After a rebound rally on Tuesday, reality set back in on Wednesday and sent the major averages sharply down with the Dow losing some 237 points.

Financial stocks tanked again with Fannie Mae and Freddie Mac leading the charge by dropping an astonishing 13% and 24% respectively and reaching price levels of the early 90s. The major indexes have now all come off their October 2007 highs by more than 20% and have entered bear market territory according to the text book definition.

Our Trend Tracking Indexes (TTIs) followed suit and to no surprise, more ground was lost confirming bearish tendencies. Here’s how the TTI’s ended up as of Wednesday’s close:

Domestic TTI: -2.83%
International TTI: -12.12%

None of our positions have changed with the bulk of our portfolios being in cash, a small percentage in Swiss Francs and Gold and a limited exposure to some hedged mutual fund positions as previously discussed.

If the entire Subprime/credit crisis disaster would not have had such dire consequences, the following story could be considered a joke as the “Fed plans new rules to protect future homebuyers.” Here is one of the highlights of these proposed revolutionary changes:

Under the proposal unveiled last December, the rules would restrict lenders from penalizing risky borrowers who pay loans off early, require lenders to make sure these borrowers set aside money to pay for taxes and insurance and bar lenders from making loans without proof of a borrower’s income. It also would prohibit lenders from engaging in a pattern or practice of lending without considering a borrower’s ability to repay a home loan from sources other than the home’s value.

Wow; these are really earthshaking rules. Somebody will actually have to prove that he has income before buying a home? Ridiculous! And to top it off, the borrower actually has to show that he can make the payments? How low can you go?

We are living in the supposedly most developed and sophisticated nation in the world, and we are now coming up with rules and regulations that have been basic knowledge around the world for centuries. It’s a sad state of affairs that we now have come to a point where we have to state the obvious, that you simply have to be credit worthy to get any kind of loan.

How this fact has been “overlooked” by those underwriters responsible for its implementation during the formation of the housing bubble will always be a mystery to me. On the other hand, this mortgage fraud was one of the greatest pyramid schemes in history and, in my view, a once in a lifetime event. The consequence will be far reaching for years to come, and I sure hope that some justice will be served as it usually is when guilty parties to a Ponzi scheme are caught.

If you look at yesterday’s chart of the Dow (thanks to MarketWatch), the word cliff diving comes to mind. Good thing that there was some type of recovery, or it could have been a real ugly day.

When all was said and done, the widely followed S&P; 500 closed at its lowest point since July 2006. It is obvious that confusion reigns, with heavy selling focused on the financials. There seems to be some panic in that sector and one analyst was quotes as saying that “the CEOs and financial officers in that industry aren’t lying when insisting that the worst is over, but they don’t understand the depths of the problem.”

I agree with that and an article from a German newspaper seems to support a similar view.

Translated, the article says that, according to a study, the crisis in the financial community is to be far worse that expected. Bridgewater Associates, the second largest hedge fund in the world and advisor to many top banks, estimates losses of $1,600 billion vs. the $400 billion which so far have been realized.

If that comes to pass, it will spell trouble for many financial institutions. However, since we don’t control that outcome, we remain in trend following mode. As of yesterday, here’s how our Trend Tracking Indexes (TTIs) stand:

Domestic TTI: -3.10%
International TTI: -11.68%

These numbers confirm that we are in a bear market, which means that we have most of our assets safely in money market (U.S. Treasury) on the sidelines as well as some small holdings in a fully hedged position.

In the past, I have poked some fun at those making outlandish predictions, since in most cases the results are more or less based on nothing but luck. However, sometimes an individual can accurately analyze present economic conditions, especially if they are totally out of whack with reality, and come to logical conclusions as to what the likely outcome will be.

This was the case with Peter Schiff, the owner of an investment company, who made some dire real estate predictions back in Dec. 2006. He actually walked the talk by selling his home in Orange County, California, relocating to another area and becoming a renter.

It appears that Peter was right on with his at the time heavily criticized and laughed at viewpoints.

Calculated Risk featured 2 video clips with Peter. One shows him on CNBC where he reiterates his opinion, which is spot on. It’s worth listening to.

The other video clip features him back in 2006 in a discussion with several so called experts making housing predictions. It’s pretty funny when you see some of these jokers making the case for a continued housing boom vs. Peter’s straight forward analysis.

Whenever stock prices correct, or the major indexes slide into bear market territory, a number of predictions are bound to follow as to its duration. Random Roger wrote a tongue in cheek piece on that subject titled “The shortest bear market in history:”

Wall Street traders and strategists alike are breathing a huge sigh of relief now that the bear market of 2008 is now over.

Ahem. AHEM.

Any trend, whether bullish or bearish, has to run it course before a turnaround can occur. Most investors, however, don’t have the patience to wait but instead follow the urge to take a stab at buying on dips, which may work in bull markets but has proven disastrous during bear scenarios. Of course, this course of action of buying early is supported by the brokerage industry for nothing but selfish reasons.

If you are following trends, you will know when the bears have run out gas and the time arrives to be bullish again. You will not buy at the exact bottom, since we need to see its formation before we can measure and identify it, but somewhere within 10% of it. While that will lessen your potential profits on the upside, it will at the same time avoid a bunch of whip-saws or portfolio losses caused by jumping in too early.

Prior to the last buy cycle coming to an end, I have addressed the fact that we have held on to two of our domestic mutual fund positions and hedged them against further downturns rather than selling them. Reader Tom had this comment:

Thanks to you, I have been sitting comfortably on the sidelines after I lost my initial 7% when the downslide first started. I also decided to sit out your most recent buy signal based upon the dire predictions of some of the references you had been quoting.

I certainly respect your advice as my portfolio took a drubbing in the 2001-2003 declines, but I managed a wry smile today when the market dipped 20% below the October 07 high.

If you search Google on the topic of hedging, you’ll find millions of answers. Most of them may not be worthwhile for you and some involve incredibly complicated computations. I think that the majority of these offerings are not for the every day investor.

I have not found a site which addresses simple hedging strategies that any investor can use along with his mutual funds and ETFs. So I designed my own. I have done some extensive research and testing with impressive results. My plan is to put these findings in an e-booklet of maybe some 20 pages and distribute it for free.

Before you ask when that will be available, I am not sure yet. Time always gets the better of me, but I hope to get something done within the next 60 days. Once I have something definitive, I’ll make the announcement on this blog and in the weekly update.