In their annual outlook Nomura Securities highlights the fact that the market is still pricing in a tail risk event.  While they say that a Lehman 2.0 event is not currently priced into equities, they say that investors are still positioned cautiously in the case that events in Europe deteriorate.  They say it’s now clear that a resolution will eventually come and that this cautious positioning will ultimately be proven excessive:

“On the second issue – the eurozone sovereign crisis – we expect an eventual solution to the crisis will emerge, most likely during Q1. It is almost impossible, even now, to envisage a situation in which the ECB and the German government allow the break-up of the euro to proceed without a concerted effort to prevent it. To the extent that the stance of both the German government and the ECB has been motivated by a desire to effect a permanent change in direction in the eurozone, any turning point is likely to involve a clear and determined commitment on the part of the new government in Italy to implement a reform agenda designed to improve the supply side of that economy, and ultimately generate growth. Generating growth through supply side reforms is a long term strategy and difficult to do in even the best of times. Because this is unlikely to be enough, in the end the ECB will likely have to utilise its balance sheet in a less equivocal way and agree to purchase large amounts of privately owned sovereign debt.

The high risk premiums on offer at the moment in global equities extend beyond the levels justified by observable “risk” in the form of implied volatility. Ergo, at least in part, the market has already moved some way towards discounting a “tail risk” event in Europe. A repeat of the “Lehman” experience is not in the price, however.”

Excessive pessimism surrounding Europe will ultimately prove bullish.  They recommend playing this by buying emerging markets which have been punished far more than US equities.

Source: Nomura


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. another delusional liquidity junkie bank comment.

    how in the earth market discounted the risk beyond justifiable levels? Emerging market growth to slow considerably, best case for Europe is zero growth, no need to say something about US which is hiding behind EU drama: and SPX is only 100 points of the highs… If this is extreme discounting, SPX should trade at 1500 in this backdrop according to these zombie wall street complex bankers.

    you liquidity and bonus junkie SOBs

  2. At least a few that understand that the Euro-hysteria is largely overblown.

  3. “another delusional liquidity junkie bank comment.”

    Agree 100%. Actually, my view is almost the opposite. IMO, the market is giving a very small probability to a LEH-type event, and i believe this is right. However, the market is also giving a high probability of an overly optimistic outcome for the EU-EMU-Euro. Whatever patch is applied to the Eurozone on Friday, conditions for the Euro and Europe will not return to the former glory of positive expectations people had when the Euro just came out and the borrow Euros cheaply instead of collecting Taxes was about to start and European banks weren’t broke.

    I think that, at best (I.e., under the best possible outcome this Friday), European, and maybe Emerging market equities, are rightly priced. However, even under the most optimistic scenario, I see downside room for US equities which are flat for the year while the outlook for the US and world economies has clearly deteriorated significantly. In terms of valuation models, we already had ZIRP when The year started. Now we have tiwsted ZIRP which has put downward pressure on long rates. This factor puts downward pressure in the rate used to discount equity cash flows, but on the other hand, there is an increased perception of risk due to the graveness of the situation in Europe, possible problems in China, and emerging markets slowdown. This factor increases the slope of the risk-return line in the CAPM model (a model which is not perfect but provides a nice framework to think about valuations).

    Reminder ECRI recession call update at lunch time today:


    Recession Call Update

    In the noon hour ECRI’s Lakshman Achuthan will talk with Tom Keene on Bloomberg TV about ECRI’s recession call.

  4. I read this article as well as your article on treasury auction failure, and how you believe that operationally, it’s highly unlikely. I’m trying to think rationally about a system where interest rates are supposed to be the price of money. Prior to reading your article on “failure”, I felt that a failure might result in the end of the “printing money” game.

    If the price (interest rates) is truly dictated by supply and demand, then theoretically you could expect that a failure of a US bond auction might be the clearest indication that bankers are unwilling to buy US debt, as they could have better alternatives elsewhere to invest….right ? So perhaps we should hope for a failure. One that occurs not because bankers are asleep at the switch, but instead one that is based on better investment opportunities elsewhere.

    Any comments ?

