FYI | Nov 27 2009
By Rudi Filapek-Vandyck
Hands up who knows where the VIX index (otherwise known as the fear index) was at yesterday?
Don’t bother looking it up. The index has been approaching the 20 level ever so closer this month. It triggered warnings such as “market complacency” and “pending correction” from more bearish inclined market commentators.
Now it would appear the universe, in the form of a de facto debt default by one of the world’s most prominent symbols of the pre-GFC era, has answered their wishes: a reminder to everyone that the world we live in post-GFC comes with more risks, and more tangible dangers than perceived before.
Already commentators have been quick in pointing out the debt servicing problems in Dubai are not a genuine surprise. It was merely a case of “when”, not of “if”. So why is the world responding like a new Lehman Bros-failure is in the making?
In one word: complacency.
The VIX index indicated as much. Commodities markets indicated as much (analysts at GSJB Were this week stated underlying fundamentals for all metals were “weak”, yet prices continued upwards and onwards). And I can report from personal impressions that many a stockbroker and market trader had come to anticipate further rises into the New Year, on light volumes.
UBS is one of global stockbrokers who measures and keeps track of overall risk appetite. StateStreet, Standard Chartered and Credit Suisse, among others, do the same, and everyone has its own technique and proprietary modelling.
Yesterday, in what proved to be a case of brilliant timing, UBS analysts reported their measure of Global Risk Appetite had once again ventured into “extreme levels” – confirming the case put forward by the VIX and other market indicators.
In fact, on UBS’s assessment, overall risk appetite had returned into “extreme” levels last week, and it simply wouldn’t come down.
Say the analysts: history shows the Risk Appetite Index tends to be a very good contrarian indicator. In other words: when risk appetite reaches into extremely high levels this is usually a sign that selling is better than buying.
Also, report the analysts, history shows that whenever such “sell” signal appears on their index, the average investment return for the year ahead is usually rather poor. The analysts talk about “just 1% on average” (it remains unclear how much this figure has been influenced by the pre-March 2009 bear market).
If UBS’s historical analysis proves correct this time around, 2011 should see an above normal return (between 16 and 25 months after the original Sell signal).
UBS’s Risk Appetite Index reached back for extreme heights in mid-October, and the initial response at the time was a rapid retreat to more benign levels. At the time, UBS analysts reported they were surprised by how quickly the retreat manifested itself.
Most among us remember that time as a rapid and quick retreat in global equities (circa 6-8%) in combination with a sudden strengthening in the US dollar, but all in all it proved simply another (failed) attempt to correct.
Separately, economists at UBS reported this week their gauge of surprises in economic data across the globe had started to become more mixed as well.
In Mid-October the Risk Appetite Index was even a little bit higher than where it was prior to last night.
History shows such a buoyant market attitude is subsequently followed by a period of less appetite for risky assets and high risk market positions. The news from Dubai last night will likely prove the trigger from left field that can accelerate this process.
For those readers who are not yet up to date with the latest developments: the Government of Dubai declared yesterday it would ask to postpone debt repayments for its flagship corporate Dubai World. The intention is to ask for at least a six months delay in repayments.
According to media reports, S&P has stated event “may be considered a default under our default criteria…”.
Dubai has reportedly over US$80bn in debt, of which US$50bn is due to mature over the next three years and Dubai World has a US$3.5bn bond due to mature next month.
