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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.

Stated Beliefs Versus Trading Behavior

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: Keep Reading

Factor Universality?

Studies of the U.S. stock market indicate that some factors and indicators may have predictive power for future returns. Do these findings consistently translate to other large equity markets? In the July 2010 version of their paper entitled “The Cross-Section of German Stock Returns: New Data and New Evidence”, Sabine Artmann, Philipp Finter, Alexander Kempf, Stefan Koch and Erik Theissen apply a new set of single-sorted and double-sorted factor portfolios based on market beta, size, book-to-market ratio and momentum to test for beta effect, size effect, value premium and momentum in the German equity market. In the July 2010 version of their paper entitled “The Impact of Investor Sentiment on the German Stock Market”, Philipp Finter, Alexandra Niessen-Ruenzi and Stefan Ruenzi test the predictive power of a composite sentiment measure combining consumer confidence, net equity mutual funds flow, put-call ratio, aggregate trading volume, initial public offering (IPO) returns, number of IPOs and aggregate equity-to-debt ratio of new issues. Using data for 955 non-financial German firms for which sufficient data is available during the period 1960-2006 for the factor portfolios and 1993-2006 for the sentiment measure, these studies find that: Keep Reading

Exploit Media Bias in Hedge Fund Coverage?

Does media coverage of hedge funds indicate their values as investments? In their July 2010 paper entitled “Media and Investment Management”, Gideon Ozik and Ronnie Sadka investigate the level and investment implications of media bias by applying textual analysis to titles of articles from three types of news coverage about equity hedge funds (General newspapers, Specialized investment magazines, and Corporate communications). They frame their investigation by hypothesizing three aspects of bias: reporting style, editorial selection and content. Using the Google News archive to collect approximately 67,000 news articles from about 3,600 unique media sources on a sample of 774 long/short U.S. equity hedge funds over the period 1999-–2008, they find that: Keep Reading

Sentiment from Google Insights and Return Continuation

Does investor interest in stocks as measured by Google Insights for Search predict which stocks will exhibit return continuation? In his June 2010 paper entitled “The Demand for Information”, Gordon Sims examines the effects of investor attention to stocks as defined by relative search frequency from Google Insights for Search (Stock Information Demand) to short-term stock momentum. The past return interval for momentum measurement is four weeks, augmented by a one-week delay in portfolio formation to avoid short-term reversal. Search term construction for Stock Information Demand focuses on intent to buy or sell a stock by appending “stock” or “quote” to a company’s name or ticker symbol. Using weekly returns for July 2003 through December 2009 for those S&P 500 stocks (as of July 31, 2003) with sufficient weekly Stock Information Demand data over the period 2004-2009 (214 stocks), he finds that: Keep Reading

When Market Sentiment Works

Is investor sentiment a better predictor of future stock returns in bull markets or bear markets? In their March 2010 paper entitled “When Does Investor Sentiment Predict Stock Returns?”, San-Lin Chung, Chi-Hsiou Hung and Chung-Ying Yeh examine the predictive power of investor sentiment for different kinds of stocks during bull (low-volatility, expansion) and bear (high-volatility, recession) equity market regimes. In each regime, they test the ability of a lagged multi-indicator sentiment index to forecast equally weighted hedge portfolio returns, focusing on stocks most likely susceptible to mispricing (small-capitalization stocks, stocks without positive earnings, growth stocks and stocks that pay no dividend). Using monthly returns for a broad sample of U.S. stocks and a value-weighted stock market index and investor sentiment data for the period 1966-2005, they find that: Keep Reading

Why the Experts Don’t Rule the World?

Why does the public resist the wisdom of scientific consensus on “questions only they [scientists] are equipped to answer?” In their February 2010 article entitled “Cultural Cognition of Scientific Consensus”, Dan Kahan, Hank Jenkins-Smith and Donald Braman examine the tendency of individuals to perceive risk with biases congenial to their visions of how society should be organized. The authors focus on the examples of climate change, disposal of nuclear waste and the effect of permitting concealed possession of handguns. They measure individual cultural predisposition along two dimensions: hierarchy versus egalitarianism, and individualism versus communitarianism. Using results of an online survey of 1,500 U.S. adults during July 2009, they conclude that: Keep Reading

Unadmired Stocks Beat Admired Ones?

Are the most admired companies the best investments? Or, is current state of admiration a contrarian indicator for future returns? In their January 2010 paper entitled “Stocks of Admired Companies and Spurned Ones”, Deniz Anginer and Meir Statman use Fortune magazine’s yearly survey-based lists of “America’s Most Admired Companies” to answer these questions by measuring the returns (April 1 through March 31) of two portfolios reformed annually: admired companies (upper half of survey scores), and unadmired companies (lower half of survey scores). Survey respondents are senior executives, directors and securities analysts, and the questions asked seemingly relate indirectly or directly to the investment value of the companies named. Using these lists for April 1983 (survey inception) through March 2007 and associated stock return data, they conclude that: Keep Reading

Using Commitments of Traders Reports to Time Asset Allocations

Is the aggregate sentiment of futures traders predictive for asset returns? In the June 2008 update of their paper entitled “How to Time the Commodity Market”, Devraj Basu, Roel Oomen and Alexander Stremme investigate whether information in the weekly Commodity Futures Trading Commission’s Commitments of Traders (COT) reports enable successful timing of U.S. equities and commodities markets. These reports aggregate the size and direction of the positions taken by different categories of futures traders in different assets. “Commercial” traders use futures contracts for hedging, “non-commercial” traders use them for other types of speculation and “non-reportable” traders operate below the reporting threshold. The study seeks to exploit “hedging pressure” (the fraction of positions that are long) for each of six liquid commodities (crude oil, gold, silver, copper, soybeans and sugar) and for the S&P 500 Index. Each Friday, the six trading strategies studied: (1) take a long position in a commodity if hedging pressure for both the commodity and the S&P 500 Index are below their 52-week averages; or, (2) take a long position in the S&P 500 Index if hedging pressure for both the commodity and the S&P 500 Index are above their 52-week averages; or, (3) hold 3-month U.S. Treasury bills. Using COT reports and associated weekly futures prices for October 1992 through December 2006, they conclude that: Keep Reading

Extracting the Irrational Part of VIX

Does the Chicago Board Options Exchange Volatility Index (VIX) have separable components of rational and irrational risk? If so, is the irrational risk component of use to investors? In their October 2009 paper entitled “Risk Sentiment Index (RSI) and Market Anomalies”, Guy Kaplanski and Haim Levy introduce the Risk Sentiment Index (RSI) as a measure of the residual risk contained in VIX after accounting for the statistical and economic variables most predictive of future stock market volatility (such as previous month actual volatility and VIX). They also analyze factors which affect RSI and its relationships with day-of-the-week and month-of-the-year stock market anomalies. Using daily closes for VIX and the S&P 500 Index during 1990-2007 (4,538 days) and for the Volatility Index Japan (VXJ) and the Nikkei 225 Index during 1995-2007 (3,200 days), they conclude that: Keep Reading

Short-term Net Money Flow and Stock Returns

A reader asked: “Is there any tradable relationship between aggregate net money flows and market returns. I have read many articles pointing out how, according to money flows, investors got out at the bottom in 2008. Can flows into the equity market at large predict (or ‘inversely’ predict) returns?” To check, we relate return to the net money flow reported in the referenced Wall Street Journal data, focusing on the Dow Jones Industrial Average (DJIA). Using DJIA net money flows and DJIA returns at weekly and monthly intervals since May 2007 (the earliest available), we find that: Keep Reading

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