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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.

Economic Policy Uncertainty and the Stock Market

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 September 2019, we find that: Keep Reading

In Search of the Bear?

Is intensity of public interest in a “bear market” useful for predicting stock market return? To investigate, we download monthly U.S. Google Trends search intensity data for “bear market” and relate this series to monthly S&P 500 Index returns. For comparison with the “investor fear gauge,” we also relate search data to monthly CBOE option-implied S&P 500 Index volatility (VIX) levels. Google Trends analyzes a percentage of Google web searches to estimate the number of searches done over a certain period. “Each data point is divided by the total searches of the geography and time range it represents to compare relative popularity… The resulting numbers are then scaled on a range of 0 to 100 based on a topic’s proportion to all searches on all topics.” Using the specified data during January 2004 (earliest available on Google Trends) through August 2019, 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 early September 2019 (685 surveys), we find that: Keep Reading

Deeply Learned Management Sentiment as Stock Return Predictor

Can investors apply deep learning software to expose obscure but useful management sentiment in firm SEC Form 10-K filings? In their July 2019 paper entitled “Is Positive Sentiment in Corporate Annual Reports Informative? Evidence from Deep Learning”, Mehran Azimi and Anup Agrawal apply deep learning to detect positive and negative sentiments at the sentence level in 10-Ks. They train their model using 8,000 manually evaluated sentences randomly selected from 10-Ks. They then use the trained model to assign sentiments to all sentences in each 10-K. Their overall measure of negative (positive) sentiment is number of negative (positive) sentences divided by the total number of sentences in the 10-K. They assess impact of 10-K sentiment on stock performance based on 4-factor (market, size, book-to-market, momentum) alpha during short intervals after 10-K filing. Using 10-K filings for non-utility and non-financial U.S. public firms with at least 200 words, associated daily stock prices/trading volumes and daily 4-factor alphas during January 1994 through December 2017, they 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 mid-August 2018 (1,674 surveys and 64  independent 6-month forecast intervals), we find that: Keep Reading

Gold Price Drivers?

What drives the price of gold: inflation, interest rates, stock market behavior, public sentiment? To investigate, we relate monthly and annual spot gold return to changes in:

We start testing in 1975 because: “On March 17, 1968, …the price of gold on the private market was allowed to fluctuate…[, and] in 1975…the price of gold was left to find its free-market level.” We lag CPI measurements by one month to ensure they are known to the market when calculating gold return. Using monthly data from December 1974 (March 1978 for consumer sentiment) through July 2019, we find that: Keep Reading

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 June 2019 (198 months), we find that: Keep Reading

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

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 resultsS&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 June 2019, we find that: Keep Reading

Sentiment Indexes and Next-Month Stock Market Return

Do sentiment indexes usefully predict U.S. stock market returns? In his May 2018 doctoral thesis entitled “Forecasting Market Direction with Sentiment Indices”, flagged by a subscriber, David Mascio tests whether the following five sentiment indexes predict next-month S&P 500 Index performance:

  1. Investor Sentiment – the Baker-Wurgler Index, which combines six sentiment proxies.
  2. Improved Investor Sentiment – a modification of the Baker-Wurgler Index that suppresses noise among input sentiment proxies.
  3. Current Business Conditions – the ADS Index of the Philadelphia Federal Reserve Bank, which combines six economic variables measured quarterly, monthly and weekly to develop an outlook for the overall economy.
  4. Credit Spread – an index based on the difference in price between between U.S. corporate bonds and U.S. Treasury instruments with matched cash flows. (See “Credit Spread as an Asset Return Predictor” for a simplified approach.)
  5. Financial Uncertainty – an index that combines forecasting errors for large sets of economic and financial variables to assess overall economic/financial uncertainty.

He also tests two combinations of these indexes, a multivariate regression including all sentiment indexes and a LASSO approach. He each month for each index/combination predicts next-month S&P 500 Index return based on a rolling historical regression of 120 months. He tests predictive power by holding (shorting) the S&P 500 Index when the prediction is for the market to go up (down). In his assessment, he considers: frequency of correctly predicting up and down movements; effectiveness in predicting market crashes; and, significance of predictions. Using monthly data for the five sentiment indexes and S&P 500 Index returns during January 1973 through April 2014, he finds that: Keep Reading

Consumer Sentiment and Stock Market Returns

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 in fact 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 April 2019 (496 monthly sentiment readings), we find that: Keep Reading

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