I've been a short-term bear of the market for some time, but I will never EVER get out of the market because of this. I may invest in ETF's that short the market (as I have since Bear Stearns collapsed) with SDS, HXD (on the TSX) and FXP (shorting China), but I always want to maintain my positions in the market, as you never know when the market will return to the good old bull days (of course, as a value investor, I'm a long-term bull). That said, I believe we are in the late innings of the financial crisis, but we are only in the first few in the US and global recession.
This credit crunch has been a lot deeper than most people really thought. The subprime mortgage mess was perpetuated by 1% interest rates in 2002-2003, and resulted in millions of US households investing into an already heated real estate market. Because housing prices were flying high, banks were giving away mortgages like they were candy: with little income and little downpayments, people were buying houses way over their budget. The banks packaged these loans and sold them to other banks (mortgage backed securities - or MBS). Banks also buy insurance against borrowings amongst each other when they either swap securities or lend cash (credit default securities). All of these securities are under pressure these days. Liquidity is drying up, as individuals shift monies out of financials and into the safety of treasury bills (taking the money out of the banking system, and banks are now trying to deleverage themselves. This is problematic for the world market.
Since banks are deleveraging themselves, they are essentially trying to sell assets (or even denying mortgages/loan renewals) and thereby getting liabilities off their books - by repossessing assets, or by allowing other companies to lend the funds to the companies that they have denied. Banks are also failing to lend new projects, including formerly lucrative gold or oil projects. As banks reduce their liabilities, investors have less money to invest with, and consumers have less money to borrow so that they can consume. Essentially this lowers demand for everything, including commodities. Therefore, we see commodities falling, companies lowering earnings and revenue estimates, as everyone tries to pay down their debts.
The cycle then brings down world markets as demand dries up for foreign products by US consumers. As the biggest consumer of foreign goods, this will destroy growth stories for the BRIC countries further than they already are, and Europe will continue to weaken. The world markets will continue to decline, until the US banks lend again, and the US consumer spends again. Disinflationary or deflationary pressures will bring prices down as the price of consumer goods decline (since unemployment will increase, and commodities will continue to fall), and no consumer wants to buy something today, when it will be cheaper tomorrow. Therefore, prices will continue to fall, similar to what is happening in Japan for years.
Once again, this is just a theory. Your comments are welcome.
I have long positions in FXP, SDS and HXD.