Two weeks ago, I discussed the challenges of being Hedged on a Big Up Day and made this observation…

“It’s tough to miss out on a rally, but the merits of hedging never show up on a big up day. Risk management approaches are for markets that actually reflect risk and that wasn’t the case yesterday.”

This week, the markets started to deal with risk and being hedged to the downside was critical for preserving gains. As we entered this week, the HEDGEfolios universe of 3,690 stocks had 64% DOWN signals. At the open on Monday, July 23rd HEDGEfolios had a year-to-date gain of 11.36% vs. 8.18% for the S&P 500. During the carnage on Thursday which resulted in a market decline of -2.2%, HEDGEfolios actually increased by 30 bps. For the week, HEDGEfolios improved by 3.2% and is showing a YTD gain of 13.75% vs. 2.9% for the S&P 500.

I am hearing that question way too much in the past few days. I know it’s great filler for CNBC and Bloomberg to ask their guests “What should investors do now?” Of course, many of these experts were suggesting to buy the market last week and so it’s not such a surprise that they would be saying similar things today.

Now is the time for hindsight. It doesn’t need to be 20/20. It just needs to be less blind than it was a few weeks ago. Once you are done asking  - “What do I do now?” - make sure to ask yourself and your advisor some better questions like “What should I have done weeks ago?”, “Why did I not do it?”, and “What can I learn from this to do better the next time?”

When we had the February 27th decline, I encouraged investors to research which stocks were holding up better than others and look to them once the selling wave ends. I feel the same this time. Jumping in now may give you a great bargain if there is an immediate rally. It might also crush you even worse than the past few days if the slide continues or accelerates.

I won’t be heading to Venezuela any time soon. Not that I had planned a visit to check out all the great investing opportunities for Americans in Chavezland, but I was informed by the Prez himself that I am unwelcome in his beautiful country.

“No foreigner, whoever it is, can come here to attack us,” Chavez said. “How long are we going to allow a person, from any country in the world, to come to our own house to say there’s a dictatorship here, that the President is a tyrant, and no one does anything about it?”

Good thing they have a lot of oil because their tourism business isn’t looking so bright with that moronic and hypocritical comment (check out the full story.) I wouldn’t think of “attacking” the country but some of my previous commentary about his dictatorial style and nationalizing of industries with foreign investment may have insulted his sensitive nature. Lo siento.  Perdoname por favor.

When I was on Bloomberg’s Taking Stock show on June 11th, Pimm Fox asked me whether I had concerns about Private Equity deals. My answer was that I wasn’t critical of the actual deals being announced, I was concerned about the follow-on speculation over companies in the same industry. That phenomenon is fueling a lot of the bullish run over the past year and I suggested that when the liquidity changed, those speculative premiums in rumored transactions would come out quickly and painfully. We’ve seen a bit of that over the past few days now that there is some doubt about financing and credit appetites for LBO’s. A perfect example of this scenario is Macy’s. On July 18th, that bastion of dealmaking information, Women’s Wear Daily reported that KKR was looking to buy Macy’s and the stock spiked about 9% on the speculation. With KKR’s easy capital called into question and the overall negative tone to the market, M has declined 20% since July 18th with 5% coming off yesterday. The Private Equity premium game has worked extremely well for momentum players and speculators until now and once this current decline is over, I don’t doubt that it will be tried again.

Just a few words of encouragement (borrowed from the permabulls) for all those upset or surprised by what happened today…

“There is a ton of cash on the sidelines.” - After today’s selling, there are at least 3 tons of cash on the sidelines. Does that make you feel better?

“Valuations are not so high.” - After today’s price declines, stocks are even cheaper on a fundamental basis - maybe only slightly higher than historical averages. Does that make you feel better?

“The Wall of Worry is great for stocks.” - After today’s selling, there is enough worry to build a really huge wall.  Does that make you feel better?

“Subprime is “largely contained.” - In his attempt to soothe the markets, Secretary Paulson said that on Bloomberg today and oh yeah, on March 13th he said the same thing. Permabulls have been saying similar things since February. Even execs at Bear Stearns and GE’s WMC made similar assurances. Does that make you feel better?

“Low interest rates are great for stocks.” - Largely due to a flight to quality, yields on the 10-year Treasury notes have dropped over 40 bps in 3 weeks. I see another 20-30 bps decline in rates as a decent possibility in the short term, especially if stocks keep getting whacked. Does that make you feel better?

“The low dollar is great for large caps, and by default the S&P 500.” - The USD index is at historical lows. If a low dollar is great for stocks, then today’s action is about as good as it can get. Does that make you feel better?

Of course, the pain of today is hard to heal so quickly. And having me throw this salt on the wounds may make it worse. But the next time we rally and you hear these crappy lines, please remember how today felt. The reminders may make you queasy then too, but it might actually help you avoid losing money. And that should definitely make you feel better.

“Repricing Risk” is a phrase that is getting a lot of play today. It’s one of those terms that people say when they need a few buzzwords to make themselves sound smart, but its definition is vague at best. Unlike the smart guys talking about it today, I am not ashamed to tell you that I have no clue what it means. That’s why I never use it. If it meant something, we would hear about it every day, not just on big down days.

