HEDGEfolios year-to-date stock performance for 2008 (through 06/30/08 close) was up 16.15%.

Over the same time period, the S&P 500 index was down -12.80%.

At the end of June, the HEDGEfolios universe consisted of 3,405 stocks.

Commentary: The first half of 2008 is complete and it certainly has not been easy. With a 16.15% gain in the HEDGEfolios universe vs. a -12.8% loss for the index, I am quite happy with the performance. While I’ve managed to be bullish 73% of this year (19 out of 26 weeks), the outperformance has come from downside hedging at appropriate times and in June, I went from approximately 70% bullish signals at the beginning to approximately 70% bearish signals by the end. For the second half, I’d really like to see reduced turnover but I doubt the volatility is over. The first 6 months have been affected by continuing credit problems, high oil prices, increasing inflation, rising unemployment, and a host of challenges to consumers and corporations. Yet, there is a persistent belief that all this bad stuff is temporary and the worst is behind us. The market may believe that, but I do not.

Here is the performance chart of HEDGEfolios vs. the S&P 500 for 2008.

Prior Years’ Performance:

• 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.

Yesterday morning, Bob Pisani of CNBC suggested that the market would rally. When that happened until about 11:00, Vince Farrell decided to suggest that Pisani was some kind of market genius and named the positive action “The Pisani Bounce”. Of course when the bounce “unbounced” from 11:00 until noon, the idea of Pisani being anything more than what he really is became apparent. But hold on…not so fast… when the Dow headed higher again by the time Cramer appeared in this “Stop Trading” segment, CNBC gave kudos once again to Pisani. This is the stuff that makes CNBC funny to watch! I love hearing about things like “The Pisani Bounce.”

I used to make fun of Countrywide being treated by the media as a proxy for the health of the housing/mortgage/credit markets.

Here are a few brief samples:

Additional September 13, 2007

Off By A Countrywide Margin October 26, 2007

Is Angelo Your Leader? November 30, 2007

I guess we all know what ended up happening to that stock and how stupid all those market moves were based upon optimism for Countrywide and the mortgage /credit crisis. So now that CFC is gone as a standalone piece of crap stock and cannot be used to hype the market, I had serious flashback hell with GM yesterday and its effect on the Dow.

The headlines like this one from CNBC indicated that GM’s better than expected sales were the reason for stock market optimism and the rebound from “oversold” (I hate that term) levels. Spinning the GM’s 9% sales decline as a good thing because it beat wrong extreme estimates reminded me of how Countrywide used to get a bounce from their pathetic (but better than really really pathetic) expectations and belief that the worst was over.

Maybe you remember in September when the contract negotiations with GM and the UAW were used as hyping tool to try and spur the market higher with the concept that what is good for GM is good for the American stock market. If not, read this post called Promises Promises Promises. And then reflect how wrong those expectations were and what happened to GM’s stock price which was $37.64 when I wrote that piece and $10.60 now.

If yesterday’s rally was based upon optimism from GM and that somehow we should believe that the company and the American consumer is doing well, then we are really messed up. GM and automotive manufacturing is in big trouble. And one day after the GM short covering rally, we get to hear from Merrill Lynch saying what we already knew but disregarded yesterday - GM Bankruptcy “Not Impossible”. What a shocker! I seem to remember people suggesting that Countrywide would fail and then the deniers came out and said that it was just fearmongering and those mean short sellers. I suspect that lovers of GM will feel the same way. And the comparisons to Countrywide will only be more complete if we get a ridiculous rally every time someone agrees to provide “Additional” capital to GM (see above link). The next step along this goofy analogy would be calls for a government GM bailout because it is too big to fail. And then, when the CDS positions on GM are too scary for a test of that disaster, we might have to see a government sponsored merger with some other troubled company (Say Ford). NAHHH! Something like that could never happen!

I used to laugh and ask “Is Angelo Your Leader?” now it looks like I can say “Is GM Your Leader?” NO SINGULAR STOCK IS A PROXY FOR ANYTHING ELSE regardless of the direction. Please do not believe the worst is over just because the media hypes a story like GM yesterday .

