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Sentiment Indicators

Investors/traders track a range of sentiments (consumer, investor, analyst, forecaster, management), searching for indications of the next swing of the psychological pendulum that paces financial markets. Usually, they view sentiment as a contrarian indicator for market turns (bad means good — it’s darkest before the dawn). These blog entries relate to relationships between human sentiment and the stock market.

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Small Business Owner Sentiment and the U.S. Stock Market

Throughout each month, the National Federation of Independent Businesses surveys members on ten components of business conditions they anticipate six months hence. They issue findings on the second Tuesday of the following month in “Small Business Economic Trends”, including a Small Business Optimism Index (SBOI). Are the expectations of responding small business owners a “grass roots” predictor of U.S. stock market behavior? To check, we relate changes in SBOI to U.S. stock market returns. Using monthly levels of SBOI, the S&P 500 Index (a proxy for the U.S. stock market) and the Russell 2000 Index (representing smaller stocks) during January 2003 through December 2018 (180 months), we find that: Keep Reading

Financial Distress, Investor Sentiment and Downgrades as Asset Return Anomaly Drivers

What firm/asset/market conditions signal mispricing? In the November 2017 version of their paper entitled “Bonds, Stocks, and Sources of Mispricing”, Doron Avramov, Tarun Chordia, Gergana Jostova and Alexander Philipov investigate drivers of U.S. corporate stock and bond mispricing based on interactions among asset prices, financial distress of associated firms and investor sentiment. They measure financial distress via Standard & Poor’s long term issuer credit rating downgrades. They measure investor sentiment primarily with the multi-input Baker-Wurgler Sentiment Index, but they also consider the University of Michigan Consumer Sentiment index and the Consumer Confidence Index. They each month measure asset mispricing by:

  1. Ranking firms into tenths (deciles) based on each of 12 anomalies: price momentum, earnings momentum, idiosyncratic volatility, analyst forecast dispersion, asset growth, investments, net operating assets, accruals, gross profitability, return on assets and two measures of net share issuance.
  2. Computing for each firm the equally weighted average of its anomaly rankings, such that a high (low) average ranking indicates the firms’s assets are relatively overpriced (underpriced).

Using monthly firm, stock and bond data for a sample of U.S. firms with sufficient data and investor sentiment during January 1986 through December 2016, they find that: Keep Reading

Aggregate Firm Events as a Stock Return Anomaly

Should investors view stock returns around recurring firm events in aggregate as an exploitable anomaly? In their October 2017 paper entitled “Recurring Firm Events and Predictable Returns: The Within-Firm Time-Series”, Samuel Hartzmark and David Solomon review the body of research on relationships between recurring firm events and future stock returns. They classify events as predictable (1) releases of information or (2) corporate distributions, with some overlap. Information releases include earnings announcements, dividend announcements, earnings seasonality and predictable increases in dividends. Corporate distributions cover dividend ex-days, stock splits and stock dividends. They specify a general trading strategy to exploit these events that is long (short) stocks of applicable firms during months with (without) predictable events. They use market capitalization weighting but, since there are often more stocks in the short side, they scale short side weights downward so that overall long and short sides are equal in dollar value. Based on the body of research and updated analyses based on firm event data and associated stock prices from initial availabilities through December 2016, they conclude that:

Keep Reading

Survey of Research on Investor Sentiment Metrics

How effective is investor sentiment in predicting stock market returns? In his October 2017 paper entitled “Measuring Investor Sentiment”, Guofu Zhou reviews various measures of equity-oriented investor sentiment based on U.S. market, survey and media data. He highlights the Baker-Wurgler Index (the most widely used), which is based on the first principal component of six sentiment inputs: (1) detrended NYSE trading volume; (2) closed-end fund discount relative to net asset value; (3) number of initial public offerings (IPO); (4) average first-day return on IPOs; (5) ratio of equity issues to total market equity/debt; and, (6) dividend premium (difference between average market-to-book ratios of dividend payers and non-dividend payers). Based on the body of research and using monthly inputs for the Baker-Wurgler Index during July 1965 through December 2016, three sets of investor sentiment survey data since inceptions (between Dec 1969 and July 1987) through December 2016 and two sets of textual analysis data spanning Jan 2003 through December 2014 and Jul 2004 through Dec 2011, he finds that: Keep Reading

Margin Debt as a Stock Market Indicator

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 change in margin debt signaling a pending reversal)? To investigate, we relate the behavior of NYSE end-of-month margin debt, published with a delay of about a month, with the monthly behavior of the S&P 500 Index as a proxy for the U.S. stock market. Using monthly data during January 1959 through August 2017 (703 months), we find that: Keep Reading

Consumer Inflation Expectations Predictive?