But here is the biggest point - you cannot “RE”price something that was not being factored in a few days ago. In other words, today may have been more about pricing risk (for once.) And then you need to struggle with another aspect of the rePRICING risk concept. Almost every stock in the S&P declined today, but not every stock was overvalued before and not every stock that declined pro rata with the S&P has the same beta. So if you believe in this rePRICING concept, you are by default suggesting that investors know how to assign risk to stock prices perfectly today but not yesterday. Let’s talk about tomorrow… if stocks spike higher for whatever reason they do what they have done in the past, are they not repricing risk? Do higher stock prices mean that investors are ignoring risk? Will we ever hear this phrase - “Stocks hit record highs today as investors repriced risk?”

While macroeconomic factors, liquidity, geopolitics, etc. all impact some percentage of each asset, stocks have unique risk factors. The breadth and uniformity of today’s drubbing was not a discriminate assignment of risk. I am certain that share prices were repriced, but as for risk - I don’t know how to define it.

The market is struggling so why have I not jumped on the bandwagon of those who are now talking smack? It’s more fun to listen and to be honest a few weeks ago I really got tired of the ignorance that was flowing all around the markets and financial media. By the way, if there is a bandwagon to jump on and discuss the risks facing stocks, I was one of the drivers when it wasn’t so cool. Just a few weeks ago, bears like me were being ridiculed for exaggerating risks and ignoring important things like M&A speculative premiums, buybacks, record highs, weak dollar, tame inflation, etc. etc.

On days like today, I move over and let the backseat drivers turn the wheel. Instead, I listen and think. The time for action in positioning portfolios is when it isn’t so rewarding. Selling on a day like today is reactive….NOT PROACTIVE. Effective portfolio management - the kind that helps you make money and avoid losing it - may cost you a few bps on big up days, but on big down days when the herd is reacting, most of your work should be done already.

The database at HEDGEfolios is free to use for the first month after a registration that takes less than five minutes and does not require that you provide a credit card upfront. If you check it out, you’ll see that I have had DOWN signals on approximately 55% of the 4000 stocks and ETFs that I cover during most of the time since last November. The HEDGEfolios Timing Indicator has been bearish since April 30th. I avoid reacting on day’s like today by being proactive last week and just listening, watching, learning and researching now so I can prepare for next week.

And don’t think that I feel the bull run is over because no matter how bad today can get, if it doesn’t close at the lows or recovers a portion of its poor opening, some investors will actually be encouraged by that. Others will be happy if it just doesn’t implode. The bullish tone that was abundant last week at Dow 14,000 isn’t gone forever - it’s just being drowned out by ignorant people talking smack. When this calms down and there’s a chance for the hypesters to push for a rally, it will happen. That’s when I might talk some real trash of my own.

Permabulls will tell you that every decline is a great buying opportunity.  Okay - maybe so - at least for now.  But at some point, the switch comes in and as prices lift they look like a great selling opportunity.  It hasn’t happened yet and it may not this time around, but you need to be watching for increased volume at high prices that don’t end up pushing the stocks to new levels.

The past month has been a taxing time in the American heartland state of Indiana where I reside. 2007 property taxes were adjusted for new assessments and in Indianapolis - the biggest city in the state - the average increase was 35%. Some property owners received hikes that were several hundred percent higher.

Thousands marched on the capitol in protest waving signs and shouting slogans. Demographically and politically - the protesters were representative of every section of society and the only common thread was the unwillingness to pay taxes. Of course, everyone wants the state, municipal and social services that the taxes pay for but paying the bill is not fair!

I won’t bore you with why this happened (the general theme is overspending and undertaxing), but the real lesson here is that individual citizens are in trouble financially and their primary asset (the home) is at the center of the problem. Some said they would have to sell and other said they could not sell because no one would want to buy their house even though prices were dropping. The governor stepped in and ordered that all 2007 taxes be the same as last year. It calmed the anger, it allows for time to come up with a solution and it avoided a likely tax-payer revolt. Since then, Indianapolis voted to increase income taxes to make up the shortfall from the frozen property taxes and some programs are going to be cut or underfunded.

Many Americans are struggling and even though it might be only $300 extra per year, they say they cannot afford it. So when you hear that jobs are plentiful, earnings are high, consumerism is strong, personal debt levels are fine, well I wish you were here to see a different reality.

Two weeks ago, the DJIA surged almost 300 points in one day and the market cheered. All was great. Last week, we closed above 14,000 and the market cheered. All was great. Today, we get a 200 point decline on the DJIA and the mood is suddenly dire. What’s all the drama about? On Sunday night, I commented on a very rare divergence in the 3,689 stock charts I studied this weekend (click here.) 72% (2646) declined last week but despite only a 1% drop in the S&P 500, I saw extreme negatives with 639 stocks declining by 5% or more. A big advantage of one guy (me) looking at all the charts and not just 1 chart of an index is that I see a much clearer picture of the action. As a result, I gave 359 new DOWN signals versus only 42 new UPs and a 9:1 ratio like that is worth noting. However, this market should not be underestimated and it will not take much positive talk to scare the bears or embolden the bulls. It’s happened repeatedly and until it doesn’t work, don’t count out the bullish run.