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9:00 AM EST, Friday, May 22, 2009. I have a little money in a hedge fund. They've usually been pretty good. As you read this -- an excerpt from today's letter covering April's miserable performance -- think their pain and my old mantra "When in doubt, stay out." My bolding:

Estimated net returns were -3.04 % for April, while the S&P 500 was up 9.39%. Net exposure averaged about neutral during the month. Average daily gross exposure was unchanged from the previous month at approximately 48%. We will continue to increase gross exposure when stocks exhibit more reasonable dispersion and lower correlation.

Our shorts were quite unprofitable during the month. Software, data communications, hardware and semiconductors were unprofitable. Generally, the stock prices of growth companies react to revenue acceleration or deceleration and our data gathering regularly provides us with information advantages to monetize. In April, the market rewarded companies demonstrating cost control even when revenue was below expectations. Many of our fundamental shorts, where we had a negative read on business trends, reported earnings that were 'less bad than feared.' This was the dominant earnings story for this season. The majority of companies have reported better than expected EPS, though many experienced worse than expected revenue. This is a testament to our economy and corporations, that they were able to effectively cut costs and lower expenses in a trying period. Furthermore, the market seems to be now discounting an economic recovery and looking through soft near-term results.

Our longs were not sufficiently profitable enough to offset the losses in shorts. The market rewarded reasonable earnings reports in April; sadly, several of our larger positions reported their March quarters in the month of May rather than April. Furthermore, we had a cluster of negative alpha events, i.e. we were simply wrong more than usual in our stock picks. Although we have been profitable in over 80% of quarters since July 2002, oddly enough we have been profitable in only two of seven April months since inception. We are not sure if this is due to allergy season or randomness.

We were very disappointed in our April returns. We have always said that sharp market moves are not conducive to our strategy. After protecting capital in 2008 and investing nimbly for the first quarter of 2009, we encountered an investing environment that was challenging in unexpected ways. The sharp rally and shifting market dynamics caught us off guard. Investors seemed focused on an economic recovery and money flowed to areas which offered leverage in a recovery in spite of near term business trends.

For years we have written about our concerns with the debt-fueled nature of our economy. We have written since 2005 about our worry over the housing bubble, and the resulting illusion of wealth that enabled consumers to spend well above their means. Perhaps our continued concerns left us with a negative filter regarding the data and reported earnings.

Some of the clear positives in the market include the removal of systemic risk, cash on the sidelines, tighter credit spreads, robust demand in developing countries, reasonable inventory levels and improving economic data. Following a horrific contraction of economic activity, data did improve. Investors in March were positioned for further market declines. When systemic risk became less of a concern, investors scrambled to adjust portfolios and put money to work. The rally off the lows drove to more speculative stocks as investors bought names that would leave them most levered to potential upside. Investors appeared to be scrambling to participate in the rally. The fear of under-performance risk amongst professional money managers created an urgent need to get off the sidelines and participate in the rally, further fueling gains.

April was disappointing and in hindsight there are things we would have done differently. We believe we acted prudently in the interest of our investors. In a month and a half the mantra swung violently from “cash is king” to “buy the highest beta stocks so you don’t miss this recovery.” Meanwhile, many companies are providing little earnings guidance for the year as they have limited visibility. While the worst may be behind us, it is a large leap to assume we are close to getting back to normal. The state of the economy is being compared to the Great Depression, highlighting how volatile, dangerous and uncharted this environment is.

After earnings season, investors may stop and reevaluate the state of the economy. We made it back from the brink. Earnings, in many cases, exceeded conservative guidance. Those who are now saying that this will be a V-shaped recovery must ask themselves what the drivers of economic activity will be. Investors have recently been following the traditional recession playbook of buying stocks when economic data stops getting worse. Those who are buying early cycle stocks should consider that we might now be in a highly unusual economic environment, one where the government is a majority owner of many of the biggest companies and industries. Government will use its power to its own advantage, but government is known neither for its business acumen nor for maximization of shareholder value. Populist politics may have unintended consequences. Regulating compensation will drive talent away from domestic banks. Halting foreclosures will merely encourage other homeowners to discontinue mortgage payments; the bumper sticker “Honk If You’re Paying My Mortgage” is painfully funny.