The previous post on my Unsettled concerns about Credit Default Swaps was long and had a deep dark ominous tone. If one of my posts is long or painful to read it’s typically because the topic is extremely important and not being dealt with appropriately in my opinion. I try not to do those commentaries too often because I know they bore readers, so I’ll try for more brevity and levity today.

Our financial system was on the brink of a meltdown from counterparty risk associated with Credit Default Swaps when the Fed bailed out Bear Stearns. We still are on the brink and for the same reason. At that time, $45 TRILLION was the estimated notional value of CDS contracts. You would think that coming so close to a collapse would cause the people involved to slow things down or try to unwind this mess. But that has not happened. The most current estimate of notional CDS outstanding was $62 TRILLION. More dangerous - not less dangerous.

Listening to advocates of derivatives (and credit default swaps in particular) you’ll hear that they are good things and do a great job of spreading out risk. People in the industry making a ton of money with derivatives defend themselves and their livelihood as you would expect. Organizations such as the ISDA and its leader Robert Pickel will tell you that credit default swaps are greatly misunderstood by people like me.

Even Chairman Greenspan said how helpful derivatives and CDS are repeatedly during his tenure - just read through his speech to the Council on Foreign Relations in November 2002. Note that the CDS market’s notional value back then was about $2 TRILLION, a mere fraction of what it is today. In that speech, you’ll find some comments that should sound ridiculous based upon what we have learned in the past few months. Unless of course you make your money pushing this crap.

There are others trying to sound the warning like Yves and Barry and Mish. However, the financial media doesn’t seem to want to keep hammering on this. Instead, they just ask the simple questions and accept the simple answers and move on. As for the regulators - the CDS market is unregulated. But the closest we had were the Central Bankers. Assume Greenspan was the regulator - his mentality is what led to the giant mess we have today and that mentality still persists with sophisticated finance and economics gurus that have some control now. As for politicians and their ability to prevent a disaster with CDS contracts…that’s a joke.

Here are a few I selected from Greenspan’s speech:

As in all aspects of life, expansion of one’s activities beyond previously explored territory involves taking risks. And risk by its nature has carried, and always will carry with it, the possibility of adverse outcomes. Accordingly, for globalization to continue to foster expanding living standards, risk must be managed ever more effectively as the century unfolds.

The development of our paradigms for containing risk has emphasized dispersion of risk to those willing, and presumably able, to bear it. If risk is properly dispersed, shocks to the overall economic system will be better absorbed and less likely to create cascading failures that could threaten financial stability.

And later…..

The wide-ranging development of markets in securitized bank loans, credit card receivables, and commercial and residential mortgages has been a major contributor to the dispersion of risk in recent decades both domestically and internationally. These markets have tailored the risks associated with such assets to the preferences of a broader spectrum of investors.

Especially important in the United States have been the flexibility and the size of the secondary mortgage market. Since early 2000, this market has facilitated the large debt-financed extraction of home equity that, in turn, has been so critical in supporting consumer outlays in the United States throughout the recent period of cyclical stress. This market’s flexibility has been particularly enhanced by extensive use of interest rate swaps and options to hedge maturity mismatches and prepayment risk.

Financial derivatives, more generally, have grown at a phenomenal pace over the past fifteen years. Conceptual advances in pricing options and other complex financial products, along with improvements in computer and telecommunications technologies, have significantly lowered the costs of, and expanded the opportunities for, hedging risks that were not readily deflected in earlier decades. Moreover, the counterparty credit risk associated with the use of derivative instruments has been mitigated by legally enforceable netting and through the growing use of collateral agreements. These increasingly complex financial instruments have especially contributed, particularly over the past couple of stressful years, to the development of a far more flexible, efficient, and resilient financial system than existed just a quarter-century ago.

And later….

