Is there a best measure of investor sentiment for predicting stock market returns? In his March 2016 paper entitled “Investor Sentiment and Stock Market Returns”, Lee Smales updates relationships between stock market/portfolio returns and five sentiment measures:
- CBOE Implied Volatility Index (VIX).
- Baker-Wurgler composite sentiment index (readily available only through 2012).
- American Association of Individual Investors (AAII) investor sentiment.
- University of Michigan Consumer Sentiment Index.
- Commitment of Traders (COT) reports from the Commodity Futures Trading Commission.
He controls for multiple economic and financial variables likely to be related to stock market returns (gross domestic product, industrial production, unemployment rate, consumer price index, Federal Funds target rate, term spread, credit spread and dividend yield). He also investigates economic recessions separately. Principal tests relate sentiment levels and changes in sentiment levels to S&P 500 Index and style/industry portfolio returns (from Kenneth French’s data library) at horizons of 1, 3, 6 and 12 months. Using monthly values of sentiment measures as available and monthly index/portfolio returns during January 1990 through December 2015, he finds that: Keep Reading