Below is an awesome chart from Credit Suisse’s global investment yearbook.
It shows the firm’s proprietary Global Risk Appetite Index (GRAI) going back to the early 80s.
When it’s high: People are in a state of euphoria and have a huge appetite for risk. When it’s low: Sheer panic, and no risk appetite.
CS doesn’t reveal the exact secret sauce, but it explains it like this:
CS GRAI is the slope of a cross-sectional, weighted, linear regression of a 6-month excess return measure (y-axis) on 12-month price variability (x-axis). This regression is estimated daily using rolling windows of data.
Currently, the returns of 64 country-based assets are used in the calculation. The constituents are broad equity and government bond indexes from developed countries and many of the more important and accessible emerging markets. These assets form a relatively continuous spectrum of risk from safer G3 bond indexes to riskier EM or pe- ripheral European equity indexes. However, their positions along the risk spectrum do shift over time, but the 12-month calculation period ensures this is more gradual than the changes in return measures.
A weighting scheme is applied in the regression based upon the market capitalisation and GDP of the countries of the respective assets. Thus the bond and equity indexes from the USA have a greater impact than those of Belgium.
The average observed value of CS GRAI has been around 1, and 1 1⁄2 standard deviations is approximately 4. For convenience we call periods when the CS GRAI is abnormally high (above 5) “euphoria” and abnormally low periods (below minus 3) “panic.”
Anyway, here’s the chart. Perhaps the most surprising thing is that their sentiment measure registered a deeper level of panic last year during the Euro meltdown than during the US financial crisis. That goes a long way in explaining the torrid rally despite the lack of progress in solving anything.
Photo: Credit Suisse