Sentiment Indicators

A reader suggested looking at Rydex asset ratios as stock market sentiment indicators. The reasoning for these indicators is that a high (low) ratio of assets in bullish funds to assets in bearish funds indicates an overbought (oversold) market. Are these indicators useful? The most timing-intensive traders arguably use leveraged exchange traded funds (ETF), thereby suggesting that bull-bear asset ratios for such funds may be especially informative. Using daily closing asset levels for the Rydex 2x S&P 500 ETF and the Rydex Inverse 2x S&P 500 ETF from the earliest available on 11/5/07 through 6/24/11 (917 trading days), along with contemporaneous daily opens and closes of the S&P 500 index, we find that: More…

Howard Marks introduces his 2011 book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor, by stating: “…I have built this book around the idea of the most important things–each is a brick in what I hope will be a solid wall, and none is dispensable. …I consider it my creed, and in the course of my investing career it has served like a religion. …You won’t find a how-to book here. There’s no surefire recipe for investment success. …Just a way to think that might help you make good decisions and, perhaps more important, avoid the pitfalls that ensnare so many. …the thing I most want to make clear is just how complex [investing] is.” Evolved from decades of investing experience, including that as co-founder and chairman of Oaktree Capital Management, some notable points from the book are: More…

Do professional money managers as a group successfully time the stock market? The National Association of Active Investment Managers (NAAIM) is an association of registered investment advisors who provide active money management services to their clients. Each week, NAAIM surveys conducts a Survey of Manager Sentiment, asking member firms “to provide a number which represents their overall equity exposure at the market close on…Wednesdays. Responses can vary [from 200% short to 200% long]. Responses are tallied and averaged to provide the average long (or short) position of all NAAIM managers, as a group.” Using historical weekly survey data and contemporaneous weekly returns for the S&P 500 Index over the period July 2006 through May 2011 (256 surveys), we find that: More…

Does construction of new tallest-in-the-world buildings indicate financial hubris and therefore pending equity market weakness? In the March 2011 version of his paper entitled “Tower Building and Stock Market Returns”, Gunter Löffler relates construction of record-breaking skyscrapers to future stock market returns. He focuses on construction start dates, since completion dates may occur after any wave of optimism that encourages construction may have passed. He focuses on the U.S. because most relevant data is American. Using U.S. building construction and stock market data for 1871 through 2009, he finds that: More…

“Exploitable Retail Trader Herding?” investigates the usefulness of the correlation of past weekly returns between small stocks and large stocks as a trading indicator, finding support for a belief that the indicator has predictive value. However, the testing is in-sample and ignores shorting costs. Do findings stand up to remedies for these concerns? Using weekly returns for SPDR S&P 500 (SPY) and iShares Russell 2000 Index (IWM) from May 2000 (inception of IWM) through April 2011 and ProShares Short S&P 500 (SH) from June 2006 (inception) through April 2011, we find that: More…

Is there evidence of investor herding in the variation of return correlations for individual stocks? In their January 2011 paper entitled “Asymmetric Correlations”, Tarun Chordia, Amit Goyal and Qing Tong investigate when and why return correlations for individual stocks vary over time. At the end of each month, they calculate average pairwise correlations of stocks at a daily frequency over the month. Using daily returns for all NYSE common stocks, along with contemporaneous stock trading data and firm characteristics, from January 1963 through December 2008, they find that: More…

Does aggregate investor sentiment affect the strength of well-known U.S. stock return anomalies? In their January 2011 paper entitled “The Short of It: Investor Sentiment and Anomalies”, Robert Stambaugh, Jianfeng Yu and Yu Yuan explore the interaction of aggregate investor sentiment with 11 cross-sectional stock return anomalies. Their approach reflects expectations that: (1) overpricing of stocks is more common than underpricing due to short-sale constraints; and, (2) a high sentiment level amplifies overpricing. Specifically, they consider the effect of investor sentiment on hedge portfolios that are long (short) the highest(lowest)-performing) value-weighted deciles of stocks sorted on: financial distress (two measures), net stock issuance, composite equity issuance, total accruals, net operating assets, momentum, gross profit-to-assets, asset growth, return-on-assets and investment-to-assets. They use a long-run sentiment index derived from principal component analysis of six sentiment measures: trading volume as measured by NYSE turnover; the dividend premium; the closed-end fund discount; the number of and first-day returns on Initial Public Offerings; and, the equity share in new issues. They measure anomaly alphas relative to the three-factor model (adjusting for market, size, book-to-market). Using monthly sentiment and stock return anomaly data as available over the period July 1965 through January 2008, they find that: More…

Do individual investors actually trade on their stated beliefs? In their February 2011 paper entitled “Do Investors Put Their Money Where Their Mouth Is? Stock Market Expectations and Trading Behavior”, Christoph Merkle and Martin Weber compare quarterly risk and return expectation survey responses to actual trading data and portfolio holdings for a group of self-directed individual UK investors. Using this investor data, along with contemporaneous measures of actual FTSE All-Share Index returns and volatility during 2008 through 2010 (first survey in September 2008 and last in September 2010), they find that: More…

Does margin debt serve as an intermediate-term stock market sentiment indicator based on either momentum (with an increase/decrease in margin debt signaling a continuing stock market advance/decline) or reversion (with high/low margin debt signaling a pending reversal)? To investigate, we compare the behavior of NYSE end-of-month margin debt, published with a delay of over a month, with the monthly behavior of the the stock market (S&P 500 Index). Using end-of-month data for the period January 1959 through October 2010 (622 months), we find that: More…

The conventional wisdom is that a high (low) ratio of stock market put option volume to stock market call option volume is bullish (bearish) because it indicates that investors are overly pessimistic (optimistic). Alternative measurements of the stock market put-call ratio are total options, index options and individual equity options. Index and equity option buyers may have different motives. Alternative sources of put-call ratios are the Chicago Board Options Exchange (CBOE) and the International Securities Exchange (ISE). CBOE counts volumes for all options transactions. ISE relies on “a unique put/call value that only uses opening long customer transactions to calculate bullish/bearish market direction. Opening long transactions are thought to best represent market sentiment because investors often buy call and put options to express their actual market view of a particular stock. Market maker and firm trades, which are excluded, are not considered representative of true market sentiment due to their specialized nature. As such, the…calculation method allows for a more accurate measure of true investor sentiment…” Do any of the alternative put-call ratios uphold the conventional wisdom? Using available historical daily data for CBOE and ISE total, index and equity option put-call ratios and contemporaneous dividend-adjusted levels of S&P Depository Receipts (SPY) through 9/27/10, we find that: More…