Feeling good, as a guide to performance: the impact of economic sentiment in financial market performance for Germany

During the financial crisis of 2007, the Economic Sentiment Indicator for Germany had already started the deepest drop in its history, reaching a new historical low in the second quarter of 2009. The drop was only temporary, as Germany became the de facto ‘safe heaven’ country and thus within 2 years the low became a sharp increase reaching a historical all-time high. The effect of ‘safe heaven’ country that Germany exhibited during the crisis and the resulting numbers for economic sentiment pose the question as to whether economic sentiment can be used to improve the positioning on the German financial market. We examine the link between sentiment and the performance of the German market, and how investors’ herd behaviour should have used such a sentiment signal to take advantage of, during the depression and beyond. We perform a careful sample-split analysis of both the characteristics of sentiment and financial market performance in various sub-periods from the 1990s until today and also use economic sentiment as a guide for timing the German stock market. In our analysis, economic sentiment acquires a leading guide role for investors in the German market.