Evaluating the Permabear Sentiment Index

Includes: DIA, QQQ, SPY
by: Babak

About a month ago Ian Dogan of Insider Monkey shared his Roubini Sentiment indicator. Today he updated this Google Trends based sentiment indicator and added two other ‘permabear’ prognosticators: Nicholas Taleb, Peter Schiff and Marc Faber. Basically, he is looking at the mentions of these four names over time in the media as quantified by Google Trends.

The new and improved sentiment index now is even more correlated (87%) with the CBOE Volatility Index and more importantly, very negatively correlated (-84%) with the S&P 500 index:

permabear index Sep 2010
Source: Insider Monkey

According to Ian, the Permabear Sentiment index can be used for timing the market both long and short. If you go short when it is 25% or more above its 4-week moving average, SPY averages -3.5% over the following week. Going long when it is 20% or more below its 4-week moving average provides 2% over the following week.

I’m a sucker for novel sentiment indicators and I’ve mentioned using Google Trends data several times (for example, Google Trends: Hunting for Sentiment Data). Their magic is no real magic in the data. The same old contrarian impulses are at work as they have been since the founding of markets. The index is merely measuring the ‘animal spirits’ within a market by targeting how the media latches on to a narrative and gives a more prominent platform at exactly the wrong time.

While this is a great new indicator, one obvious caveat is that over time, the personalities that the media favors change. So this measure shouldn't be mistaken for a static one. Rather it is a very qualitative measure that will need to be monitored and adjusted as old pundits fade away and new ones appear. But it is nevertheless, a very interesting way of measuring the prevailing sentiment in the mainstream media.