Great chart from the Merrill Lynch Global Fund Manager Survey courtesy of the Daily Shot.

Note how the trade war, quantitative tightening and China slow down risk rankings didn’t change much from October to November. It’s surprising they’re considered tail risks as they’re widely known and priced in right now, in my view. Unless the magnitude of these events is significantly amplified beyond current expectations, they aren’t true tail risks. In my experience when investors are consistently obsessing over specific risks the outcomes tend to be far more benign than most anticipate.

Tail risks are outcomes that have a small probability of actually happening. When they do happen, they result in a significant change in asset prices (>3 standard deviations from current levels). The trade war is happening now. We’re in the middle of quantitative tightening. It’s also no secret that China has been slowing down. Sure all of these events pose risks to asset values but they’re all known, currently happening and on everybody’s radars.

Tail risks are outcomes we’re currently not expecting that actually end up happening. Think of the housing, subprime and liquidity crises from last cycle. In 2006, 2007 and 2008 most people weren’t expecting a financial crisis. As a result, not many people were talking about it. Not many people were prepared. When it hit, it was a true shock to the system. I was at Merrill Lynch at the time and remember companies that would eventually go on to implode were upgraded to “Buy” pretty regularly  even as their stock prices plummeted. Nobody seemed to believe things could get bad enough to result in insolvency.

Interestingly, an EU crisis and credit default cycle made it onto the list this month. I think there’s a higher probability of true tail risks arising from those events than the survey’s top three. However, my bet is that the true tail risk right now is in the “Other” category and as a result is relatively unknown.