What a difference a day makes. Take Tuesday, after the Dow shot up 391.47 points. Immediately, Wall Street’s latest party line, ridiculed by some skeptics, spread from a murmur to a veritable roar that the stock market has bottomed, the worst of the credit and housing crises has passed, and the economic downturn, possibly a recession, will not be as bad as some expect.

Apparently, a lot of investors are buying the sunny scenario, having eagerly snapped up an estimated $3 billion worth of American stock mutual funds over the past week or so. One hedge fund, New York’s Balestra Capital Partners, vigorously disputes such thinking. Based on the firm’s assessment, investors who took part in that $3 billion buying spree are living on cloud nine.

Balestra, a bearish $575 million hedge fund, up from $250 million of assets a couple of years ago, is not to be taken lightly. As of late, its performance is what Wall Street dreams are all about — up so far this year in a losing, agonizing 2008 stock market, and showing a dazzling 199% increase last year. Late last year, when I caught up with Balestra’s top money manager, James Melcher, his words were was downright frightening. Citing then what he thought were significant dangers for the financial system, he told me, “I would run for the hills; the worst is far from over.” He was right on the money. His investment thesis was simple enough: “The ingredients are in place for the worst kind of a recession, which means it’s the wrong time to own stocks.”

Backing up this strong view, Balestra’s strategy has included shorting stocks and bonds (a bet they would fall in price), notably mortgaged-backed and junk bonds, through the use of derivatives, put options, credit default swaps, and buying gold bullion. That strategy is basically still in effect.

Mr. Melcher, described by one admiring client as “a modern carbon copy of George Soros or Michael Steinhardt” (two investment superstars, the latter of whom is an owner of The New York Sun), declined to be interviewed. Instead, a senior analyst at the fund and a member of its investment policy committee, Ryan Atkinson, updated me on the firm’s thinking. He declined to quantify the extent of the fund’s 2008 gain so far, other than to note, “We’re having another good year.” He added, “We haven’t changed; we’re still negative.”

Near term, say over the next month, Mr. Atkinson believes a combination of factors, such as an oversold market, the Federal Reserve’s establishment of a credit facility for investment banks, and a record short interest, could produce a stock rally of 5% to 7%.

“I wouldn’t look for anything beyond that,” he says, “because the fundamentals longer term are still negative.” He points in particular to the danger of a recession, which may already be underway, the enormous leverage built up in the financial system over the past several years, a record amount of consumer debt, financial institutions’ huge amount of debt relative to equity, and the likelihood of a lengthy deleveraging process.

Mr. Atkinson thinks the market is headed considerably lower by year-end from current levels, say, at least another 10%.

For the average long-term investor, he recommends that stock portfolios be 30% to 50% in cash. “I just wouldn’t have much equity exposure now and I’d use any rallies to lighten up,” he says.

What about hiding in overseas stocks? Mr. Atkinson thinks they’re a bad hiding place. Over the next six to eight months, he expects the direction of foreign stock markets to be highly correlated with the American market, saying, “they’re going down.”

Buy recommendations on beaten-up financial stocks abound on Wall Street, but Balestra figures they’re about as appetizing as cancer. “Fundamentals of the financials have changed materially,” he says. Looking ahead, he sees considerably more write-downs, a sharp downturn in the return on equity from prior lofty levels, a continued widening of credit spreads on fixed-income instruments relative to Treasuries, and a lot more red ink.

Though there has been a longterm energy bull, Mr. Atkinson thinks prospects of a recession here and possibly worldwide suggest a negative outlook for energy stocks over the next year or two. His overall bottom line: “More bad news ahead, both economically and for the stock market.”

One veteran investment adviser, Martin Weiss, the head of Weiss Research of Jupiter, Fla., shares Balestra’s bleak outlook. His argument: Recent action by the Federal Reserve — speeding up credit easing and bailing out troubled Bear Stearns — will not stop home prices from falling, debts from defaulting, or the economy from sinking into a severe recession.

“The real world is we’re in a bear market, stocks are risky as hell, and anyone who believes we’re out of the woods is living in a dream world,” Mr. Weiss says.

dandordan@aol.com