Investor Sentiment and Short-Term Returns for Size-Adjusted Value and Growth Portfolios

We examine the sentiment levels of individual investors relative to subsequent short-term market returns for 1992–2010. We find that sentiment, proxied by percentage of investors who are “bullish” on the market, is significantly negatively related to the subsequent three- and six-month performance of the market. The negative relationship is consistent with the contrarian notion of sentiment. In other words, high (low) levels of bullishness tend to be followed by subsequent low (high) returns. This is true even with the inclusion of standard control explanatory variables (Fama-French [1993]). While the significant results hold for the overall market, they are clearly driven by growth, rather than value stocks. Contrary to some earlier studies, we also note significant explanatory power for sentiment when looking at returns of small-, mid-, and large-cap growth stocks. We also noted that the long-term moving average of monthly bullishness increased from 33.3% to 39.0% over the last 18 years. In our study period, about 5% of the total sentiment observations are above 56% (very bullish) and about 5% are below 27% (quite bearish). Finally, we find some strength in the lagged autocorrelation structure for the sentiment variable that lasts for just about three to nine months.