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Merrill conducts a periodic survey of US institutional money managers. One
area the survey focuses on is a set of questions on the so-called “tail risks”, the less probable but potentially devastating events that negatively impact financial asset valuations. Here are the survey results from September and October of this year. Words: 535
So says Walter Kurtz (www.SoberLook.com) in edited excerpts from his original article* entitled Tail risks lurk in the shadows. Fiscal cliff is out in the open.
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), may have edited the article below to some degree for length and clarity – see Editor’s Note at the bottom of the page for details. This paragraph must be included in any article re-posting to avoid copyright infringement.
Kurtz, goes on to say, in part:
The Biggest Tail Risks
The U.S. fiscal cliff is clearly on people’s minds and is quickly becoming the dominant concern in the financial community. If this survey were conducted today, the percentage of participants who would view the upcoming budget cuts and tax increases as the main risk to their portfolios would increase sharply.
Source: Merrill Lynch/BofA
The Fiscal Cliff
In fact, based on Google Trends, the public’s concerns about the U.S. fiscal cliff have spiked recently.
Google search trend for “fiscal cliff”
Risks vs. Tail Risks
Once certain risks become widely “respected”, they can no longer be called “tail risks”. In fact, as we saw in today’s equity markets, these risks are already being priced into the markets. Tail risks are usually those events that are not fully priced, risks that are ignored, sometimes leading to formations of asset bubbles. An example of a potential tail risk candidate these days may be some of the U.S. bond markets, such as credit.
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The CS Risk Appetite Index
Below is the famous CS Risk Appetite Index shown together with its US Credit Risk Appetite sub-index. US credit risk appetite is approaching what CS refers to as the “euphoria” level.
CS: – US Credit Risk Appetite is a whisker away from Euphoria while Global Risk Appetite appears range-bound, close to its long-run average of about 1. US CRA being this close to Euphoria suggests caution- riskier corporate credit seems overbought both in absolute terms (yields are near record lows) as well as relative to safer credit. The last time the gap between Global Risk Appetite and US CRA was this large was August 2011, and it did not persist for long.
Source: Credit Suisse
Interestingly, the Merrill researchers who conducted the institutional investor survey (above), list “bond market bubble” as one of the key tail risks. For those who still don’t think we have a bond market bubble, just take a look at the net fund flows in the last few years (bonds vs. equities).
Source: Merrill Lynch/BofA
It doesn’t mean that this bubble in bond markets can’t continue much longer. The U.S. housing bubble lasted for years. Clearly the Fed continues to provide support to spread products for now, which makes the probability of a major spread widening quite low (thus a “tail risk”).
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Conclusion
When looking for “tail risks” [one should] not… zoom in on areas where the investment community, and particularly the public, is already heavily focused, such as the “fiscal cliff”. The time for that was back in April and May, possibly even earlier. Instead one should look at the less probable events that most investors are now simply ignoring.
*http://soberlook.com/2012/11/tail-risks-lurk-in-shadows-fiscal-cliff.html (For more news and analysis, visit Also sprach Analyst)
Editor’s Note: The above post may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
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