End demand is still quite uncertain. Consumers spending rebounded a bit since December, with higher tax refunds, help from a foreclosure moratorium and perhaps some pent up demand. Warren Buffett and Best Buy have warned against expecting the consumer to quickly recover. Many consumer product companies highlighted that the consumer is retrenching, trading down to cheaper items, saving more and spending less. Wal-Mart had a large jump in new customers who used to shop at high-end retailers but are now looking for lower prices.

Mortgage foreclosure activity is heating up again. The Financial Times recently published an editorial suggesting that the U.S. AAA credit rating could one day be at risk, something we have written about in the past. Supply of stock offerings and insider selling vastly outweighs insider buying. Government intervention in the economy is heating up, worrying market participants.

Going forward there are many risks. Economic news seems less bad compared to earlier horrific readings, but there are few indications of a recovery around the corner. What we just saw in 2008 was the bursting of a multi-decade debt, credit, and consumption bubble. The ripples of this will be felt for years to come. You cannot have a multi-decade party and not expect a hangover. The U.S. consumer has been carrying a heavy load, accounting for over 20% of world consumption. The enablers of this levered consumption were housing, credit cards, and the shadow banking system. These pillars are all now structurally impaired.

With $14 trillion of consumer debt outstanding, we are entering a period where people must choose between saving and consumption. There is no longer any magic ATM machine from which the consumer can draw. Baby boomers, the largest segment of our population, are at retirement age but now may be forced to continue to work after the recent financial setbacks. These people cannot be expected to invest, save, and also spend. We could be facing a multi-year period of retrenchment of consumption and muted economic activity. Following a credit bubble of this magnitude, our economic recovery should not depend on unprecedented government spending or artificial support for asset prices but on a repair of balance sheets and capital investment in economic ventures. ...

The stockmarket continued: Now you're thoroughly confused, read this piece from yesterday's SmartMoney:

Why Jeremy Grantham Changed His Mind
IF PEOPLE HAD PAID ATTENTION to veteran investor Jeremy Grantham over the past two years, their investment portfolios would be looking much better than they likely are. While many investors were caught up in bull-market euphoria in 2007, Grantham, who oversees $85 billion for Boston-based institutional money-management firm GMO, told anyone who would listen there was a global bubble: “It’s everywhere, in everything.” Then, in early March of this year, when the market looked its worst, he wrote that people needed to get over their fears and invest, because U.S. stocks were cheap and foreign stocks even cheaper.

Grantham’s disregard for the conventional wisdom has brought him grief at nearly every point of his 40-plus-year investing career. But more often than not, the often grumpy Grantham, 70, has been right over the long term. The irony of all his remarkable forecasting is that few ordinary investors can invest with him. The funds GMO runs are mostly geared toward institutions, such as pension funds or school endowments, although the Evergreen Asset Allocation fund invests exclusively in funds managed by GMO. GMO investors lost money last year because many of its funds dictate a substantial degree of stock holdings even when the boss is decrying the market. Still, GMO’s U.S. stock funds lost only about half what the S&P did during the crash, and some other GMO funds did much better.

Grantham, 70, has an opinion for everyone about the best investment strategies in these uncertain times. Sitting in his office lined with giant Buddhas and relics of civilizations long gone, Grantham talked to SmartMoney about the stock market and the current financial mess.

SmartMoney: In 2007 you were worried the global financial market could fall apart, and you said a market downturn was probably coming. Okay, say it: “I told you so.”

Jeremy Grantham: That seems so long ago. I felt like saying that a few months ago, but now onward and upward, and wait for the next unexpected twist.

SM: Why were you so certain things were going to get so ugly?

JG: There wasn’t a whole lot of doubt where I was coming from. I thought the fair value of the S&P was 925; the S&P went to 1500. And by 2006 the housing bubble was at a 100-year peak. This was the 32nd asset bubble that we’ve tracked, and all but the U.K. housing bubble have popped.

