I've been through several bear markets (1987, 1990-91, and 2000-02), but this one takes the cake because it just keeps going. As soon as one key fundamental turns the corner (e.g., swap spreads declining), something else rears up to take its place. In the past week or two, one new problem has arisen in the market for the debt of GSEs (e.g., Freddie and Fannie), with the spread between their yields and Treasury yields blowing out to unprecedented levels, as shown in this chart. I mentioned this problem three weeks ago, before things got really crazy, and thought it would be fairly easy for somebody in Washington to put the market's fears to rest by making the government guarantee of Agency debt more explicit. But things have only gotten worse since then; the market is in full panic mode. Another recent problem is the apparent meltdown in the market for asset backed and commercial mortgage-backed securities (ABX, CMBX). The selling is intense, and the pirates are pouring over the transom, as one former colleague puts it.
I don't have a good explanation for what is going on, but I'm tempted to blame this latest problem on foreigners and not deteriorating fundamentals (the news has been so awful for so long that it's hard to see how the fundamentals could get much worse). Foreign central banks, sovereign wealth funds, and foreign insurance companies have accumulated gigantic volumes of our debt (most of which was rated AAA when they bought it) in the past decade, and those funds are being managed in most cases by people who have never lived through a financial crisis or have never managed risky assets. Agency debt was once thought to be virtually risk free, but now it is behaving almost like BAA corporate debt behaved in the 2000-02 period. That is a shocking reality that has destroyed the confidence of investors all over the world.
In short, there is not a great deal of institutional memory or expertise overseas, whereas the collective wisdom of Wall Street and large U.S. institutional money managers runs deep and spans decades. As a result, and in my experience, foreign money managers tend to be trend-followers, not contrarians.
Being a trend-follower in today's market has been a good thing, because the selloff has been long and extended. Selling has saved people lots of money. So now, despite the fact that many prices are absurdly low, any bit of bad news, including news that prices are falling, invites a new wave of selling.
Just put yourself inside the head of an overseas money manager in charge of many billions of dollars of asset-backed securities that were once considered almost gold-plated. If you sold 3 months ago, you are a genius, but if you don't sell today on bad news and prices end up going lower, you will be branded a moron by your superiors. How could anyone not understand that this is a bear market of unprecedented proportions? Bad news must always be a reason to sell.
This can go on mindlessly, but at some point most of the selling will have been done. At some point the economic news will start to get less bad, and here and there we will see glimmers of improvement. And at that point we can expect to see prices head much higher. I just wish I knew when that point will come.