In decades past, such a sequence would have been a recipe for creating severe distress in the wider financial system. However, compared with decades past, banks now have significantly more capital with which to absorb shocks, and they employ improved systems for managing credit risk. In conjunction with this improvement, both as cause and effect, banks have more tools at their disposal with which to transfer credit risk and, in so doing, to disperse credit risk more broadly through the financial system. Some of these tools, such as loan syndications, loan sales, and pooled asset securitizations, are relatively straightforward and transparent. More recently, instruments that are more complex and less transparent–such as credit default swaps, collateralized debt obligations, and credit-linked notes–have been developed and their use has grown very rapidly in recent years. The result? Improved credit-risk management together with more and better risk-management tools appear to have significantly reduced loan concentrations in telecommunications and, indeed, other areas and the associated stress on banks and other financial institutions.

He went on to say a bunch of other positive things about Credit Default Swaps and derivatives in general before this prophetic warning….

More fundamentally, we should recognize that if we choose to enjoy the advantages of a system of leveraged financial intermediaries, the burden of managing risk in the financial system will not lie with the private sector alone. Leveraging always carries with it the remote possibility of a chain reaction, a cascading sequence of defaults that will culminate in financial implosion if it proceeds unchecked. Only a central bank, with its unlimited power to create money, can with a high probability thwart such a process before it becomes destructive. Hence, central banks have, of necessity, been drawn into becoming lenders of last resort.

But implicit in such a role is the assumption that the burden of risk arising from extreme outcomes will in some way be allocated between the public and private sectors. Thus, central banks are led to provide what essentially amounts to catastrophic financial insurance coverage. Such a public subsidy should be reserved for only the rarest of occasions. If the owners or managers of private financial institutions were to anticipate being propped up frequently by government support, it would only encourage reckless and irresponsible practices.

You really should read the whole thing before you make up your own mind. And then you might want to take a look at this Greenspan piece from May 5, 2005 - similar stuff with great praise for CDS and prescient warnings that went unheeded but interesting nonetheless. Just read everything you can from the supporters of credit default swaps like Robert Pickel. Let them convince you that they are smart and critics like me are stupid. Make sure you get settled on what you think is really going on here.

And then just when you have that figured out… whichever way you decide…ask yourself about settlement. “Settlement”?

I tried to get settlement information from the ISDA a month ago by sending them an email. I never really expected to see an answer so it wasn’t a surprise that I didn’t get one. But go ahead. Do your own investigation. Pretend like you are a “real journalist” and ask anyone that might have the information - how many times there have been actual settlements of CDS contracts when there was an event and what happened. Good luck finding any data much less comprehensive information. It’s an unregulated market so while you might want to know the open interest or volume or settlement - if someone has this data I think there is a good reason why it is not being shared.

Why is this important? Well, I think it’s important to know the negative and the positive consequences of anything that happens in life, not just the upfront price. And especially, I think it’s relevant to find all that out for something that could bring down our global financial system. Listening to CDS advocates - you are led to believe that they only have big benefits and the possible negative effects are minimal. Don’t you want to know what you are getting out of this CDS “risk management system” to offset what might cause a meltdown?

One of the things that has me unsettled is that CDS contracts supposedly protect against a credit event in the referenced entity - but how often has that happened?

Isn’t it relevant to know how much “protection” there is against an individual referenced entity even if that means it is 10 times the corporation’s debt?

Isn’t it relevant to know exactly how many dollars of defaulted bonds have been recovered by the “insurance” that a CDS provides?

Isn’t it relevant to know whether there was physical or cash settlement?

Isn’t it relevant to know whether the settlement specified in the contract had to be “fixed” when there was a problem like Delphi’s auction mechanism?

Isn’t it relevant to know how many settlement claims are being litigated to avoid payout?

Corporate defaults have been very low for years. So what risk was being hedged? For all the money that has been made and lost on the CDS market which now totals over $62 TRILLION - how much of that has come from trading and covering bets and how much has come from actual payouts from the outcomes supposedly being hedged?

When Countrywide was on the brink of bankruptcy before the Bank Of America bailout, there was a risk of seeing what would happen to all those Countrywide CDS contracts. We never found out did we? When the Monoline Insurers MBIA and Ambac and ACA were about to test the CDS settlement mechanisms, everything possible was done to just avoid it. Bear Stearns almost gave us a test of the counterparty risk and we were prevented from finding out what would happen.