SM: Why didn’t you just put all the money in GMO’s funds into cash?

JG: Every quarter, we do our best to tell our clients the truth. We were comfortable with telling our clients there was a major bubble in every asset class, everywhere. Then they go to investment committees and decide what to do with their money. They don’t want to do anything that looks eccentric and costs them their jobs. It’s a miracle that any of our advice perks up the pipeline.

SM: Why did your own funds lose so much money when you were confident the market would fall apart?

JG: Most of our mandates require us to be nearly 100 percent invested. But even when you had to be at least 45 percent equity, then you couldn’t help but to go down. There was nowhere to hide. Everywhere and everything got hit.

SM: Yet now, for the first time in years, you like U.S. stocks.

JG: We think a fair price for the S&P 500 index is 900. By sheer divine intervention we bought into the market on Mar. 6, the day it hit the recent low of 666. It’s likely, but far from certain, that we’ll go back and make a new low. You aren’t going to get to buy at the absolute low unless you have a time machine.

SM: Anything else besides U.S. stocks?

JG: U.S. stocks were nicely cheap, and frankly, the rest of the world was even cheaper. In early March, when we bought, we invested only in stocks we thought would have a 10 to 14 percent average annual return after inflation. That’s magnificent. We haven’t seen anything like that in 20 years. It was somewhat disappointing that prices moved up so fast in just a couple of weeks. The odds are a bit more than 50-50 that we will go back and test that low.

SM: So you’ve made a quick buck. Now what?

JG: You have a set of possibilities. First, if the market nosedives, it’s easy: You buy. The second is confusing, when the market just goes sideways, between 700 and 800. The market is irritatingly cheap then, but not supercheap. The longer that goes on, the less probability we will set a new low, so we’ll ultimately put money each month into the market.

SM: What if stocks keep rallying?

JG: If the market goes higher, above 950, and then starts moving sideways, between 950 and 1050, we probably do very little. Then the market is moderately overpriced.

SM: Over the long haul, is there any particular industry or sector you like?

JG: The people who move quickly in this market can make money. The people who invest in energy alternatives will make more. Alternative energies and combating climate change are the single most important economic initiatives over the next 10 years—really over the next 50 years. It will be a very exciting next 50 years.

SM: That’s the future. But why did so many supposedly smart people miss this disaster over the past two years?

JG: The ultimate villain of this is the belief in rational expectations—that the market tends to be efficient. People who have anything to do with investing either believe it a bit or believe it a lot. There are only a few of us ornery disbelievers who don’t believe that the market is efficient at all.

SM: What’s wrong with believing that the market is efficient?

JG: If you believe in it, then you don’t see asset bubbles. And there’s nothing as dangerous as an asset bubble. If you even slightly believe in it, you believe in [former Federal Reserve Chairman] Alan Greenspan’s idea that markets can control themselves. You believe that you should buy and hold the market. You believe you should have a fixed asset mix and you should never change it, because why would you? The market is efficient! When you believe in market efficiency, it’s like being on the railroad watching the locomotive coming toward you. Then you just stand your ground just for the discipline of not moving. It’s ruinously expensive.

SM: Will we get out of this mess?

JG: The stimulus is so great in the United States, China and the United Kingdom, it will kick the economy up. GDP will go back positive for two to three quarters. They’ll assume everything is settled, that throwing money at it has worked. But the long-term imbalance between overproducers [like China] and overspenders [like the U.S.] will continue. It’ll be a multiyear drag on growth.

SM: We’re just throwing money at the problems?

JG: If the problem is that we consume too much and borrow too much, does it make sense to borrow more and spend more? It doesn’t make sense to solve alcoholism by giving an alcoholic a quart of whiskey, but everyone believes that we must stimulate. So that’s why we feel this is a temporary cure. This is like when you revive the drunk, he staggers down a few blocks, then falls down again.

SM: That does not sound promising.