  5. No serious person expects a solution of the crisis over the weekend, because Markozy stated already several month ago: it will take years to solve this crisis.

    However reality is not so dramatic as anglo-american media and blogs describe it. I think the view of Nomura is closer to reality.

    Nevertheless I will go short for next spring, although I dont expect an overly large move down.

  6. I think when you have the police, fire and rescue squad hovering over a ‘situation’ such as Europe, you cannot have a Lehman 2.0. I think the market has been over analyzing out of a fear of 2008. 2008, no one knew what was swept under the rug in its entirety at first.

    Now, 3 years later, with all hands on deck, we are very unlikely to run this gambit again. I will grant you that most of the hands on deck are and have been inept, but look at what they’ve done in Europe. Trichet-gone. Berlusconi-gone. G-pap-gone. Politicians and parties that enabled the b.s. are slowly being tossed out.

    Besides, since when did the world depend on Europe growing? Eurozone growth has been sub 1% for the last 10 years, so where’s the fire? Meanwhile, places like China and other emerging markets have not only been growing like crazy, they have plenty more room to grow.

    Lastly, have you seen the China PPP compared to Brazil? China is $8394 and Brazil is $11767 according to wikipedia’s 2011 estimates. In order for China to match Brazil in PPP it has to grow by another 30%!

    Just some food for thought when we start building the pyre all b/c Europe and US growth has slowed.

  7. 20 years of Euro experiment vs. 2000 years of European history. I’ll take the latter.

  8. BRIC growth supposedly depends on US/ Euro demand. If US/Euro demand falls, as it will, how will BRIC grow?

  9. So Realist,

    Do you think Mr. Market has over analyzed or priced in all the CDS and other gotchas and knows all the gory details such as this:

    I think it is typical US psychology: Well, I got away with a little of ‘this’ last time so I’m bored with that and I’ll just ignore it next time. Everything is OK, full steam ahead. Bullish.

  10. Today’s big selloff in equities indicates a disappointment on the part of investors that the big bazooka they were expecting might not be coming any time soon. If the ECB won’t be a last resort buyer of periphery gov bonds, and if the IMF is not stepping up any more than $ 200B, then the market will sell off to protect itself against the deep recession from Euro banks pulling back and not lending anywhere near as much as they have in the past. The banks must focus on raising capital. Watch ECRI on Bloomberg TV at noon to see if they renew their recession call.

  11. Everyone should step back and examine whats happened since 2008. Trillions of dollars,euros, yuan et al have been dumped free of charge into the world wide financial system and what have we gotten, a pathetic 100% gain. See this

    Quit worrying about daily, weekly, monthly market moves. Worry about a black hole in the center of our financial universe that is sucking you financial future into it. Assets with little or no value and declining world wide growth rates are accelerating our decent and until policy makers recognize this the process will not stop.

  12. Nomura is that super-successful financial company that’s lost 85% of its market cap since 2007, right?

  13. @ Realist-

    I disagree with your thesis as well as Dr.Olivers comment-“it will take years to solve this crisis.”- First- Dr. Oliver..the market is an armed criminal who will use his gun. Not to be confused with someone who wants the money but is not willing to actually pull the trigger. that was 2010. he is gone and replaced with someone much more frustrated and menancing. If we have learned anything on this site it’s that based on the structural issues in Europe there are only a couple of options. Given the austerity being pushed it will not take years to solve. The market will soon force policy makers hands. They will be forced to make the tough decision. Except now like that video I never returned in college. The late fees will be much higher than had I paid the price early on. I’m not offering my opinion on what should happen…I think its too late. Europes fate is in the Markets hands because the leaders don’t know how the machine works.