I look at the CDS market like betting / speculating on the outcome of a sporting event but where the window never closes and the final outcome is never disclosed.

People are making money and losing money along the way but this is not a zero sum game. Sooner or later, we will find out what happens when risk dispersion meets the settlement.

The Greens are excited about hybrid cars and there seems to be a cheer that goes up every time we hear a story of somebody who got fed up with their gas guzzler and bought a Mini or Prius or any other vehicle that was more energy and environmentally-friendly. I am in favor of improving our environment too, but I don’t see this trading of an SUV for a green car as having a measurable impact on either gas consumption or lowered pollution. Where the hell do you think those gas hogs are going? For the green argument to work, the vehicle being sold has to just be written off and sent to the big green junkyards in the sky. Think about it. Do you think that a 3-year old SUV that might have a market value of $20,000 and get 15 mpg is just going to be demolished for the sake of cutting into Big Oil profits or making the Sierra Club dreams come true? Nope - someone is going to buy it and drive it and use the same amount of gas and pollute just as much as the person that had it before. Maybe the new owner of the SUV gets rid of their car that might have even worse gas mileage or worse emissions and there will be some trickledown net benefit. But if that old clunker still rolls, someone is going to buy it and on-and-on it goes.

Buying a more efficient or more environmentally-friendly car is a great thing. But just like President Bush’s offshore / ANWR drilling plan, it isn’t going to make an immediate impact. Over many years and many cycles of car trade-ins, it might have a measurable effect. Hopefully, before then we will have come up with a better national transportation system and alternative energy systems to replace our existing fleet of cars. Unfortunately for every new green car that is purchased there are thousands (if not millions) of people that cannot afford to sell what they have, regardless of how much they want to. More importantly, many Americans are in real financial trouble as they cannot afford the gas consumption of their existing car or the cost of fixing their fuel issues and they certainly don’t have the $15,000-$20,000 for a used Prius or an SUV that just appeared on the used car lot. Sorry - the green junkyard is a myth as much as I wish it were true.

Watching this brewing battle with Bud and InBev, I couldn’t help but reflect on the similarities with Hershey’s board and the politicians surrounding Hershey, Pennsylvania who told the foreign company (Cadbury) to Kiss Off. With all the St. Louis and Missouri politicians and that “Show Me” attitude, it isn’t surprising that Republican Gov. Matt Blunt and other politicians are trying to block it with that same protectionist refrain used during the Hershey deals…about how the company is a national treasure, about how important it is to the community, about how this is going to cost so many jobs, and about how shareholders should not choose dollars over jobs.

For the record, I suggest investors should never buy a stock based upon how many employees the company has!

And, oh by the way….politicians and other protectionists….you might want to check out this headline from late last week when the company announced its intention to cut 10-15% of its workforce. Hey, I thought the politicians were going to save jobs by blocking a merger!?! Now it looks like they are silent about the company cutting over a thousand jobs to block the merger. I guess they think that’s okay.

Regardless of what you think of those political arguments….please look what happened to HSY stock since the Pennsylvania politicians had their way.

As for YHOO, I just cannot miss the comparison with a board that did nothing to boost a stock price for 4 or 5 years (like BUD) and then suddenly, they know what is in the best interests of shareholders to block an acquisition. Nevermind that the acquisition was the sole reason for the stock to increase and never mind that blocking the deal or having the suitor walk away will end up with a sudden decline in the stock. Will BUD’s board ensure its shareholders are the next to get Yahooed!?

Richard Fisher, President of the Dallas Fed has been talking tough lately about inflation. He even dissented (BFD) from the rest of the FOMC yesterday and voted for a 25 bps hike. But before you get impressed that Fisher knows what he is doing and is the lonesome hawk or is serious about fighting inflation or defending the US dollar, please consider where he was on this topic in September. Click on this link. Okay - so now Fisher is fighting inflation but just 9 months ago, he said we had “wiggle room”. I called bullshit on that when it happened with this post.

