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The Roubini Sentiment Indicator

This is a guest post by Ian Dogan of Insider Monkey, it originally was published at his blog and is being republished here with his permission:

I started doing this as a joke and did not expect to find a way to make money with Roubini Sentiment Indicator. Nouriel Roubini, a.k.a Dr. Doom has recently been stating that he is not Dr. Doom but he is Dr. Realist despite the fact that he is on TV mostly when things are going wrong, volatility spiking and stock market going down. You can clearly see this pattern from the graph below:

roubini sentiment indicator SP500 index Aug 2010

I gathered the Roubini sentiment index from weekly values provided by Google Trends. A simple correlation analysis shows that Roubini sentiment index has a negative correlation of (0.68) with the market and a positive correlation of 0.82 with the VIX. Some might dismiss the Roubini sentiment indicator because of its high correlation with the VIX, thinking that Roubini’s popularity is caused by the increase in VIX. Before jumping into any conclusions, we need to answer the following question: What is the exact nature of the relationship between VIX and Roubini Sentiment Indicator? If VIX is leading Roubini Sentiment Indicator, then you could rightly claim that Roubini is merely a parasite exploiting the increased fear in the marketplace. If the two indices are coinciding then Roubini is merely expressing what the market is thinking, hence he is truly the Dr. Realist or maybe Dr. Journalist?

On the other hand, if Roubini Sentiment Indicator is leading the VIX, then it might be the case that Roubini is spreading the fear like the plague and causing the spikes in VIX and declines in the market. In this case, he is the dreaded Dr. Doom. Take a look at the graph of Roubini Index vs. VIX and see the high correlation yourself.

roubini sentiment indicator VIX volatility index Aug 2010

How do we test our hypothesis about VIX and Dr. Doom, I mean Roubini? Granger Causality Test is the perfect tool for this job. We use VIX as the dependent variable and lagged values of VIX and lagged values of Roubini index as independent variables. So the idea is if lagged values of Roubini index can explain the movements in VIX in the presence of lagged values of VIX, then we can say that Roubini index is Granger causing the VIX (we run some other tests to make this claim, I don’t want to bore you with the technical details). We also test whether VIX Granger causes the Roubini index. Our test results clearly show that Roubini Sentiment Indicator Granger causes the VIX up to two weeks in advance with a very high degree of statistical significance. Naturally VIX does not Granger cause Roubini index. Roubini is indeed the Dr. Doom and maybe he should be put away for the sake of our economic recovery and millions of unemployed workers.

Maybe not. Since Roubini index is a leading indicator of an imminent spike in VIX and usually spikes in VIX come with a decline in stock market, we can develop a profitable trading strategy around this finding. Hey, I have a full-time job and did this quickly for fun, so the strategy I will present now may not be refined enough. However, it is good enough for a modest blog post. Here is our simple trading strategy: Go long the VIX when Roubini Sentiment Index goes %25 above its four-week moving average. Following this strategy over the 2007-2010 period will earn us a weekly average return of an amazing 2.4% (If we had simply gone long VIX at all times, the average weekly return would have been 1.6%). If we hold on to our long VIX position for three weeks, the average return over this time period is 8.25%. Dr. Doom has been sitting on a huge pile of gold all this time, yet he does not trade (Would it be insider trading if he traded based on what he is going to say on TV the next day?). Google guys could also utilize Roubini index in real-time and trade profitably :)

Another trading strategy is shorting the SPY when Roubini Sentiment Index is 25% above its 4-week average. In this strategy when we keep our short position for three weeks, SPY declines an average of (1.6)% over three weeks. Normally the average weekly decline in SPY is only (.06)% from Jan-2007 to Aug-2010. It is really interesting that we can make money by using Roubini Sentiment Indicator.

What does the Roubini Sentiment Indicator tell us lately? The latest value for Roubini Index is 2.2 and it is more than 25% above its 4-week average. The latest reading was from Aug 22nd. So this means that the stock market is expected to decline by an average of 1.6% between Aug 22nd and Sep 12th. Of course stock market losses would be much higher if Roubini shows up on CNBC tomorrow and scares the bejesus out of investors :)

Disguised Advertising: This article is brought to you by insidermonkey, which is going to be your source for free real-time insider trading data. At least, we hope so. We also aim to educate ordinary investors and give them the tools to help them make informed decision. Again, we hope so. Come back in a few days, and I will present another interesting and entertaining article. Btw, I have a Ph.D. in financial economics with a focus in insider trading. Maybe you will come back for serious articles on insider trading.

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In a very short period of time, it has become almost unanimous consensus that the US economy is entering a "double dip" or a second recession before it has gotten a chance to recover from the previous one. This is a potentially dangerous situation because the monetary and fiscal policies have all been basically exhausted.

Beating the Business Cycle Achuthan BanerjiThe mentions of "double dip" are all over the media and Google trends shows that people are interested to know more as they search for this keyword on the internet. So we have a spike in attention and concern about this issue.

Whether this is a legitimate concern or not depends on who you ask. If you pay attention to bearish analysts like Albert Edwards of Societe Generale or David Rosenberg of Gluskin Sheff, then yes. But if you listen to the actual creators of the index and the authors of the book Beating the Business Cycle, you get a completely different perspective.

