Google Trends as a Stock Market Indicator?

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Includes: GOOG, SPY
by: TWS Investments

Google Trends is a feature recently released from the Google (NASDAQ:GOOG) empire. The Google Trends site allows users to mine through search data back to 2004 studying the broad patterns in search volume of particular words and phrases. Our study looks at the relative volume search for the phrase "market crash" from 2004 to the present. The spikes in search volume for "market crash" are compared with the Standard & Poor's 500 and the CBOE Volatility Index.

The charts below paint a very interesting picture. The charts highlights the four major spikes in search volume from 2007 to the present. The data between 2004 and 2007 show no spike above the 200% level. Coincidentally, the VIX had not registered a reading over 20% both indicating a time of calm in the equity markets. Yet, 2007 is when things got interesting.

The end of February 2007 saw a 4.7% drop in the S&P 500 based on weekly price data. This drop was not unlike the 4.4% drop seen less than a year earlier in May of 2006 but the VIX and Trends data did not see spikes in that drop. So, why was the February 2007 drop different? The VIX offered no noticeable indication of change, not breaking through the previous highs of the last four years. Yet, the Trends data on "market crash" showed an increased reading of 270%. Investors seemed to begin worrying about the coming turn in the markets long before the top. The spike and subsequent rapid drop signaled a good time to enter equities for renewed momentum to the upside.

The next large spike occurred the week of January 22, 2008 after the S&P 500 had dropped 17.1% from the October 1, 2007 weekly high. Search queries on "market crash" rose to 230% above average. The rapid decline in search volume the following week offered another time for a decent entry into stocks for the next couple months. The VIX indicator did not provide much worthy of analysis during this time.

Massive declines in equity prices were seen towards the end of 2008. As the markets plummeted, searches for "market crash" jumped to 725% over the average by the week of October 6, 2008. The next two weeks saw a dramatic crash in search volume. The data very rapidly reflected the stabilizing of equity prices. The VIX was a useful measurement during the time as well but the readjustment to price stabilization was much slower.

The final spike worth studying occurred the week of March 2, 2009, when the searches registered 190% above average and the equity market bottomed. The ensuing quick drop in searches once again signaled an excellent time to be a buyer of equities while the VIX gave no such clues.

Could Google Trends data become a robust stock market indicator in the future? As most indicators of market sentiment are painfully lagging, Google Trends may be a great sentiment indicator, especially considering its rapid adjustment to changing moods. The advantages are numerous as the data reflects real search queries and not surveys, covers an absolutely massive audience and does not require participants to know they are even participating. The data hits the true hearts and minds of investors across the globe.

The data show that after a large spike in queries and a subsequent rapid decline, investors would have been well-advised to buy shares in equities. Clearly, the data do not point to when to sell stocks but have offered the most attractive entries on every decline in the markets over the past 2 years. Also, the data did not indicate that each bottom was the ultimate bottom in prices but gave investors a much better level to buy than just randomly buying as stocks fell. Waiting for a top in the search query spike and investing two weeks later appears to have worked very well during this bear market.

At the very least, the Google Trends data seem much more useful than the often quoted CBOE Volatility Index which showed strong inverse correlation to the market but did not offer much by way of forecasting of future prices. Perhaps the future could see more on this topic as the study on market participant sentiment continues on. If this is the bottom and stocks continue their ascent, it will be quite interesting to watch for a spike in "bull market" queries.

Disclosure: No relevant positions.