Using sentiment surveys to predict GDP growth and stock returns

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

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Sentiment; GDP; economic growth; stock returns; return anomaly; predictability; forecasting; principal components analysis; composite factor; surveys; sentiment factor; econometric models; household sentiment; consumer sentiment; business sentiment; asset pricing; alpha; excess returns; small-capitalization stocks; Efficient Markets Hypothesis; Rational Expectations Hypothesis
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C51 - Model Construction and Estimation; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E21 - Consumption ; Saving ; Wealth; G - Financial Economics > G0 - General > G00 - General; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E47 - Forecasting and Simulation: Models and Applications; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E66 - General Outlook and Conditions; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D84 - Expectations ; Speculations; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E17 - Forecasting and Simulation: Models and Applications; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O40 - General; G - Financial Economics > G0 - General > G01 - Financial Crises; D - Microeconomics > D0 - General > D03 - Behavioral Microeconomics: Underlying Principles; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C13 - Estimation: General; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness; C - Mathematical and Quantitative Methods > C8 - Data Collection and Data Estimation Methodology ; Computer Programs > C81 - Methodology for Collecting, Estimating, and Organizing Microeconomic Data ; Data Access; ; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E37 - Forecasting and Simulation: Models and Applications; C - Mathematical and Quantitative Methods > C0 - General > C01 - Econometrics; Y - Miscellaneous Categories > Y4 - Dissertations (unclassified) > Y40 - Dissertations (unclassified); C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C12 - Hypothesis Testing: General; E - Macroeconomics and Monetary Economics > E0 - General > E01 - Measurement and Data on National Income and Product Accounts and Wealth ; Environmental Accounts; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D53 - Financial Markets; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E27 - Forecasting and Simulation: Models and Applications; C - Mathematical and Quantitative Methods > C0 - General > C02 - Mathematical Methods; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; C - Mathematical and Quantitative Methods > C4 - Econometric and Statistical Methods: Special Topics > C43 - Index Numbers and Aggregation; C - Mathematical and Quantitative Methods > C8 - Data Collection and Data Estimation Methodology ; Computer Programs > C82 - Methodology for Collecting, Estimating, and Organizing Macroeconomic Data ; Data Access; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C63 - Computational Techniques ; Simulation Modeling; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E60 - General; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; D - Microeconomics > D1 - Household Behavior and Family Economics > D12 - Consumer Economics: Empirical Analysis; G - Financial Economics > G1 - General Financial Markets > G10 - General

References

Stiglitz, Joseph (2011). "Rethinking Macroeconomics: What Failed, and How to Repair It." Journal of the European Economic Association, Volume 9, Issue 4, pp. 591-645, August 2011.

Stiglitz, Joseph (2011). "An Agenda for Reforming Economic Theory." http://economistsview.typepad.com/files/session-3---stiglitz_agenda_for_reform.pdf

Guzmán, G., Internet Search Behavior as an Economic Forecasting Tool: The Case of Inflation Expectations. The Journal of Economic and Social Measurement, Volume 36, Number 3, December 2011.

Baker, M. and J. Wurgler (2006). “Investor Sentiment and the Cross-Section of Stock Returns.” The Journal of Finance, Vol. LXI, No. 4, August 2006, pp. 1645-1679.

Bentham, J. (1781). “An Introduction to the Principles of Morals and Legislation.” Oxford, At the Claredon Press, London, New York, and Toronto, Henry Frowde. MCMVII.

Bram, J. and S. Ludvigson (1998). “Does Consumer Confidence Forecast Household Expenditure? A Sentiment Index Horse Race.” FRBNY Economic Policy Review, June 1998, pp. 59-77.

Brown, G.W. and M.T. Cliff. (2004). “Investor Sentiment and the Near-Term Stock Market.” Journal of Empirical Finance, Vol. 11, pp. 1-27.

Brown, G.W. and M.T. Cliff (2005). “Investor Sentiment and Asset Valuation.” Journal of Business, Vol. 78, No. 2, pp. 405-439.

