I touched on this last week, but the WSJ also had a blurb on Sowood Capital’s admission that its hedge fund had lost more than 50% of its value, or about 1.5 billion. I posted Saturday, that the loss at the time had been 25%. Oh well, things are happening so fast, what’s another 750 million? It’s only mad money.

The hedge fund manager detailed how Sowood bet on senior debt positions and hedged itself by betting against stocks and more risky debt. However, the corporate debt tumbled in value and did worse than the stocks. Very concentrated positions along with leverage ended up crippling the fund.

I’m sure they’ll be paying the hedge fund manager a big bonus out of remaining assets before he gets kicked out. Is there a chance that he will be banned from the securities industry for life? I doubt it because hedge funds are unregulated, and I believe that they may even be allowed to use certain zoo animals for selection of their investments.

Continued failures of institutions/funds will increase fear that the current credit crunch may get worse, and I am sure that some have already looked towards the Fed for help (translation: bailout).

Last week, however, St. Louis Federal Reserve President William Poole dismissed any Fed involvement to bail out the stock market by saying:

“The Fed should respond to market upsets only when it has become clear that they threaten to undermine achievement of fundamental objectives of price stability and high employment, or when financial-market developments threaten market processes themselves.”

Hmm, let’s see if the Fed sticks to that game plan.

A few months ago, I read Gregg Easterbrooks’ book “The Progress Paradox,” which carries the intriguing sub title “How Life Gets Better While People Feel Worse.”

He draws on three decades of research and thinking to support the idea that almost all aspects of Western life have greatly improved in the past century—yet today, most men and women feel less happy than in previous generations.

He delves into the emerging science known as “positive psychology,” which tries to understand what causes a person’s sense of well-being and offers an alternative to our culture of crisis and complaint. He makes a compelling case that optimism, gratitude and acts of forgiveness not only make modern life more fulfilling but are actually in our self-interest.

He talks about subjects like “Abundance Denial,” “The Tyranny of the Unnecessary” and explains that we have more of everything than any generation before us except happiness. I liked this quote:

“From the standpoint of happiness math, it should be reiterated that it is far better there be millions of free, prosperous people who have the time and leisure in which to become depressed—many undergoing depressions in nice houses and attempting to distract themselves with nice vacations or nice dinners out—than numerous possible alternatives.”

He references very interesting studies about ‘self-reported’ happiness by a psychologist of the University of Illinois that offers some interesting facts and explanations. I won’t disclose the details here, but it’s a well written book, which could give guidance to many that are wondering why they’re doing well but not feeling it. I enjoyed it and give it thumbs up.

In a recent post, I talked about Bear Stears’ closure of 2 hedge funds that were essentially worthless.

A few days ago, Bear Stearns (BS — hmm, I’m not sure if this is a fitting abbreviation) halted investors’ redemptions from another $900 million Asset-Backed Securities Fund, as worried investors were trying to pull their money out as fast as they could.

Here’s where the fear factor sets in. BS said that only 0.5% of the fund was invested in subprime, or high-risk, loans. Yeah right; maybe so, but once you lose credibility, no matter what you say, investors will assume the worst.

That’s a clear indication that the subprime virus has spread, and will continue to do so, even to institutional investments that may have very little exposure to it. Herein lays the danger that perception may take a hold of reality and pull asset classes down that are not directly related or connected.

Here are some more tidbits from infected parties. Sowod Capital Management acknowledged that it had lost 50% of its value in July and sold most of the assets for fear of not being able to meet margin calls. Australia’s Macquarie Bank said two if its hedge funds could face losses of 25% in July.

It is stories like these that, if continuously fed to the media, will eventually spillover and severely influence stock market direction as well, which may have already happened. This phenomenon is also called reaching a “tipping point,” where the viral effect takes over and feeds on itself.

Again, my point simply is that you need to be alert to any change in investment climate and be ready to pull the trigger on your sell stops should the need arise. Stick to my rule number 1 of investing: Never invest in anything unless you have established clearly defined exit points.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Today’s sharp sell-off brought several of our sell stops back into play. We will liquidate those positions on Monday. For more details, please see the above link.

Our Trend Tracking Index (TTI) for domestic funds/ETFs fell but still remains +1.45% above its long-term trend line (red) as the chart below shows:

The international index has now moved to +1.21% above its own trend line, as you can see below:

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Reader Nitin sent in a link to an article called “Protecting the Investments of the Bad Investor,” which was recently featured in Yahoo Finance.

I agree with the overall premise that there are many investors who are not doing well, getting below average returns by buying, holding and selling at the wrong time.

The article goes on to state that “the Pension Protection Act of 2006 is encouraging increased use of asset-allocation funds, such as target-date and lifecycle funds, particularly as defaults in defined-contribution plans.”

I guess the idea is to protect investors from themselves, and their untimely decisions, by establishing a group of “default” investments. What that means is that someone decided that a default investment will do better than you could do on your own.

This may be correct in some cases, but the problem is with the default investments, which are pegged to be asset allocation funds like target-date and lifecycle funds. However, the study admits that asset allocation funds severely under-perform equity funds, but they “have prevented significant losses due to fear-based selling.”

Huh? I am simply dumbfounded by the fact hat one study can come up with that much garbage.

Are you now supposed to invest in underperforming asset allocation funds, which then will lose as much or more in a bear market scenario? Translation: Get less of a return but lose more since the obvious conclusion is to Buy and Hope through any type of market environment.

Don’t believe it?

I wrote the article “Do Lifestyle Funds Provide More Security” in early 2003, just before the bear market ended. It clearly confirms that Lifecycle and other allocation funds suffer just as much in a bear market scenario as equity funds but, in a bull market, you don’t get nearly the upside potential.

The article goes on to make other moronic statements like “this analysis shows that asset-allocation funds deliver what they promise — lower risk, no switching and real returns for the investor.”

Suuuure; and I have some subprime loans I’d like to sell you for top dollar…

Let me make it clear again: The biggest danger to your portfolio is the re-occurrence of another bear market and not whether you are in the best performing fund during a bull market. If you can avoid the bear by being safely on the sidelines, your investment returns will beat just about any equity mutual fund, index or stock that was held to oblivion.

After the markets meandered for most of the day, I liquidated 2 positions that had dropped off their highs by -7.5% as announced yesterday.

Of course, I had no idea that my trades were so influential that they confused Wall Street traders and promptly ignited a strong rebound rally during the last hour. While all major indexes closed higher, it was clearly a party of one, as the Dow was the king of the Street for today.

If this feels like a roller coaster to you, you are not alone. Increased volatility may stay with us for a while and is an indication that the market is in a shakeout mode. That simply means that future direction is uncertain and a break either way can occur at anytime.

For tomorrow, none of my other sell stops have been triggered, so I will watch and wait.