Bull markets are characterised by virtuous cycles. During the credit boom easy money boosted profits, inflated asset values and lowered default rates. Now, a vicious cycle has taken over. Loan losses are reducing supply of credit, which has prompted a downward spiral in asset prices, thereby generating yet more losses. Tighter lending standards, in turn, are accompanied by shrinking profits and rising bankruptcies. The good news for investors is that credit spreads have widened so far that the bond markets are already anticipating the worst case scenario.

There’s no shortage of bad news out there. In October, US retail sales registered the largest monthly decline on record. Job claims were at their highest level since 1982. Worse still, dreaded deflation appeared as retail prices fell over the month. It’s little wonder the bond markets are spooked. Since Fannie Mae and Freddie Mac were nationalised in July, there’s been a rash of defaults among investment grade financial companies. Furthermore, Lehman showed that recoveries from busted financials could be negligible.