Sentiment Indicators

Are broad measures of public sociopolitical sentiment relevant to investors? Do they predict stock returns as indicators of exuberance and fear? To investigate, we relate S&P 500 Index return and 12-month trailing S&P 500 price-operating earnings ratio (P/E) to the percentage of respondents saying “yes” to the recurring Gallup polling question: “In general, are you satisfied or dissatisfied with the way things are going in the United States at this time?” Since individual polls span several days, we use S&P 500 Index levels for about the middle of the polling interval. To calculate market P/E, we use current S&P 500 Index level and most recent quarterly aggregate operating earnings. Using Gallup polling results, S&P 500 Index levels and 12-month trailing S&P 500 operating earnings as available during July 1990 (when polling frequency becomes about monthly) through September 2022, we find that: Keep Reading

Does combining a sentiment indicator with a trend following indicator improve performance of a stocks-bonds timing strategy? In his October 2022 paper entitled “The Complementarity of Trend Following and Relative Sentiment”, Raymond Micaletti investigates effects of combining the following trend following (TF) and relative sentiment (RS) indicators:

• TF – at the end of each month switch to a broad U.S. stock market index (an aggregate bond index) when the prior-close stock market index crosses above (below) its 10-month simple moving average (SMA) strategy. This strategy is the best of six similar SMA strategies.
• RS – each week update the equity allocation from 0% to 100% based on an equal-weighted combination of three prior-week inputs, two of which are driven by weekly Commitments of Traders reports and one of which is driven by monthly Sentix relative sentiment, with the balance of the portfolio in an aggregate bond index. Update the equity allocation only if it differs from the prior allocation by more than 10%.

The combined strategy (TFRS) is a 50-50 mix of TF and RS. He applies frictions of 0.04% to account for costs of both stock and bond index allocation changes. For interpretation of results, he focuses on nine times the equity index suffers a drawdown of at least 10% from an all-time high. Using daily U.S. equity market total returns and U.S. Treasury bill yields (for Sharpe ratio calculations) from the Kenneth French data library, daily levels of Bloomberg Barclays U.S. Aggregate Bond Total Return Index, weekly Commitments of Traders reports and the monthly Sentix economic outlook survey of institutional and individual investors during November 1994 through August 2022, he finds that: Keep Reading

Does the sentiment expressed by major newspapers about the economy usefully predict stock market returns? To investigate, we employ the Daily News Sentiment Index, constructed from “economics-related news articles from 24 major U.S. newspapers [across] all major regions of the country…with at least 200 words… The Daily News Sentiment Index is constructed as a trailing weighted-average of time series, with weights that decline geometrically with the length of time since article publication.” Update frequency is weekly, suggesting use of a 7-day simple moving average (SMA7). We calculate the SMA7 on Sundays and relate this series to weekly S&P 500 Index returns calculated from closes on the following Mondays. Using the specified weekly data series during January 1980 (limited by the sentiment series) through July 2022, we find that: Keep Reading

A subscriber suggested testing SentimenTrader’s Dumb Money Confidence model “that incorporates more than a dozen indicators that have a track record of cycling to extremes, and equating with ebbs and flows in sentiment among broad categories of investors.” To investigate, we transcribe monthly values of Dumb Money Confidence from the chart at the link and relate this series to monthly SPDR S&P 500 ETF Trust (SPY) total returns, calculated from the open on the first trading day after a Dumb Money Confidence date to the open on the first trading day after the next Dumb Money Confidence date. Using the specified data from the end of December 1998 (limited by the Dumb Money Confidence series) through the end of July 2022, we find that: Keep Reading

Does quantified uncertainty in government economic policy reliably predict stock market returns? To investigate, we consider the U.S. Economic Policy Uncertainty (EPU) Index, created by Scott Baker, Nicholas Bloom and Steven Davis and constructed from three components:

1. Coverage of policy-related economic uncertainty by prominent newspapers.
2. Number of temporary federal tax code provisions set to expire in future years.
3. Level of disagreement in one-year forecasts among participants in the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters for both (a) the consumer price index (CPI) and (b) purchasing of goods and services by federal, state and local governments.