Here are a few of my prior comments about our Fed and their desire to deny that inflation existed or that we needed to do anything about it.

On September 6, 2007 - shortly before Fisher was talking about his wiggle room I asked Does Inflation Matter To Central Bankers? For a long time, it was convenient for Mr. Fisher and the other guys guesstimating incorrectly about economics to suggest inflation was not a problem or that it was going to recede in the future. Well, we are in the future now. As I suggested in that post, their desire to ignore inflation would catch up to us. Now their desire to deal with inflation is going to catch up to us.

Last June 14, 2007 when the market was flying high in record territory, I wrote a post discussing the inevitability of Global Inflation impacting the US whether we liked it or whether we wanted to ignore it. I am confident that Mr. Fisher didn’t care what I said back then - he was in good company.

In fact, he was in really good company. Like Mr. Kohn, another voter on the Fed who was still denying the threat of higher prices at the end of February 2008 when I wrote about Inflation-Adjusted Inflation. Just 4 months ago, Mr. Kohn was trying to convince us that we should not be worried about inflation because it would moderate in a few years. Maybe Mr. Fisher should have convinced him then about what we are dealing with now.

As you can tell, I am not impressed with Mr. Fisher and his inflation-fighting abilities or his inflation-fighting timing. But it doesn’t matter what I think. I don’t have a vote.

Don’t worry - we bottomed already. Weren’t you paying attention when so many smarties said that over and over again the past three months? March was the bottom. Remember? Bernanke set the bottom with the Bear Stearns bailout. Remember? The worst is behind us. Remember? Maybe you and my friend Jack didn’t turn the television on to see all that nonsense.

A few days ago, I heard several morons say stuff like “we were in a bottoming process” and all this takes weeks and months. That’s a neat way to pretend that the previous claims of a firm bottom in March weren’t ridiculous or that we should just sit back and relax and feel fortunate about this new “great buying opportunity” over the next few weeks or months of this “bottoming process.” Good luck with that. And as for this sudden desire to pull out the “C” word (capitulation!) - that is a common tactic by the same bottom callers who are now suggesting that panic is a good thing. They want to assign any bad day as a “capitulation bottom” so we can rescue one stupid and incorrect concept with another stupid and incorrect concept. Capitulations are not required for bottoms and losing money real fast is not a good thing.

I cannot stand bottom calling and I have said it repeatedly on this site. Click here for my last diatribe on this topic. I just like taking days like today and pointing out how wrong the previous claims by experts and media hacks can be. I am wrong too….(about 68% of the time) but as for believing we hit a bottom in March - I wasn’t wrong. Just read through my posts - you might run into this one from June 3rd where I warned about Divergent Signals or the change to bearish on the HEDGEfolios Timing Indicator June 9th.

Listening to people calling bottoms is a dangerous idea - it may make you feel better but that only lasts until the next time you get your bottom handed to you.

I’ve lost trust in the merits of antitrust regulatory decisions. As a free trade capitalist, you might expect that I would love to approve any deal. That is not the case. Some mergers are certainly anti-competitive and hurt consumers and should not be approved.

In theory, I actually support the regulatory reviews for antitrust / anticompetitive mergers. But when I look at recent cases, I cannot help but wonder where our priorities are.

Sirius and XM have been under review for about 16 months and sometimes I question whether they’ll survive before the regulators decide what to recommend. Some interests are being protected here, but I think that has more to do with the traditional broadcasters, their lobbyists and their political power than it does with the guy driving down the street trying to listen to some tunes. How about the nonsense surrounding the FTC’s desire to block the Whole Foods and Wild Oats deal for about 6 months? Cornering the organic grocery market? Oh my, you might have to pay higher prices for organic food! Did any of the regulators ever notice that organic foods were more expensive than the chemical-laden stuff sold at regular grocers before the deal was announced? Maybe they could better protect consumers and help reduce food inflation by telling their buddies in government to stop all these farm bills, crop subsidies, ethanol fiascoes, etc.