Since this came on everyone's radar a few weeks ago, Lakshman Achuthan has tried in different venues like CNBC to calm everyone down. Here is a video interview between Achuthan and Larry Kudlow, where he tries to set the record straight. The strain and frustration is even clearer in the more more meaty rebuttal written by the co-founders of ECRI to both the naysayers and the doomsayers, titled "ECRI WLI Widely Misunderstood". They conclude succinctly that,

A slowdown in U.S. economic growth is imminent, but a new recession is not.

If we ignore Achuthan and Banerji, we still have more than a few other reasons to not automatically conclude that the US economy is headed towards another recession. I already shared with you the Anxious Index, which has a very good track record. It is indicating an improving economy with no recession forecasted in the immediate future. As is MacroAdvisor's recession probability model.

Another argument is the relationship between the Leading (LEI) and Coincident Economic Indicators (CEI) from the Conference Board. These are competing indicators but provide a similar perspective. As you can see from the chart below, historically, when the LEI year-over-year momentum peaks and starts to turn down, the coincident indicators momentum turns positive, indicating that the economic recovery has taken hold. So while short term momentum may wane in the economy, it doesn't necessarily presage an imminent recession.
Continue reading 'Questioning The “Double Dip” Shibboleth'

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Since we've discussed at length the reasons that this is an important low for the stock market, last week a reader asked me to give a bit more weight to the other side of the argument.

To do that we have to give turn our backs on technical indicators and give our attention to econometric indicators. Among these is the nervous attention lavished on the "double dip" scenario. At the beginning of the year we looked at the Google search trend for those dreaded words. Since the prevalence of searching for "double dip" gives us an indication of the sentiment out there, I thought we should update those charts.

Rather than just update the Google trends search results for "double dip", I went a step further and compared its weekly results with the weekly Leading Indicator index from the ECRI for the past 12 month period:
ECRI leading indicator compared to google trends double dip Jun 2010

We still see the two spikes from last year - the first in August 2009 and the second in November 2009. To understand the chart, I should explain that the Google Trends data is relatively scaled. This means that each point is presented relative to the average over the time period (12 months). So the most recent data point from last week at 3.38 means that searches for "double dip" last week were 3.38 times that of the average for the past 12 months.

The first spike, signaling an increase in concern about a weakening economy, happened last summer in August. When we compare it to the ECRI's LEI we see that it was a considerable amount of worry for nothing. If we look at the year over year chart of the LEI we can see that the index was still expanding quite rapidly:
Continue reading 'Should We Be More Worried About A “Double Dip”?'

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While a lot of data suggests that the great recession ended in June 2009, many are concerned about the possibility of a 'double dip' recession. You can see this reflected in the number of mentions that the term "double dip" is repeated in the media as well as the number of internet searches for it.

Here is a chart from Google Trends showing the growing popularity of the term in the US:

google trends double dip US chart Jan 2010

The spikes correspond to August 23rd 2009 and November 15th 2009. This is the same chart from Google Trends but represents data for the entire globe:

google trends double dip Global chart Jan 2010

And here's a chart (courtesy of Grant's Interest Rate Observer) showing similar data from another source:
double dip references in periodicals Aug 2009

It is wise to be cautious when you find yourself among the majority because usually the majority is wrong. But if we zoom back a mere two years, when I wondered if the recession was inevitable, Google Trends was showing a similar growing concern for the word "recession". And that proved an accurate prediction of what was to come. So I wonder if the popularity of "double dip" is less contrarian and more prescient.

Of course, throughout this analysis, I'm assuming here that "double dip" isn't followed by "glazed donuts" but rather refers to the economy.

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Earlier in the week we looked at the situation the gold market finds itself in with the precious metal sitting at the important $1000 level. I offered various takes on the technical position as well as the sentiment for gold. Here I want to delve in a bit deeper into the sentiment to see if we can glean whether there is any excess optimism which would flag a contrarian sell signal.

Here is the Google Trends chart for the keywords "buy gold":
google trends buy gold sentiment Sept 2009

Not surprisingly, the peak occurred in the week of October 5th 2008 (3.66). The keywords: "how to buy gold" also reached a peak a bit earlier on Sept 21st, 2008 (not shown in graph). That's still around the same time. This was, of course, right around the time that the equity market was getting a shellacking.

The term "stock market crash" reached a peak in Google searches at the same time (October 5th 2008). But right now, while slightly elevated, this makeshift indicator isn't really signaling an excessively speculative sentiment towards gold. Of course, this is noteworthy because gold is trading about 20% higher than it was in October 2008.

In my earlier analysis of the gold market, we looked at the Commitment of Traders report, MarketVane's as well as the Hulbert Gold Newsletter sentiment indexes. Let's take a quick look at several other measures of sentiment for gold:

Rydex Traders
Guy over at the Technical Take mentions the asset levels in the Rydex gold fund. While the Rydex investor is the trigger happy type to jump on a trend, either long or short, there is no evidence that they have piled on gold at this time. There is only about $200 million in the Rydex Precious Metals Fund. I agree with Guy, there is a distinctive lack of froth.

Put Call Ratio
The put/call ratio for gold is also in neutral territory. This is the options data on the futures contracts which is about as speculative as you can get considering the built in leverage. There was a slight uptick in call buying as gold made its latest move towards $1000 but even as that level has been pierced, the put/call ratio has backed off (traders are less optimistic).

The consensus from several different measures of gold sentiment is that there is mostly a shrug of the shoulders from traders and investors in reaction to the latest rally in gold. The only conflicting data point is the CoT report which shows small speculators in the futures market heavily long gold contracts.

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