    @ Realist-
    Current- Investors intelligence survey is greater than 15%(17.9%) this is not consistent with your comments. Bulls @ 47.4% Bears @ 29.5%. Further creeping optimism in SPX vs. Skew crosses above lower bolinger band(3 months, 2 std) & first time in 1 months, This is consistent with near term tops as relative price of downside options vers upside ones is NOT overly bearish. But too Bullish.
    The commodities not ratifying this rally is also another sign that the SPX is either too high or the CCI needs to rally here.(maybe with further easing..QE3 probaly..but that’s not good for the economy..just risk assets)
    Those leaders were removed not by the people. They were placed by those who want further austerity…I don’t know how that is good for Europes economy.
    Commodities are not ratifying your EM-and Asia story.
    But who cares how much room they have to grow. GDP has little correlation to stock prices and ultimatley that is where I have to invest. In ETFs and other securities and based on your comments if you e-mailed me your account I would expect to see EWJ- EM, EMM and other Emerging market international holdings. right? And if I sent you mine…it would show 15% dblfx and alot of cash.
    SO…I must have sold to you my EM ETFs and you must have sold to me my conservative postions. Well one of is is right and one of is is wrong. And that’s the market. two different views. backed up by data and sometimes loose selective perception.

  14. It’s never what you think..It’s not LEH 2.0
    It is always a 1.0 we just don’t know what the name is.
    LEH 2.0 is being prevented but that may not be what central bankers should be worried about.

  15. excellent observation! When it comes to survival and tribal allegiance, economic cooperation does not always grab the the highest priority in the human psyche.

  16. @Octavio R. ECRI’s Ackshuman was on Bloomberg at noon. He re-iterated his Recession call. He is very confident that the USA is going into a recession within the next two quarters. He also said that Europe is already in a recession. He said that the GDI (Gross Domestic Income, the other side of GDP) in the USA was only growing at 0.8% over the last two quarters. This and many other indicators are screaming a coming recession to him.

    @VII Given the above, I think you should have more than 15% in DBLFX or other bond funds. I am a bond bull, with 50% in investment grade bonds, and 50% cash. The coming recession will drive the 10 yr T yield down to 1.7% or lower.

  17. Thanx Doc,
    But I think you see the US media the same way I see some of the UK tabloids. I get worked into a lather just by looking at the cover stories. However, as time goes on I expect more ‘drama’ out of the European media:

    and yes it will take a long time to come to conclusion, but I think we may be down 50% by next October. Lots of building negativity out there. Maybe only a sensitive and emotional guy like me can see it, and maybe I’m delusional, but I have seen politicians (EU and US) in action a lot lately and I’m not impressed. Maybe the mild-mannered ‘Confederacy of Dunces’ have one thing going for us though. Their low key mannerisms hopefully will keep us all out of war.

  18. Thanx Larry,
    I’m mostly bonds too with a couple of shorts and one pharma(PPHM) and a goodly amount of cash(not mmkts) of course.

  19. Thanks for the update. Today, I sold my 1250 SPX JAN puts, it is too crazy out there so I took profits; perhaps too early. Good you mention bonds. A few days back when risk was on, and treasuries went down, I went heavily into bonds, just could not stand 0% yield cash and I see little downside risk given QE3, slow economy, benign inflation. And ZIRP promise as far as the eye can see.

    Cyrrently, my portfolio looks as follows: TIAACREF bond account, DBLTX, DBLSX (I think DBLFX Is a great bond fund but still too early to dip into EM Sovereign debt), some PTTRX, BABZ and PFL for a total of 47%, NLY 6%, TIAACREF insured account 3%, 44% king cash. It has not been an easy year in terms of making a buck but I am glad to be at 8.21% YTD, beating most genius money managers out there. Year is almost over, I don’t want to mess it up (like I did last year, went from 5+% in early October down to 1% courtesy of a wrong call on volatility) so I will risk little, no more than 2% to 4% of portfolio.

    However, a contrarian call based on an interesting investing principle: small bet on high payout events is as follows. Buy TODAY short dated spx close to the money calls in the hope tomorrows meeting will exceed the low market expectations???

    This is not investment advice, just free advice probably worth less than that. In terms of portfolio management, I drive a stick shift that is far from optimized. I am at this point totally risk averse, with preservation of capital being my número uno consideration.

  20. Haven’t made the spx call move. Too afraid to pull the trigger. Afraid to catch a falling knife??? Smart contrarian is ok, contrarian just for the sake of swimming against the current is stupid:-)

  21. @ Larry- I agree..I’m 55% Cash today…I do have to post 2011 numbers and the combination of Sugar dispensing Central Bankers and Sugar Addict for me to sit out the remainder..unless we get something attractive.

