Market Insider: You Are Entering the Twilight Zone

The stock market is now officially in no man's land.

Those were the words of one trader, but he certainly isn't alone in that view. Friday promises to be no less strange as options expire in equities, and credit markets continue to show new signs of frosting over.

In the credit markets Thursday, spreads for all types of securities blew out to record levels against Treasurys. Meanwhile, the flight to quality into the Treasury market took yields on T-bills to near zero, pushed the yield on the two-year below one percent for the first time since the 1950s, and took the 30-year's yield to record lows.

"I don't think people get how historic this really is," said Kevin Ferry of Cronus Futures Management.

Meanwhile, stocks were pounded Thursday with the Dow losing another 5.6 percent to 7552.29, the lowest level since March, 2003. But the action in the S&P 500 was truly frightening. The index fell through its 2002 lows, a level traders were hoping would hold.

The S&P ended the session down 6.7 percent at 752.44, a more than 11-year low. In fact, stocks in that index have been so crushed that now that more than a third of them would no longer officially qualify for membership in the index because their market cap is less than $4 billion.

For traders following technical charts, the next stop for the S&P 500 would be 700 or lower.

"I think stocks are cheap, but on emotion they're not and in the short-term, emotion will always win out over fundamentals," said Tim Smalls, head of equities trading at Execution LLC.

The Dow is now down 19 percent so for this month and off 47 percent from the high it hit in October, 2007. The S&P is down 22 percent on the month and is 52 percent from its all-time high. The Nasdaq, which fell 5 percent Thursday, is at its lowest level since March, 2003 and 54 percent below its October, 2007 high.

There is no economic data on Friday. Philadelphia Fed President Charles Plosser speaks on the financial crisis at 8:30 a.m., and Chicago Fed President Charles Evans speaks on the economic outlook at 12:40 p.m.

Financials Get Fried

Financial stocks lost 11 percent on top of Wednesday's 12 percent decline. One standout was Citigroup , which fell below $5 per share, a level that spooked an already nervous market. CNBC's Charlie Gasparino was first to report that Citi management acknowledges that it must now explore its options-- perhaps seek a merger partner or injection of capital.

This came the same day that Saudi Prince Alwaleed bin Talal said he would increase his holdings in Citigroup to 5 percent, and that he is supportive of Citi's management. That development did nothing to lift Citi's stock.

More From ...

Swirling in the same circle of fear with the crippled financials are rumblings that there are deep problems lurking in the trillion dollar commercial mortgage backed securities market. Since Treasury Secretary Hank Paulson declared last week that the TARP bailout program would not buy toxic mortgage debts, the market for these securities has deteriorated and spreads have continued to widen to record levels.

These securities are held on the books of banks and insurers. Hedge funds are also holders, and it's easy to see that they could be sellers this week. All types of credit securities are being dragged down in this latest credit market calamity, including high-yield and investment grade corporates.

"Risk is priced higher in the market than it ever has been before," said Ferry. Credit markets got into trouble because of the opposite problem: risk was priced way too low.

Investors are running into the long end of the Treasury market after buying the short end. Ferry said it would be an excellent time for the Treasury to do a snap auction, flooding the zone with new long term bonds.

Anybody Home?

More than a few investors today talked about the transition between Administrations as they bemoaned the behavior of markets. First, much focus was on the auto industry after two days of hearings and a failed effort by Congress to cobble together a plan. Now, it seems Congress will revisit the issue of a bailout bill for autos in Decemberas the clock ticks on a GM bankruptcy.

From Fast Money:

But the other buzz around the markets is the absence of a force that is focused on the financial system bailout. Paulson's comment that he was not going to ask for any more funds and his shift in the original intention of the TARP to capital injections has shaken confidence in the bailout. That is clearly being reflected in the behavior of financial stocks and the credit markets.

Cambridge Energy Research Chairman Daniel Yergin, expert on energy and global economics, said he thinks it will be significant for markets when a Treasury secretary is announced.

"It's hard to imagine a worse time for a crisis like this than during a Presidential transition. Right now, in Washington, there are two Administrations and neither one is in power. Never in memory has the choice of the new Treasury Secretary loomed as a new President's most important Cabinet appointment," Yergin said in a note.

Questions? Comments?