Asset Bubble Bursting

| About: SPDR S&P (KBE)

The following chart (the price of a derivative contract based on single-A rated commercial mortgage backed securities as provided by Markit Partners) speaks for itself (click to enlarge):Click to enlarge

As defaults on commercial mortgages rise, the mini-bubble in toxic waste assets deflates. Note that the spike in the price of these middle-rated tranches of CMBS peaked at the end of the third quarter, just in time to produce unexpectedly large “trading profits” for a number of financial institutions. As I noted when earnings were reported, the bodacious results from fixed-income trading were a non-repeatable event. Since September 30, prices for such securities have fallen by a third.

Structured securities backed by subprime pools issued in late 2007 still are close to their recent peaks (click to enlarge):

Click to enlarge

I expect this bubble to deflate as well. I agree with Bill Gross’ comment on his web site today:

Broadening the concept to the U.S. bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and “old normal” market standards. Not likely, and the risks outweigh the rewards at this point. Investors must recognize that if assets appreciate with nominal GDP, a 4–5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.

Bank stocks are likely to fall further.