“In the range of music we play — roughly 300 years’ worth — there really are more similarities than differences.” — Esa-Pekka Salonen
I’ve addressed the price performance of emerging-market sovereign debt a couple of times here on InvestorPlace as a way of gauging risk appetite.
In the latter half of May, there was a notable decline in the price of emerging-market debt as credit fears increased dramatically in a few short days. I highlighted this in an article on May 21, in which I showed the price-ratio collapse that was then occurring between the PowerShares Emerging Market Sovereign Debt ETF (NYSE:PCY) relative to the iShares 7-10 Year Treasury Bond Fund ETF (NYSE:IEF). The speed of the decline was ominous in that it suggested that an “event” may be upon us if a significant reversal did not occur.
Below is an updated chart of that price ratio. As a reminder, a rising price ratio means the numerator/PCY is outperforming (up more/down less) the denominator/IEF.
Click to Enlarge
I have highlighted the behavior of the ratio before and after the summer crash of 2011 (after which the October 3 low and ensuing fall melt-up began) and the behavior now.
As June’s trading took place and various market internals began reaching levels characteristic of what happens in the midst of an actual credit event and crash, a sharp reversal did indeed occur, and emerging-market debt came back strongly.
The “V” formation is a very positive sign, since it means the sudden fear of a credit seize-up that the price in May was then suggesting was a real possibility was not justified.
The implication, though, is perhaps more interesting.
Should the ratio continue to rally, as it did in October, it may be a sign that further gains are ahead for risk assets as continued healing in credit markets occur. This is but one of the many reasons I have been arguing recently that a situation similar to 2011′s fall melt-up may be under way.
The way to play this? Quite simply, be less bearish and consider that a big move higher in equities could soon occur in the face of the negative narrative that all too many know and thus have likely overestimated the odds of happening.