Do Investors Care About “the Way Things Are Going”?

Are broad measures of public sociopolitical sentiment relevant to investor behavior? Do they have predictive power for stock returns as potential indicators of exuberance and fear? To investigate, we relate both U.S. stock market level and 12-month trailing price-earnings ratio (P/E) to response of the public to the recurring Gallup polling the question: ”In general, are you satisfied or dissatisfied with the way things are going in the United States at this time?” Using Gallup polling results from PollingReport.com and contemporaneous S&P 500 Index and 12-month trailing S&P 500 operating P/E data for January 1998 through July 2011 (181 polls, roughly monthly but with some gaps), we find that:

The following chart tracks the S&P 500 index and the level of public sociopolitical satisfaction over the entire sample period, encompassing part of the Clinton administration, all of the Bush administration and part of the Obama administration. The horizontal access for the polling schedule is irregular because of variations in polling frequency. It appears that there may be some relationship between the two series, but they trend in opposite directions during much of 2003 through 2007 and during 2010.

The large jumps at the beginning of 2009 are at least partly reflective of a gap in polling activity during January through July of 2009.

Does sociopolitical satisfaction relate better to a valuation metric such as P/E, arguably a measure of investor risk aversion?

The next chart tracks S&P 500 12-month trailing operating P/E and the level of public sociopolitical satisfaction over the entire sample period. Again, the horizontal access for the polling schedule is irregular because of variations in polling frequency. There appears to be a relationship between these two series in terms of both broad trends and finer features.

Again, the large jumps at the beginning of 2009 are at least partly reflective of a large gap in polling activity during January through July of 2009.

For another perspective, we use a scatter plot.

The following two scatter plots relate S&P 500 12-month trailing operating P/E to sociopolitical satisfaction over the entire sample period at the polling frequency (approximately monthly) and at an annual frequency (using polls nearest beginnings of years). The relationship between overall stock market valuation and broad public sentiment appears significant. At the polling frequency, a linear best-fit yields an R-squared statistic of 0.55, indicating that variation in sociopolitical satisfaction explains over half the variation in P/E.

At an annual frequency, the R-squared statistic is 0.50 (but sample size is just 14).

For a closer look at potential exploitability, we relate change in satisfaction from poll to poll to the S&P 500 Index return from the latter poll to the next poll.

The following scatter plot relates the change in sociopolitical satisfaction from the last poll to a given poll to the change in the S&P 500 Index from the given poll to the next poll over the entire sample period. This test roughly (ignoring polling gaps) relates the change in satisfaction last month to the change in the S&P 500 Index next month. The R-squared statistic is 0.00, indicating no relationship between change in satisfaction from poll to poll and near-term (approximately next-month) stock market movement. No exploitable non-linearities are evident.

Whatever trading behavior keeps sociopolitical satisfaction and the stock market in step, it appears to be coincident (efficient) rather than predictive at the measured frequency.

In summary, evidence suggests that public sociopolitical satisfaction and stock market valuation move substantially in step, with no way to exploit the broad sentiment measure in stock market trading.

There may be an incentive for politicians to act in ways that create investment bubbles (elevated P/E) in the course of maximizing public sentiment.

Cautions regarding findings include:

• Sample size is very small with respect to the numbers of independent annual earnings measurements and four-year political cycles.
• The above analyses are in-sample (retrospective). An investor operating in real time during the sample period would not know all the data used in the charts above and may draw different conclusions based on strictly historical information.

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