The Big Tell

Long Overdue

The only consistent theme from this week was volatility. As long as conditions remain volatile, including both the highs and lows, the market remains at risk. Investors may look at Friday’s 2%+ rise in U.S. stocks and claim that the bottom is in, but those sharp whipsaws are really just a symptom of the uncertainty and lack of price discovery in risk assets right now. The VIX closed the week at 22 and, while that’s a noticeable improvement from where it was earlier in the week, it’s still not at the level that would suggest a return to normalcy yet.

The big tell of whether or not we’re exiting this higher volatility is in high yield spreads. This number, which tends to go up when investors demand more yield for the risk they’re taking, has risen from 2.6% to 3.4% in a month’s time, the sharpest and steepest rise since last August. The question now is what happens if stocks start rallying again and the VIX comes back down. If spreads come right back down too, we could conclude that this was just a short-term jolt to the markets that ultimately demonstrated no longer-term impact. If stocks rally and high yield spreads hold their current levels, I think we’re looking at a genuine regime change. Spreads have stayed far too low for far too long. A normalization is long overdue and a resetting of spreads could indicate that risk-off is still in control even as stocks are rising.