In this article I explore the possibility of using the “Google Trends” website as a leading indicator to forecast the trends in the financial markets. As per my research presented below, I am trying to see if forecasting 30-year Treasury yields and underlying inflation using the data provided by 'Google Trends' is feasible.
Using “Google Trend” to forecast long term (30-year) U.S. Treasury yields
Normally, the long term U.S. Treasury yields are traded based on the investors view of the future inflation rate. Hence, I have looked at the trend in the search term “Inflation” as a leading indicator to forecast the 30-year U.S. Treasury yield. To avoid the short term noise I have used the 3-month rolling trend in the chart given below.
Chart 1: An increasing correlation post-GFC [Global Financial Crisis] between “Inflation” search volume vs. 30-year. Treasury yield.
(Click to enlarge)
Source: Google Trends
By looking at chart #1, it is clear that in the post-GFC era, the correlation between search rates and the 30-year Treasury yields has increased. This increase in correlation is expected, as well. Prior to the GFC, inflation was not a popular topic among investors. But post GFC, following the massive money supply that has been created by the Fed, inflation has become a poplar theme and long term Treasury yields rely more on future inflation expectations.
How useful is this correlation to forecast short term yield movements?
To assess the usefulness of 'Google Trends' in predicting the short term movement in the long term yields, I have looked at the movements among the 1-month moving average and the 3-month average of the search volumes.
As can be seen in chart #2, in the Post-GFC era, whenever the 1-month moving average search volume went over the 3-month moving average, 30-year Treasury yields increased.
But interestingly, a slowdown in the search momentum (ie. 1 month moving average going below 3-month average) didn’t guarantee a yield contraction.
In my view, this is due to the fact that, despite less people searching for the “inflation” term, investors remain wary of the hangover effects of the money supply and the weak U.S. federal balance sheet. But an increasing momentum always ignites fear about future inflation and sets an expansion in the long term yields.
Chart #2: Increasing search momentum corresponds with increasing Treasury yields
(Click to enlarge)
Using 'Google Trends' to forecast underlying inflation
I have carried out a similar analysis as above to study the possibility of forecasting underlying U.S. inflation. As can be seen from chart #3 below, in the post GFC era, the correlation between the two has increased significantly.
Chart 3: An increasing correlation post GFC between “Inflation” search volume vs. 30-year. Treasury yield
(Click to enlarge)
Using 'Google Trends' to forecast short term movements in inflation
By looking at the chart given below (where I have plotted the underlying inflation, 3 month moving average of the search trend and the 1 month moving average of the search trend), it looks like short sudden movements in the momentum are less important in forecasting the future direction of the inflation. However, an extended period of change in the search momentum can be helpful in forecasting future inflation.
Chart 4: Longer shifts in the search momentum helps in forecasting
(Click to enlarge)
What does 'Google Trends' tells us about the future?
Based on the above analysis I can make two forecasts:
Long term Treasury yields are going to increase:
In chart #2, short term momentum has increased recently. If the post-GFC trend continues, long term Treasury yields could increase.
- The next few inflation reports could remain flat
In chart #4, despite a slowdown in January 2011, the short term momentum sharply bounced back. So I think we are going to see a flat or a slight increase in the next few monthly inflation reports, but no significant change. Of course, if oil prices remain at current elevated levels, we will see some increase in March and also a continued increasing momentum for “inflation” search term in the next few weeks.
What is the impact on your portfolio?
Reduce your exposure to 30-year U.S. Treasuries in the short run.
Note: Before applying the above analysis into the portfolio it should be noted that 'Google Trends' is a short term leading indicator and this should be used only to form a short term (1-2 month) view.
Based on the above analysis, we can safely assume long term yields will increase in the short run. This means it is advisable to avoid 30-year Treasury bonds at current levels. This recommendation fits well with the increasing long term inflation theme and also sits inline with a short term oil prices rising scenario.
As I mentioned earlier, the current inflation chart (Chart #4) is not very conclusive in predicting the future direction of inflation. Hence, I would avoid using that chart for investing decision-making at this moment. But if the short term momentum remains constantly above the 3 month moving average, we can start using this chart (Chart #4) for investment decision-making as well.
Risk to recommendation
In the short run, the key risk to not investing in 30-year Treasury bonds is the political turmoil in the Middle East. If this continues, investors’ may well start to go back to investing in U.S. Treasuries and drag the yields.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.