Business | Investment
Keep your eyes on 'recession' in the newspapers
Researchers on both sides of the Atlantic are using the frequency of use of the word in dailies as a gauge of stock market sentiment.
- By John Authers, Financial Times
- Published: 01:39 February 2, 2008
When a market reporter cannot explain why the market has just moved, there is always one easy candidate to blame: sentiment. In the short run, buying and selling decisions are dictated by humans.
A welter of evidence from the growing field of behavioural finance confirms the intuition of common sense - that even in investment, most decisions are not made rationally and rely on sentiment.
So get a handle on moves in sentiment and you can also, possibly, get a handle on the market. The problem is to measure something that is inherently unmeasurable. This year, sentiment has plainly grown sharply more pessimistic. That has fed through into the sell-off of stocks across the world, and into the buying of safe-haven investments such as treasury bonds or gold.
Anxious
Investors are more anxious than they were a few weeks ago that the US is slipping into a recession and that will have effects elsewhere in the world. How might it have been possible to see this sea change in sentiment coming?
One way to get a handle on this is to read the newspapers. Researchers on both sides of the Atlantic now use papers as a gauge of sentiment. In the US, the Liscio Report, an economic consultancy, monitors use of the word "recession" in the New York Times and the Washington Post as a gauge of concern. It was a great leading indicator in the past. The TLR Index, with 100 set as the average number of recession references, has recently leapt above 200 - higher than its level entering the last recession.
London's Absolute Strategy Research conducts a more sophisticated exercise and derives similar results. Looking for the gap between positive and negative stories, and searching for several key phrases, it finds that news flow is almost as negative as it was in 2001 and, tellingly, far more negative than in 1998, when market crises opened up the risk of a recession that was avoided.
The correlation between ASR's balance of positive and negative stories, and the relative performance of stocks and bonds, is spookily close. I tried a crude repeat of this exercise, using the Factiva database, and restricted it to the FT and our respected US competitor, the Wall Street Journal - the two media outlets that will be most affected by the sentiment of those working in the markets.
The results were dramatic. In the week to Wednesday, we published 174 stories with the word "recession". Our counterparts at the Journal published 118.
For the same week last year, only seven articles in the FT mentioned the word, while "recession" was not mentioned at all in the Journal. There were plenty of bears around a year ago who thought the US housing collapse would force the country into recession. But this exercise shows that sentiment was nowhere near as bearish then as now. If these measures sound crude and old-fashioned, rest assured that hedge funds have much more high-tech tools. Last year saw the announcement that 10 hedge funds were trying out a system to allow them to hunt more than 40 million Internet sources - from blogs to regulatory filings.
The idea is to gauge sentiment. If a company has a product launch coming, for example, and it finds thousands of web references the week before, that is evidence that it is creating a "buzz" in advance.
There is another way to view all of this. Contrarians believe that the cover stories of news magazines provide great signals. Once the editors of these magazines have noticed some big economic or corporate trend, they argue, it has almost certainly just about played out.
Research published by the Financial Analysts' Journal last year gave this partial support.
Looking at coverage of companies, it failed to substantiate that positive coverage on a magazine cover signalled the moment to sell a company. But a negative story, in many ways reflecting sentiment that had already expressed itself in the market, often signals the moment to remove a "short" position on a stock.
It does not signal an imminent bounce-back, but it does tend to signal that the worst of the news is now out there.
If we attempt to screen out sentiment and assess the situation rationally, where have we reached? Much more evidence that the US is heading for a recession has accumulated in the last few weeks.
Losses
The terrible results emanating from corporate America, the losses for the banking sector which seem likely to lead to some contraction in credit, and the bearish pronouncements from executives, would make this a fair statement even without the negative macroeconomic data. But the possibility of a US recession is not yet 100 per cent. Employment appears to be growing and surveys of business and consumer confidence are ambiguous.
The various attempts to stimulate the US economy, all of which would only act with a lag, may yet mitigate the effect of any recession once it happens. The big swings last week reflected a correct belief in the market that negative sentiment may have been overdone.
That in turn implies that sentiment is on a knife-edge. Expect the market to overreact to new data for weeks to come.
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