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.