JG: We’re not rich, and we’re undersaved and underpensioned. Those will be a real brake on economic growth. This will be a pretty long recovery period, longer than we’re used to, but hopefully not as long as Japan took. It will not be as long as the Depression, but it will be several years, and not just two. Lord knows we have had several fat years.

SM: Won’t our leaders help?

JG: President Obama is not doing the right thing. I admired his appointments in many areas, certainly in the environmental area. But then he got these tired old retreads from the financial area that notoriously didn’t blow a whistle over the last few years. They’ve all been Rubin-ized [influenced by former Treasury Secretary Robert Rubin].

SM: So why are these life-size Buddhas and other statues in your office?

JG: I’m a history freak. I find old civilizations fascinating. Great empires all rise and fall. It’s sad that we don’t know how the future will work out. A time machine would be a wonderful device, even if you couldn’t use it for investing.

Grantham’s Outlook
Jeremy Grantham’s firm, GMO, predicts long-term returns, adjusted for inflation, for a variety of assets. Here’s its prognosis for the next seven years.

U.S. stocks: GOOD
GMO has recently warmed to homegrown stocks. It expects a nearly 9 percent average annual return, above the historic average.

International stocks: VERY GOOD
GMO was bullish early in the decade, then turned sour. Now it expects a 10.7 percent average annual return for large foreign firms and12.7 percent for smaller ones.

U.S. government bonds: BAD
Long-term bonds will average a tiny return of 0.5 percent a year.

Timber: FAIR
Even though GMO expects a 6 percent average annual return, it thinks stocks are a better deal now.

The full article is at SmartMoney.

Three girlfriends Meet for Lunch
I had lunch with two of my unmarried friends. One is engaged, one is a mistress, and I have been married for 20+ years.

At an earlier lunch we had decided to amaze our men that evening by wearing a black leather bra & bodice, stiletto heels and a mask over just our eyes. The results:

My engaged friend: The other night my boyfriend came over and found me wearing a black leather bodice, tall stilettos and a mask. He saw me and said, 'You are the woman of my dreams. I love you.' Then we made love all night long.

The mistress: Me too! The other night I met my lover at his office and I was wearing the leather bodice, heels and mask over my eyes and a raincoat. When I opened the raincoat he didn't say a word. We had wild sex all night.

Then I had to share my story: When my husband came home I was wearing the leather bodice, black stockings, stilettos and a mask over my eyes. As soon as he came in the door and saw me he said. What's for dinner, Batman?"

Getting one's priorities straight.
A man seeking to join a south Texas Sheriff's Department is being interviewed by the Sheriff: "Your qualifications all look good, but there is an attitude suitability test that you must take before you can be accepted."

Then, sliding a service pistol across the desk, he says: "Take this pistol and go out and shoot six illegal aliens, six meth dealers, six Muslim extremists, six Australians and a rabbit."

"Why the rabbit?"

"Great attitude," says the Sergeant. "When can you start?"

Serious sacrifice
An elderly couple were having dinner one evening when the husband reached across the table, took his wife's hand and said, 'Martha, soon we will be married 50 years, and there's something I have to know. In all of these 50 years, have you ever been unfaithful to me?'

Martha replied, 'Well Henry, I have to be honest with you. Yes, I've been unfaithful to you three times during these 50 years, but always for a good reason.

Henry was obviously hurt by his wife's confession, but said, 'I never suspected. Can you tell me what you mean by 'good reasons?''

Martha said, 'The first time was shortly after we were married, and we were about to lose our little house because we couldn't pay the mortgage. Do you remember that one evening I went to see the banker and the next day he notified you that the loan would be extended?'

Henry recalled the visit to the banker and said, 'You saved our home. What about the second time?'

Martha asked, 'You remember when you were so sick, but we didn't have the money to pay for the heart surgery you needed? Well, I went to see your doctor and, if you recall, he did the surgery at no charge.'

'I recall that,' said Henry. 'You did it to save my life, so of course I can forgive you for that. Now tell me about the third time.'

'All right,' Martha said. 'So do you remember when you ran for president of your golf club, and you needed 73 more votes???

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.