Campbell, J. (2004). “Comment: Perspectives on Behavioral Finance: Does ‘Irrationality’ Disappear with Wealth? Evidence from Expectations and Actions” in NBER Macroeconomics Annual 2003, eds. Gertler, M. and Rogoff, K., The MIT Press, Massachusetts Institute of Technology, Cambridge, Massachusetts, pp.194-199.

Carroll, C.D., J.C. Fuhrer, and D.W. Wilcox (1994). “Does Consumer Sentiment Forecast Household Spending? If So, Why?” The American Economic Review, Vol. 84, No. 5, pp. 1397-1408.

Charoenrook, A. (2005). “Does Sentiment Matter?” Unpublished manuscript. The Owen Graduate School of Management, Vanderbilt University. http://www2.owen.vanderbilt.edu/fmrc/papers%20data /2005%20papers/does%20sentiment%20matter_aida.pdf

Chen, N., R. Kan, and M. Miller (1993). “Are the Discounts on Closed-End Funds a Sentiment Index?” Journal of Finance, Vol. 48, pp. 795-800.

De Bondt, W.F.M. (1993). “Betting on Trends: Intuitive Forecasts of Financial Risk and Return.” International Journal of Forecasting, Vol. 9, pp. 355-371.

De Bondt, W.F.M. and R. Thaler (1989). “Anomalies: A Mean-Reverting Walk Down Wall Street.” Journal of Economic Perspectives. Vol. 3, No. 1, Winter 1989, pp.189-202.

Dominitz, J. and C. Manski (2003). “How Should We Measure Consumer Confidence (Sentiment)? Evidence from the Michigan Survey of Consumers.” Working Paper 9926, National Bureau of Economic Research.

Elster, J. (1998). “Emotions and Economic Theory.” Journal of Economic Literature. Vol. XXXVI (March 1998), pp. 47-74.

Elton, E.J., M.J. Gruber, and J.A. Busse (1998). “Do Investors Care About Sentiment?” Journal of Business, Vol. 71, pp. 477-500.

Fisher, K. and M. Statman (2000). “Investor Sentiment and Stock Returns.” Financial Analysts Journal, March/April 2000, Association for Investment Management and Research, pp. 16-23.

Garner, C. A. (1991). “Forecasting Consumer Spending: Should Economists Pay Attention to Consumer Confidence Surveys?” Federal Reserve Bank of Kansas City Economic Review, (May/June), pp.57-71.

Grossman, S. and J. Stiglitz (1980). "On the Impossibility of Informationally Efficient Markets." The American Economic Review, Vol. 70, No. 3, pp. 393-408.

Guzmán, G.C. (2003). "GDP Growth Signals, Investor Psychology, and Hedging Pressure: A Multivariate Approach to Forecasting Returns on the S&P500 Index." Unpublished manuscript. The Wharton School, University of Pennsylvania. April, 2003.

Howrey, E.P. (2001). “The Predictive Power of the Index of Consumer Sentiment.” Brookings Papers on Economic Activity, Vol. 2001, No. 1, pp. 175-207.

Hymans, S.H., G. Ackley and F.T. Juster (1970). “Consumer Durable Spending: Explanation and Prediction.” Brookings Papers on Economic Activity, Vol. 1970, No. 2, pp. 173-206.

Katona, G. (1951). Psychological Analysis of Economic Behavior, McGraw-Hill, New York.

Katona, G. (1957). “Federal Reserve Board Committee Reports on Consumer Expectations and Savings Statistics.” Review of Economics and Statistics, Vol. 39, 40-46.

Katona, G. (1975). Psychological Economics. Elsevier, New York.

Keynes, J.M. (1936). The General Theory of Employment, Interest, and Money, London: Macmillan for the Royal Economic Society.

Klein, L.R. and S. Ozmucur (2002). “The Predictive Power of Survey Results in Macroeconomic Analysis.” in Wladyslaw Welfe, ed. Macromodels 2001, Chair of Econometric Models and Forecasts, University of Lodz, Lodz, 2002, pp. 181-197.

Klein, L.R. and S. Ozmucur (2004). “Some Possibilities for Indicator Analysis in Economic Forecasting.” in Pami Dua, ed. Business Cycles and Economic Growth: An Analysis Using Leading Indicators, Oxford University Press, pp. 243-257.

