After falling to its lowest level of the year, the market ended the month of November on a positive note, with five up days in a row.  After today’s market drop, we now see the previous five days of trading as the perfect definition of a quick bull rally in a bear market.

Given that we are dealing with a broken financial system and a crisis of confidence that most have not seen in their lifetime, it is no surprise that volatility and uncertainty remain at historical highs.  The fact that the one and three month T-bills are yielding 0.01% shows us just how scared investors are.  What’s next, paying the Government to hold our money?  With many credit markets still highly dislocated (evidenced by record spreads on corporate and municipal bonds), we cannot with any confidence state that the financial panic is behind us.

Despite the HUGE government policy actions, including last week's move by the Fed to buy (with hot off the press dollars) up to $800 billion of mortgage-related securities, the downward spiral in home values does not yet appear to be broken. The unwinding of leveraged positions by the banks, hedge funds, mutual funds, and other institutions has caused a vicious circle of selling.  To a degree, this crisis is self-generating.  Fear is creating the panic runs on various debt instruments and financial institutions as well as the disorderly liquidations of stocks and bonds.

Trust, confidence, and certainty are the keys to our financial markets and economy. All have been damaged, and there is no way of knowing when confidence will return.  This is most unfortunate since financial assets are trading at their most attractive levels in decades, which implies that prospective multi-year returns are likely to be quite attractive by historical standards.  Clearly we are in the midst of a deepening recession, but it remains a very open question how severe the ultimate outcome will be.  Today, most asset classes are trading at levels consistent with the unfolding of the worst recession since the 1930s.

The key question is whether markets are right to price in such a severe recession, or do asset prices at current levels represent an over-reaction based on forced and panic selling?  Hopefully the markets have overshot like they usually do and the recession won’t be as bad as is currently feared.  This would bode well for investors who have endured the last two months, and hopefully be rewarded for not abandoning the investment world.