The Pragmatic Capitalist | Apr. 9, 2010, 5:45 AM | 2,392 | comment 8

(This guest post previously appeared at the author's blog)

UBS called the bottom of the recent downturn to the exact day on February 9th (see here). They’ve been bullish since then, but are now warning of extreme risks in the market. According to their Risk Appetite Indicator, risks are surging as the market advances and investors turn increasingly complacent:

“Our Risk Appetite Indicator edged higher last week, moving up to 1.21 from 1.15. After briefly dipping into negative territory in early February, the indicator has risen 5 out of the last 6 weeks (with one week unchanged) and is nearing the +1.30 level, which we define as extreme risk seeking territory. Last week, each component ticked marginally higher as the MSCI AC World index was up 1.9%.”

chart

Their index has proven quite timely. Based on UBS data going back over a decade the market’s have returned about 1% over the following 12 months after a “sell signal”. 12 month returns following a “buy” signal were over 6%.

“When the index is greater than +1.3 standard deviations from its mean, the index is showing investors are very willing to take risk, which is when historically the index has given its best “sell signal”. Equity returns 12 months on from such high risk appetite are typically very poor, just 1% on average.”

Source: UBS