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Using sentiment to predict GDP growth and stock returns

Guzman, Giselle C. (2008): Using sentiment to predict GDP growth and stock returns. Published in: The Making of National Economic Forecasts No. Edward Elgar Publishing LTD (2009): pp. 319-351.

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Abstract

This study sheds new light on the question of whether or not sentiment surveys, and the expectations derived from them, are relevant to forecasting economic growth and stock returns, and whether they contain information that is orthogonal to macroeconomic and financial data. I examine 16 sentiment surveys of distinct respondent universes and employ the technique of principal components analysis to extract the common signals from the surveys. I show that the ability of different population groups to anticipate correctly economic growth and excess stock returns is not identical, implying that not all sentiment is the same, although there exist some common components. I demonstrate that sentiment surveys have significant predictive power for both GDP growth and excess stock returns, and that the results are robust to the inclusion of information pertaining to the macroeconomic environment and momentum. Furthermore, the findings reject the conventional wisdom that the effect of sentiment is apparent exclusively in small-capitalization stocks.

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