Valuation ratio style investing and economic sentiment: evidence from major Eurozone markets
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Valuation ratio style investing and economic sentiment: evidence from major Eurozone markets Spyros I. Spyrou1
© Springer Science+Business Media, LLC, part of Springer Nature 2019
Abstract This paper explores the role of sentiment in style investing for a sample of eight Eurozone markets and makes a distinction between fundamentals-driven sentiment and sentiment based on non-fundamental information. The findings indicate that style portfolio returns are statistically and economically significant, however, their return differential is not. Style portfolio returns are sensitive to changes in sentiment with value portfolios exhibiting higher sensitivity, and sentiment variance explains a significant percentage of style portfolio return variance. For example, for Germany during the US financial crisis the variance of fundamentals-driven sentiment accounts for 19.65% of the value portfolio variance and the variance of non-fundamental sentiment for a further 24.67%. The results are robust to the choice of valuation ratios in defining investment style. Finally, style portfolio returns tend to be higher, on average, during optimistic months (high sentiment), for the majority of the markets. For instance, during the US crisis, when high non-fundamental sentiment prevails, for five northern Eurozone markets, value portfolio monthly returns range between 2.54 and 3.87%. Keywords Style investing · Valuation ratios · Sentiment · Financial crisis JEL Classification G4 · G11 · G12
1 Introduction This paper explores the role of expectations and sentiment for style investing and aims to fill a specific gap in the literature. More specifically it examines the profitability of value and growth portfolios for a sample of eight important Eurozone markets (Austria, Belgium, Finland, France, Germany, Netherlands, Italy, and Spain). Motivated by studies that report an association between style portfolio returns and investor sentiment (see, among others, Lakonishok et al. 1994; Bird and Casavecchia 2007) it also empirically explores the association between expectations/sentiment and style portfolio returns in the Eurozone, * Spyros I. Spyrou [email protected] 1
Department of Accounting and Finance, Athens University of Economics and Business, Patision 76, 10434 Athens, Greece
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especially during financial crisis periods. Although many studies examine either style strategies or the role of sentiment on equity returns, there is a lack of empirical evidence for Eurozone markets on both issues, especially during the recent crises. In addition, previous studies either use a single variable to proxy for sentiment or purge the effects of fundamental information from their sentiment proxy. In this paper, we employ local and global macroeconomic variables in order to decompose sentiment to sentiment driven by fundamental information and sentiment driven by non-fundamental information, and study the effect of both, in order to examine which component drives style returns, if any. For example, the finding
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