Don't Fear The Spreads...Not Yet Anyway
1.) SPREADS – Credit spreads are the difference in yields from safe Treasurys to “Junk” bonds. When those spreads widen, trouble tends to follow to some degree. However, not all credit spreads are widening like some headlines might make you think. I’m not sure why some are freaking out about CCC rated spreads blowing out when the other 90% of the junk bond market remains relatively calm. If this is the first domino, the rest of the market hasn't gotten the memo.
2.) GOLD – I commented yesterday that gold does not like rising real yields. This remains true regardless of how much gold central banks are buying. And…yes…they are buying. Global central banks remain on pace with gold accumulation this August, with reported net buying totaling 39 tonnes. On a year to date basis, central banks have reported total purchases of 170 tonnes. Gold won’t care until real yields settle down. Until then, it would not be surprising to see gold touch the $3,900 range. There’s decent support around the $3,975 mark.
3.) BRAZIL – I rarely discuss emerging markets. But this is interesting to me. At one point on Monday afternoon, The Brazil stock market was up more than 13%, with volume running several times higher than normal. That’s not a normal move. Depending on how you measure volatility and how far back you look, we’re talking about something in the neighborhood of a 10-sigma event. “Sigma” is just a fancy statistics word for “standard deviation.” If stock market returns were perfectly distributed like the bell curves you learned about in school, a true 10-sigma event would be so unlikely that waiting a billion years wouldn’t even begin to cover it. In other words, according to the textbook, this basically shouldn’t happen. Yet, according to financial markets, it happens every few years. Oh the absurdity of human nature. Welcome to markets. And markets don’t follow nice little bell curves. People panic. People get greedy. Elections happen. Wars start. Governments change. But in all this hubbub regarding the Brazilian move, its not the sigma that has me that interested. It’s the thrust. You tend to see these violent thrusts early in moves, not late. Think about what has to happen for a market to jump 13% in a day on enormous volume. Investors weren’t positioned for it. Then something changed and suddenly everyone wanted in. The explanation this week is politics. Investors clearly preferred the election result to the alternative. That’s fine. What’s important now for Brazil is how these gains are handled. The preferred outcome would be a sideways move to digest this gain before moving higher. And I don’t think this is necessarily just a Brazil story. A sustained breakout in Brazil could be a major tailwind for Latin America more broadly. Brazil is the giant in the neighborhood. When investors start getting excited about Brazilian assets, they tend to look around and ask what else they might have been ignoring. That’s how new leadership can develop.
