I have no reason to believe they will not cover to finally take some profits. The only question is whether they will do it in orderly ways which will sustain the downward momentum or whether they will panic and bring on the Mother of All Short Covering Rallies.

For quite a while, the end of month window dressing has been a positive for the markets.  Sell the few losers, keep your winners and load up on a few high profile winners that you had missed during the month.  The challenge for the last few days of this month will not be so easy.   I would hope that window dressing isn’t too much of a factor and we just focus on making good financial decisions, but it will be interesting to watch.

As markets stress people out, some stupid (obvious and useless) comments start flying and here are a few repetitive ones that I chuckled at last week…

• “This is just a correction.”
• “Markets don’t go up in a straight line.”
• “It was time for a decline.”
• “We got ahead of ourselves.”
• “We are nearing a bottom.”
• “Investors have been waiting for a buying opportunity like this.”
• “A little fear is healthy but this amount of fear is unwarranted.”
• “It’s going to climb right back up.”
• “Flight to safety is great for stock markets.”

AND MY FAVORITE STUPID COMMENT FROM LAST WEEK WAS…..

• “If you haven’t sold, you haven’t lost.”

There’s a massive amount of speculation going on this morning and most of it seems to have a hopeful tone for a positive day.   My thoughts are “Maybe, Maybe Not.”  Asia was down, then it was up.  S&P futures were down, then turned up.  Europe was up, then it was down.  As usual, you will see the positives that match your positive view.  The danger comes when you ignore what you don’t want to see.  That ignorance of risk factors is what got us into the mess that played out last week.