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Relative Sentiment plus Machine Learning for Stock Market Timing

| | Posted in: Individual Investing, Sentiment Indicators

Do economic expectations of sophisticated investors relative to those of unsophisticated investors predict stock market returns? In the September 2020 revision of his paper entitled "Relative Sentiment and Machine Learning for Tactical Asset Allocation", flagged by a subscriber, Raymond Micaletti investigates use of relative Sentix sentiment for tactical asset allocation. He each month constructs relative sentiment factors for regional U.S., Europe, Japan and Asia ex-Japan equity markets as differences in 6-month economic expectations between respective institutional and individual investors. He then applies machine learning algorithms to test 990 alternative strategies of relative sentiment for each region, augmented by both cross-validation and adjusted for data snooping. He tests usefulness of the most significant backtest results in two ways:

  1. Translation of relative sentiment to equity allocations ranging from 0% to 100% for each equity market, with the non-equity allocation going to either bonds or cash. As benchmarks, he uses the average monthly equity allocation of relative sentiment strategies, with the balance allocated to bonds or cash, rebalanced monthly.
  2. Ranking of regions by relative sentiment to predict which equity markets will be outperformers and underperformers next month.

Using monthly Sentix sentiment data as described, monthly returns for associated equity market indexes and spliced exchange-traded funds (ETF) and monthly returns for the Barclays US Aggregate Bond Index during August 2002 through September 2019 (with a 3-month gap in sentiment data during October 2002 through December 2002), he finds that:

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