Scotia’s $10.17 million notes on non-U.S. index basket still too risky despite deep buffer

By Emma Trincal

New York, Dec. 16 – Bank of Nova Scotia’s $10.17 million of 0% buffered enhanced participation notes due Dec. 10, 2025 linked to a weighted basket of international indexes remain risky despite a large buffer and a diversified underlier given the prospect of a global economic slowdown, said a contrarian portfolio manager who is bearish on equities.

The basket consists of the Euro Stoxx 50 index with a 36% weight, the Topix index with a 26% weight, the FTSE 100 index with a 17% weight, the Swiss Market index with an 12% weight and the S&P/ASX 200 index with an 9% weight, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket return is positive, the payout at maturity will be par plus 139.15% of the basket return.

Investors will receive par if the basket declines by 40% or less and will lose 1.6667% for every 1% that it declines beyond 40%.

Tenor

The three-year timeframe of the investment was too short, according to Steven Jon Kaplan, founder of True Contrarian Investments.

“By December 2025, I’m not sure international stocks will have fully recovered from the bear market,” he said.

“There may be a rebound; those countries may be on the way up. But three years is not enough time, and the return at the end will probably be negative. Right now, I am repositioning my portfolio for a big drop in the next half a year. I think we have two more years to go. So, I don’t believe three years is enough time.”

Euro focus

The majority of the basket consists of European stocks. This group is split between the euro zone region for about a third of the basket and non-euro zone countries (the U.K. and Switzerland) for slightly less than a third.

Despite the deep buffer in place, Kaplan said the risk of losses remained high.

“Europe is less overpriced than the U.S. But in a bear market it doesn’t really matter. Even if European stocks drop less than U.S. equities, there is still going to be a loss,” he said.

Recent exuberance

European equities have rallied in the past two months with the Euro Stoxx 50 index up more than a third from its mid-October low.

The FTSE 100 index has also rallied but at a slower pace.

“If the deal had priced two months ago, it would have been slightly better,” he said.

Part of the recent rebound is because Western Europe is relatively undervalued, he noted.

“A month ago, the Euro Stoxx 50 crossed above its 200-day moving average. It’s a buying signal for technicians so investors have been piling into the ETF.

“Now that people are getting back in, taking a position in Europe is becoming more dangerous. Europe is no longer a bargain, he said. This is a time to sell, not buy.”

Commitments of traders

Another reason to be cautious could be found in the traders’ commitments for the euro, as reported to the Commodity Futures Trading Commission.

“Commercials have never been so bearish on the euro,” he said.

The so-called “commercials” are companies trading the currency for the purpose of hedging their business activity, not as professional traders.

“Commercials tend to be right. They trade to protect themselves, not to speculate. What they’re seeing is an increasingly vulnerable Europe,” he said.

A region with a shared currency will likely run into trouble when times are tough, he added.

“European governments tend to disagree and go through tensions during crises. We’ve seen that scenario unfold between Greece and Germany during the sovereign-debt crisis. These tensions reflect the disparities between rich and poor countries,” he said.

Leaving the zone

Kaplan focuses on value and would concede that European stocks up until recently were still attractively priced.

But the region was not stable, he said, pointing to investors’ growing lack of confidence in the stability of the euro.

“There is always the risk of one country leaving the euro zone, which would have a devastating impact on the region. The big or stable countries like Germany and Belgium are the ones providing the subsidies to the poorer countries in the south,” he said.

As a result, the “rich” countries may be tempted to leave the euro zone, he said.

“If unemployment was very high in Germany, you could imagine the emergence of a far-right government which would promise Germans a return to the Deutsch mark. This would not happen in a bull market. But history has taught us that the worse can happen during a depression,” he said.

“Investors have avoided European stocks for a long time because they know that the euro is not going to be around forever. As long as those countries share the same currency, Europe will remain a risky place to be in.”

Bearish take

For Kaplan, both the U.S. and Europe are in a bear market. The recent rallies observed in both regions are not indicative of the end of the downtrend.

“It could take at least a couple of years if not three for the market to recover,” he said.

“The fact that it remains less overvalued than the U.S. is not going to help much. If the U.S. falls by two-thirds and Europe only by half, what’s the point of buying this note? You may have a good protection, but that’s not why you’re buying the note.”

Japan

The Topix was maybe the most undervalued of the five components. It also modestly rebounded.

“Japan offers the best bargain in the world. But again, it matters very little when you’re in a bear market,” he said.

He expects Japanese stock prices to decline as well albeit to a lesser degree than the other markets composing the basket.

“What you want from the notes is not one market performing better than another. You want most of them to do well,” he said.

In the midst of a bear market, which could last as long as the note, investors should not even want to own the cheapest index, he said.

“International stocks face a lot of dangers. A note tied to this basket may lose less than a note on the S&P. But the timing is wrong either way. I would stay away from the deal. There is too much risk of a severe bear market and global economic slowdown.”

Scotia Capital (USA) Inc. is the underwriter. Simon Markets LLC is acting as dealer.

The notes settled on Dec. 13.

The Cusip number is 06417YCB3.

The fee is 2.5%.

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