What Does News Tell Us About the Current Sentiment of the US Equity Markets?

In a previous blog posting, I presented a methodology for how to construct a news sentiment index, that being either on a sector, industry or a broader equity index (in fact, any portfolio of stocks can be used as a basis). In the below figure, I have included a Market News Sentiment Index using a 90 day trailing news aggregation window, where values above 50 represent positive sentiment, values below 50 negative sentiment, and values at (or close to) 50 neutral sentiment. The figure includes data from January 2005 through November 2009.

As can be observed, the Market News Sentiment Index broke into negative territory well before the market high in October 2007 (in fact, it happened as early as June 2007), and thus could have acted as an early warning sign for following market downturn.

Since March 2009, sentiment has significantly improved entering a positive sentiment regime in May the same year. Using a 30 day news aggregation window, the regime shift would have been detected already in March 2009 indicating a sudden change in the "mood of the market". Since May 2009, the market sentiment has continued to improve with a drop in sentiment levels in August 2009 and September, which could be read out of the more "muted" market performance in September and October 2009. Recently, News Sentiment levels have significantly improved starting in October, with a following strong performance of the equity markets in November.

With the current News Sentiment levels at a record high, equity markets could well continue to increase in the periods ahead. Surely, it will be interesting to keep an eye on the development of the Market News Sentiment Index and look out for sudden changes (warning signs) in news sentiment.

Wishing you all a Happy Holiday and a prosperous 2010!