    But I would agree with you. From yesterdays Rosie Missive-

    “But this is what the bond bears have consistently missed-disinflation or deflationary pressure in wide swaths of the consumer discretionary space. The reality that there is no sustainable bear market in bonds until the Fed starts to take the carry away in a tightening cycle(which is not in the cards for at least two more years)”

    What this says to me Larry is…play on playa.

  22. Jumped in at $16 with less than 1% of my portfolio. The spx 1250 call I bought expires in just one week, dec 17 so this is a good recipe to throw away some money if things go bad tomorrow:-) already lower…

  23. “However, as time goes on I expect more ‘drama’ out of the European media”

    Well, maybe there will be more drama. But IMHO the more likely outcome is that poeple get annoyed of reading sentences about “greece tragedy” and “burning Rome” without seeing something really spectacular.

    However if the Greece negotiations about a debt hair cut fail, a default is IMHO likely. But IMHO the impact will be much less spectacular than the media drama of the past 2 years.

  24. So, we will all fall.

    The European crisis reaches all states …
    Next year, 2012 – possible recession - and you know what’s involved …
    What is next? I do not know.
    Emerging markets will naturally grow faster … look at Poland – where I come from … When other European countries have a GDP of around 1.8% in the last quarter – Poland maintains 4%.
    That little or a lot of development in such conditions?

    Some companies from the hole in 2008, made ​​nearly 1,000% … some large and very liquid as KGHM in three years earned billions for clean with no loss…
    Today, take over other companies in the region and not only …
    Of course this is not Facebook or Google … but …
    Maybe because Morgan Stanley has recently opened an office in Warsaw – the capital of Poland.

    For people not knowing where is Poland – is in central Europe

  25. If you would like to invest your money I would think about the new companies – somehow their old crisis they are not born …

    Did you hear about Facebook, Google, Microsoft, Amazon .. all of these giants have one thing – created during the wider crisis.

    I must admit that I’m afraid the Euro-zone collapse because it reaches the U.S. – which are MUCH more indebted and the consequences can be terrible …

    What to Nomura … the bank and its practices leave much to be desired.
    Recently lowered the price of certain companies from dozens of $ to 0.0 $ at the time when they are fully solvent. The appropriate Regulatory Commission investigates these abuses now.

  26. Ha, I love the Polish. Great sense of humor. I always shed a tear when I think back to the sufferings at the hands of facists and then communists during and after WW II.

  27. For Poles crisis – this is not the case so far … 25 years ago, we were suddenly somewhere else – than we are now. Currently this is not a crisis – it is slowing down – even though the actual breakdown of the EU it may be a shock to the world …
    For the Greeks, French Spanish, Italians, Irish … Crisis is – they do not get increases, allowances, is that you will not buy another holiday for thousands of Euro … While Poland and other countries in Central and Eastern Europe are tightening the belt. With a much larger work several times times lower salary.
    Once a well-known Chinese said that Europe is silly with those social privileges. She does not work and gets hundreds of euros.
    In China, as one who does not work you will die of hunger …
    Brutal, but very easy rule.

  28. What are people bullish on? Most of you claim 50%+ cash and/or short. Besides sentiment and money where people’s mouths are two totally different ball games. We’ll find out who is right soon enough.

  29. Anonymous

    We are 4 people on a blog. Your in trouble if we are you bear contrary data sample.

    There’s more data but…go with what you think. Load up on risk assets. We need people like you.

  30. The S&P moves in 5% increments every two weeks. This is a phenomenon that has never happened in the past-wouldn’t happen for years at a time, but you believe too many are bullish?

    No one in the media or any sort says to be all in, everyone says go to gold, everyone’s hedged and NO ONE holds a gain over night. So yeah, you might get individual bullish days, but the overall sentiment is bearish. Who is buying equities? Who is long the market?

  31. Then go Long SPX.

    What do you want me to tell you. My call is Q1 990 on SPX— I will be a buyer then.

    You should go long on risk assets and not worry about trying to convince me. The data doesn’t support what your cognitive bias wants me to buy into.

    But…go long. We need your kind also.