They normalize each component by its own standard deviation prior to 2012 and then compute a weighted average of components, assigning a weight of one half to news coverage and one sixth each to tax code uncertainty, CPI forecast disagreement and government purchasing forecast disagreement. They update the index monthly at the beginning of the following month, potentially revising recent months. Using monthly levels of the EPU Index and the S&P 500 Index during January 1985 through July 2022, we find that: Keep Reading

Do active investment managers as a group successfully time the stock market? The National Association of Active Investment Managers (NAAIM) is an association of registered investment advisors. “NAAIM member firms who are active money managers are asked each week to provide a number which represents their overall equity exposure at the market close on a specific day of the week (usually Wednesday). Responses can vary widely [200% Leveraged Short; 100% Fully Short; 0% (100% Cash or Hedged to Market Neutral); 100% Fully Invested; 200% Leveraged Long].” The association each week releases (usually on Thursday) the average position of survey respondents as the NAAIM Exposure Index (NEI).” Using historical weekly survey data and Thursday-to-Thursday weekly dividend-adjusted returns for SPDR S&P 500 (SPY) over the period July 2006 through mid-July 2022, we find that: Keep Reading

Is conventional wisdom that aggregate retail investor sentiment is a contrary indicator of future stock market return correct? To investigate, we examine the sentiment expressed by members of the American Association of Individual Investors (AAII) via a weekly survey of members. This survey asks AAII members each week (Thursday through Wednesday): “Do you feel the direction of the market over the next six months will be up (bullish), no change (neutral) or down (bearish)?” Only one vote per member is accepted in each weekly voting period.” Survey results are available the market day after the polling period. We define aggregate (net) investor sentiment as percent bullish minus percent bearish. Using outputs of the weekly AAII surveys and prior-day closes of the S&P 500 Index from July 1987 through mid-July 2022, we find that: Keep Reading

Do the Best Brands, as published annually by Interbrand based on net present value of predicted incremental earnings due to brand, offer superior investment performance due to pricing power and superior operating practices? In their June 2022 paper entitled “Is Buffett Right? Brand Values and Long-run Stock Returns”, Hamid Boustanifar and Young Dae Kang examine the investment performance of Best Brands. Best Brands companies must be global, have publicly available financial data, be visible and have the expectation of positive long-term profitability above the cost of capital). Up to 2007 (subsequently), Interbrand published Best Brand lists in July or August (late September or October). The authors each year reform a Best Brands portfolio limited to U.S. firms the first day of the month after publication, thereby excluding immediate announcement effects on stock prices. For stocks encompassing multiple brands (e.g., Google and YouTube for Alphabet), they map brands to stocks by summing brand values. Using firm characteristics, accounting data and stock prices for a broad sample of U.S. stocks during 2000 (the first Best Brands list) through 2020, they find that:

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Business media and expert commentators sometimes cite the monthly University of Michigan Consumer Sentiment Index as an indicator of U.S. economic and stock market health, generally interpreting a jump (drop) in sentiment as good (bad) for future consumption and stocks. The release schedule for this indicator is mid-month for a preliminary reading on the current month and end-of-month for a final reading. Is this indicator predictive of U.S. stock market behavior in subsequent months? Using monthly final Consumer Sentiment Index data and monthly levels of the S&P 500 Index during January 1978 through May 2022, we find that: Keep Reading

A reader requested evaluation of the Fosback Index and its Ned Davis variant. The creators of these indicators argue that a high (low) ratio of cash equivalents to assets among equity mutual funds indicates strong (weak) potential demand for stocks. The Investment Company Institute (ICI) surveys mutual fund managers monthly (with a lag of about a month) to measure the aggregate equity mutual fund liquidity ratio (LR). Only past year-end values of LR are readily available. Norman Fosback adjusts raw LR based on current interest rates, reasoning that mutual fund managers have more (less) incentive to hold cash when interest rates are high (low). We adjust the effect of interest rates via linear regression of annual LR against year-end yield of the 3-month U.S. Treasury bill (T-bill). We then define the difference between raw and adjusted values as Excess LR and relate this variable to annual returns of the Fidelity Fund (FFIDX) as a proxy for U.S. stock market total performance. Using year-end values of aggregate equity mutual fund LR from the 2021 Investment Company Fact Book, Table 15, year-end T-bill yield and annual returns for FFIDX during December 1984 through December 2021 ( 36 years), we find that: Keep Reading