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Spreads show 'big trades' coming for US, emerging stocks

Thursday, 8 Aug 2013 | 12:37 AM ET
Spread between EM and US stocks to close
Michael Gayed, chief investment strategist at investment advisor Pension Partners, says the spread between the MSCI Emerging Market Index and the S&P 500 is at levels not seen since the Russian default crisis of 1998.

The spread between the emerging markets MSCI and the S&P 500 indexes has widened to levels not seen since the Russian default crisis of 1998, which could mean "big trades" are coming for both markets, a strategist told CNBC.

Michael Gayed, chief investment strategist at investment firm Pension Partners said the spread is now more than 3,000 basis points, which means emerging markets are pricing in a big event that has not happened and could be due for a rally.

During the Russian financial crisis of 1998, when the Russian government defaulted on its debt, the spread in the first half of the year was well north of 3,700 basis points, Gayed added.

"The spread is so wide that at some point it has to close... [It] could close with a correction in the U.S. markets and emerging markets going down less," Gayed told CNBC Asia's "Squawk Box" on Thursday.

"Emerging markets, which on average are down more than 10 percent year-to-date, have priced in quite a bit more negative news than the U.S., so it's less susceptible to downside negative surprises as the U.S.," he added.

U.S. equities have largely been ignoring a lot of the bad news that has been happening this year like falling commodity prices, the downside in emerging market equities and the spike in bond yields, Gayed said.

"In the event that U.S. stock markets starts to get worried about what's happened in the bond market, which has been largely, fairly unprecedented historically - you could see a very, very quick readjustment on the downside," Gayed added.

(Read more: Goldman Sachs:Treasury yields will hit 4%)

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U.S. Treasury yields have risen at a faster-than-expected pace in recent months on expectations that the Federal Reserve will begin scaling back its $85 billion monthly bond buying program later this year. Benchmark yields rose to a 23-month high in early July of 2.755 percent.

(Read more: 6% Treasury yields? May come sooner than you think)

Gayed said what's happening in U.S. markets right now is also very similar to what preceded the stock market crash of 1987, when bond yields spiked and the Dow Jones Industrial Average was experiencing a "runaway."

"If the yields spike ends up being a deflationary force - which by the way homebuilders and their weakness suggests, then this whole move higher can very quickly get undone in the U.S. and you could see a doozy of a correction," Gayed said.

Both U.S. benchmark indices - the Dow Jones and S&P 500 - are up around 18 percent this year, hitting all-time highs in recent months as investor pile into the safety of developed market equities amid Fed tapering fears. The MSCI Emerging Markets Index, meanwhile, is down more than 11 percent.

(Read more: Business activity in BRICs shrinks for first time in 4 years)

For those looking to get into emerging markets to catch the bounce up when it happens, Gayed said markets where there is a lot of liquidity are good plays.

"I probably go more for the BRICs (Brazil, Russia, India and China) largely because they've discounted more and if you needed to get out of them relatively quickly at least you have the opportunity to," Gayed added.

—By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @ RajeshniNaidu

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