Klein, L.R. and E. Sojo (1989). “Combinations of High and Low Frequency Data in Macroeconometric Models.” in Economics in Theory and Practice: An Eclectic Approach, eds. Klein, L.R. and Marquez, J., Kluwer, Dordrecht, 1989, pp. 3-16.

Klein, L.R. and J.B. Lansing (1955). “Decisions to Purchase Consumer Durable Goods.” Journal of Marketing, Vol. XX (October 1955), pp. 109-132.

Lee, C.M.C., A. Shleifer, and R.H. Thaler (1991). “Investor Sentiment and the Closed-End Fund Puzzle.” The Journal of Finance, Vol. 46, No. 1, pp. 75-109.

Lee, W., C. Jiang, and D.C. Indro (2002). “Stock Market Volatility, Excess Returns, and the Role of Investor Sentiment.” Journal of Banking & Finance, Vol. 26, pp. 2277-2299.

Leeper, E. M. (1992). “Consumer Attitudes: King for a Day”. Federal Reserve Bank of Atlanta Economic Review, 77(4), pp. 1-15.

Lemmon, M. and E. Portniaguina (2006). “Consumer Confidence and Asset Prices: Some Empirical Evidence.” The Review of Financial Studies, Vol. 19, No. 4, pp. 1499-1529.

Lowenstein, G. (2000). “Emotions in Economic Theory and Economic Behavior.” The American Economic Review, May 2000, 90, 2, p. 426-432.

Malkiel, B.G. (1977). “The Valuation of Closed-End Investment Company Shares.” Journal of Finance, Vol. 32, pp. 847-859.

Manski, C. (2004). “Measuring Expectations.” Econometrica, Vol. 72, 1329-1376.

Matsusaka, J.G. and A.M. Sbordone (1995). “Consumer Confidence and Economic Fluctuations.” Economic Inquiry, Vol. XXXIII, April 1995, pp. 296-318.

Mishkin, F.S. (1978). “Consumer Sentiment and Spending on Durable Goods.” Brookings Papers on Economic Activity, 1, pp 217-232.

Mueller, E. (1963). “Ten Years of Consumer Attitude Surveys: Their Forecasting Record.” Journal of the American Statistical Association, Vol. 58 (304), pp. 899-917.

Newey, W. and K. West (1987). “A Simple, Positive Definite, Heteroscedastic and Autocorrelation Consistent Covariance Matrix.” Econometrica, Vol. 55, 703-708.

Otoo, M.W. (1999). “Consumer Sentiment and the Stock Market.” Board of Governors of the Federal Reserve System.

Romer, P.M. (2000). “Thinking and Feeling.” The American Economic Review, May 2000, Vol. 90, No. 2, pp. 439-443.

Stock, J.H. and M.W. Watson (2002). “Macroeconomic Forecasting Using Diffusion Indexes.” Journal of Business & Economic Statistics, April 2002, Vol. 20, No. 2, pp. 147-162.

Stone, R. (1947). “On the Interdependence of Blocks of Transactions.” Supplement to the Journal of the Royal Statistical Society, Vol. 9, No. 1, pp. 1-45.

Swaminathan, B. (1996). “Time-Varying Expected Small Firm Returns and Closed-End Fund Discounts.” Review of Financial Studies, Vol. 9, pp. 845-887.

Thaler, R.H. (2000). “From Homo Economicus to Homo Sapiens.” Journal of Economic Perspectives, Vol. 14, No. 1, Winter 2000, pp. 133-141.

Throop, A.W. (1992). “Consumer Sentiment: Its Causes and Effects.” Federal Reserve Bank of San Francisco Economic Review 1, pp. 35-59.

Verma, R. and P. Verma (2007). “Are Survey Forecasts of Individual and Institutional Investor Sentiments Rational?” International Review of Financial Analysis (2007), doi:10.1016/j.irfa.2007.04.001.

Wiesenberger, A. (1946). Investment Companies Services. New York, NY: Warren, Gorham, and Lamont, (1943-1991).

Zweig, M.E. (1973). “An Investor Expectations Stock Price Predictive Model Using Closed-End Fund Premiums.” Journal of Finance, Vol. 28, pp. 67-78.