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Tuesday, February 26, 2008


updating the risk appetite index

i mentioned in passing some time ago jonathan wilmot's credit suisse global monthly risk appetite index, and in writing the last piece caught an update (in chinese, translated thanks to google) which indicated that it had fallen below the critical (-3) "panic" level by january 23.

As for the survival of the fittest-the timing of how to pick? 28 years has been recorded related to the Credit Suisse Global Risk Preference Index (Credit Suisse Global Risk Appetite Index) (see figure), on 23 January, the index fell to negative four -time ‧ February 2 standard,二○ ○ hit the lowest in the three years since, that the world market entry "panic", in a non-market has been rational Chaotu stage.

"see figure", indeed, but i saw none. but i did find a link to this excellent pdf authored in part of wilmot on january 21 -- just after the registraton of the panic reading. thanks to the be early aggregator.

The basic pattern is quite clear. By the time Risk Appetite enters the panic zone (1.5 standard deviations below average), the worst is usually over for world wealth and global equities; small declines tend to occur between entering the panic zone and the ultimate trough; and very strong performance is typical in the three and twelve month periods following the risk appetite low. Note that the buildup to this panic episode has been close to average, although the distribution is different, with emerging equities doing a lot better than average, Japanese equities much worse, Germany a little better and the US a little worse. Absolutely in line with the real economy.

... Other episodes confirm this historical pattern: it is usually a lot safer to buy US stocks immediately after entering the panic zone than to buy Germany, Japan or emerging equities.

Second, risk appetite briefly bounced out of panic soon after its first entry, before plunging back in again, a pattern that occurs in a few of the longer panic episodes documented below. Clearly, therefore, entry into the panic zone is not a perfect market timing signal, merely a very good one most of the time.

but they urge caution:

So what about this time round?

Our best guess is that the ultimate low in risk appetite may not occur for several weeks, and that there may well be a brief bounce out of the panic zone along the way. (note that this was written four weeks ago. -- gm)

First, we think there is a very good chance that global industrial production momentum will trough around April/May unless global demand absolutely craters. This is largely an inventory cycle point, and we would expect risk appetite to trough around then, or more likely a month or two before.

Second, valuation is ultimately more important than market sentiment. At today’s bond yields, for example, equities would arguably still be good value versus bonds even if earnings were to decline as much as they did in the last two recessions. In which case, we are in effect already discounting a recession, and we are hardly very likely to see a larger than normal bear market.

this would be sympathetic to the idea of a retest or pair of retests such as i outlined earlier.

the key theme is clearly that not until the divergence of new lows became clear did the subsequent longer-term rally hold -- but also, that there was already very little material risk of deeper price lows from the time of the initial new low spike.

UPDATE: mark hulbert with a pretty interesting view on market timers -- the best are vastly more bullish than the worst.


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