A subscriber noted and asked: “Michigan (at one point) claimed that the inflation expectations part of their survey of consumers was predictive. That was from a paper long ago. I wonder if it is still true.” To investigate, we relate “Expected Changes in Prices During the Next Year” (expected annual inflation) from the monthly final University of Michigan Survey of Consumers and actual U.S. inflation data based on the monthly non-seasonally adjusted consumer price index (U.S. All items, 1982-84=100). The University of Michigan releases final survey data near the end of the measured month. We consider two relationships:

  • Expected annual inflation versus one-year hence actual annual inflation.
  • Monthly change in expected  annual inflation versus monthly change in actual annual inflation.

As a separate (investor-oriented) test, we relate monthly change in expected annual inflation to next-month total returns for SPDR S&P 500 (SPY) and iShares Barclays 20+ Year Treasury Bond (TLT). Using monthly survey/inflation data since March 1978 (limited by survey data) and monthly SPY and TLT total returns since July 2002 (limited by TLT), all through May 2017, we find that: Keep Reading

Finding Event Types with Pure Effects on Stock Returns

Do certain types of news about specific stocks reliably predict risk-adjusted returns of those stocks? In their March 2017 paper entitled “Using Natural Language Processing Techniques for Stock Return Predictions”, Ming Li Chew, Sahil Puri, Arsh Sood and Adam Wearne investigate relationships between financial news headlines and stock returns stripped of non-news risks. They use natural language processing to classify corporate events by firm, illustrating via five types: dividend declaration; oversold conditions; receipt of approval; signing an agreement; and, hiring an advisor. They isolate each type by segmenting headlines into 10, 20, 50 or 100 clusters of similar headlines. They then form portfolios for the most relevant clusters that are long (short) stocks for which events have occurred (same-industry stocks for which there are no events), with positions weighted to eliminate exposures to market, size and value factors. Outputs include factor-adjusted cumulative and daily average returns. They focus on stocks in the S&P 500 as it evolves and divide the sample into 2006-2014 to identify event clusters in-sample and 2015-2016 to test cluster portfolio performance out-of-sample. Using 60,949 active voice financial news headlines that relate to specific S&P 500 firms and associated daily/quarterly stock price and firm characteristics data during 2006 through early 2017, they find that: Keep Reading

Mojena Market Timing Model

The Mojena Market Timing strategy (Mojena), developed and maintained by professor Richard Mojena, is a method for timing the broad U.S. stock market based on a combination of many monetary, fundamental, technical and sentiment indicators to predict changes in intermediate-term and long-term market trends. He adjusts the model annually to incorporate new data. Professor Mojena offers a hypothetical backtest of the timing model since 1970 and a live investing test since 1990 based on the S&P 500 Index (with dividends). To test the robustness of the strategy’s performance, we consider a sample period commencing with inception of SPDR S&P 500 (SPY) as a convenient and low-cost proxy for the S&P 500 Index. As benchmarks, we consider both buying and holding SPY (Buy-and-Hold) and trading SPY with crash protection based on the 10-month simple moving average of the S&P 500 Index (SMA10). Using the trade dates from the Mojena Market Timing live test, daily dividend-adjusted closes for SPY and daily yields for 13-week Treasury bills (T-bills) from the end of January 1993 through March 2017 (over 24 years), we find that: Keep Reading

Active Investment Managers and Market Timing

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, currently Wednesdays. Responses can vary widely [200% Leveraged Short; 100% Fully Short; 0% (100% Cash or Hedged to Market Neutral); 100% Fully Invested; 200% Leveraged Long]. Responses are tallied and averaged to provide the average long (or short) position or all NAAIM managers, as a group [NAAIM Exposure Index].” Using historical weekly survey data and weekly Wednesday-to-Wednesday dividend-adjusted returns for SPDR S&P 500 (SPY) over the period July 2006 through mid-March 2017 (550 surveys), we find that: Keep Reading

AAII Investor Sentiment as a Stock Market Indicator

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 February 2017 (1,545 surveys and 59 independent 6-month forecast intervals), we find that: Keep Reading

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