Monopoly, Duopoly or Oligopoly power is an important consideration for our government. And yet - when the average person they are supposedly protecting looks at the deal and wonders why it’s being blocked, then there is a problem. When it takes forever to get the antitrust decision announced, then there is a problem. And when some deals get fast track approval, there is a problem.

Let’s look at the merger of JP Morgan and Bear Stearns and how that was handled from a regulatory approval perspective. If Bear Stearns and JP Morgan hadn’t needed a bailout to avoid global financial meltdown, how long do you think it would have taken to approve the merger? Look at other bank mergers or how long it took to get clearance for deals like JPMorgan and Bank One when the credit markets were not in crisis mode and it’s a bit different. I know it’s impossible to expect that this deal would have had one agency of government dare criticize the “independent Federal Reserve” and their role as the broker in this transaction, but this deal needed regulatory approvals, “including all antitrust clearances from or notices to” the following: “SEC, FINRA, FERC, the FSA, the Financial Services Agency of Japan, the Federal Reserve Board, the CFTC, the DOJ, the FTC, various foreign and state securities authorities, and various other federal, state and foreign regulatory authorities and self-regulatory organizations.” (source for that quote was the SEC filings on this deal.) They managed to get all that done in a matter of weeks. Impressive…. but appropriate?

Maybe you can say that the Bear Stearns regulatory approval should have been done really fast because it would apparently have hurt consumers if it was not done. But is that the standard of the antitrust concept? Is it okay to approve a deal if it avoids a catastrophe but may lead to higher prices or less competition? You decide. But can you honestly say that the Bear Stearns merger was less important to consumers and society as a whole than something like Organic Food Retailers or Satellite Radio? In the grand scheme of things…. does anyone want to bet how many billions or trillions this rubber-stamped antitrust transaction (Bear Stearns / JPMorgan) will cost us compared to how much the failed blocking of Whole Foods will cost organic food consumers?

I’ve lost trust in antitrust.

In the SAB Miller - Molson Coors proposed transaction - here is the DOJ decision and a snippet:

“After a thorough, eight-month investigation, during which the Division obtained extensive information from a wide range of market participants — including the companies, rival brewers, beer distributors, and national retailers — the Division has determined that the proposed joint venture between Miller and Coors is not likely to lessen competition substantially.

“In one of the key parts of the investigation, the Division verified that the joint venture is likely to produce substantial and credible savings that will significantly reduce the companies’ costs of producing and distributing beer. These savings meet the Division’s criteria of being verifiable and specifically related to the transaction and include large reductions in variable costs of the type that are likely to have a beneficial effect on prices.

Eight months to decide a case about beer. Less than that month for a case about Bear Stearns. MMMMMMMM. I love cases of beer. I don’t love cases of Bear.

And sooner or later, they’ll get to decide the InBev / Bud case. They’ll probably find that the merger will save expenses for the brewers and therefore, it must mean that consumers will benefit from it. MMMMMM. I love beer. Cheaper prices means that people can afford to drink more beer. MMMMMMM - beer. All is well.

Not really, because this “approve if costs are lowered” concept seems to be the current measuring stick in antitrust approvals from either the DOJ or FTC or the FCC or the appropriate regulatory agency. The logic of this does not work too well for me. Here are some painful examples - Exxon and Mobil or Chevron and Texaco or Conoco and Phillips. I am confident that those mergers lowered costs for Big Oil, but how did energy prices do since then for consumers? NOPE - I am not suggesting that the mergers are the reason for high gas prices. I am just saying that getting antitrust clearance (like the SAB Miller / Molson Coors example) just because it “significantly reduce(s) the companies’ costs of producing and distributing” whatever product does not mean those expense savings will be passed on to consumers.

I have lost trust in antitrust.

I have been confused by the reasons for blocking some mergers. On the other hand, I don’t believe that all mergers are inappropriately approved. I just believe that it’s hard to convince me that many mergers that get antitrust clearance end up with lower consumer prices, better competition and more product innovation. I see how they usually help speculators and investors. I see how the financial industry racks up huge advisory fees. I see how these mergers often help companies save costs. I see how it helps lobbyist groups and politicians. As for helping consumers, I have don’t have much trust in antitrust.