Social Media Collective Wisdom Predicts Tech Stock Performance

"What Keynes recognized is that ... investors are concerned not only just with what the average investor thinks but with what the average investor thinks the average investor thinks. And the truth is: Why stop there? Maybe what you need to think about is what the average person thinks the average person thinks the average person’s view is."
-- James Surowiecki : The Wisdom of Crowds, p484.


At MarketPsych Data we've begun to analyze longer term predictive patterns in our social media data.  We've created indices that aggregate the perceptions of investors about companies and stocks expressed in their conversations, discussions, and (of course) rants in social media such as Facebook, Twitter, chat rooms, and blogs.

The index I'd like to discuss today is called "Innovation Perceptions" and it is self-explanatory.  Investors' perceptions of a company's innovativeness are measured using our proprietary linguistic analysis tools and then smoothed over time.  You can see the innovation perceptions of eight randomly selected (my personal brainstorm) tech stocks for the past decade (mid-1998 through Feb 1, 2011).  It's pretty fascinating on its own:

What's even better is when you run our backtesting software (developed for our hegde fund) on the data, and we see that the top one standard deviation of high-innovation tech stocks have a 10bps (0.10%) daily = 30+% annual outperformance of the rest of the tech stocks in our sample over 37,000+ stock-days.  Interestingly, the average tech stock outperforms the S&P500 by 10 bps daily since 1998:

In behavioral finance terms, this may be a sign of investor underreaction to the level of perceived innovation at a company.

The next step is to expand the sample size.  We'll continue to examine this effect and keep you posted.

Happy Investing!
Richard  Peterson M.D.
+1.310.573.8523
http://www.marketpsychdata.com/

ETF sentiment reads for Tuesday February 15, 2011

Overall our data is currently pointing to the upside trend continuing in the near term in the U.S. stock market - upwards price momentum is combined with solidly positive, but not excessively optimistic, sentiment.  That said, there are a number of interesting psychological trends we're seeing that present potentially good ETF trade ideas for the next one to two weeks.

The essence of our data is to measure crowd opinion and strong concentrations of sentiment.  When sentiment is extremely biased in one direction, we look for signs of reversal, and usually our clients will bet on an unraveling - that's their essential strategy.  Due to the characteristics of crowd behavior, most of the trade ideas below will naturally be contrarian. 

SHORTS
The ETF PBS (Leisure and Entertainment) is overextended to the upside.  Our data demonstrates high investor optimism which is coupled with recent price outperformance.  PBS may pause its recent run for a week or two and underperform the market.

KOL (Coal ETF) is likely to lag the market as well.  We're seeing very high levels of optimism coming off a strong bull move, which is a blow-off top scenario.  Due to the high optimism, it's likely to continue to underperform until investors adjust their expectations downwards.

Oil is likely to underperform over the next few weeks due to the investment community's concerns about Egyptian instability and associated fears and pessimism about oil supplies.  As the nervousness about Middle Eastern insecurity gradually resolves, the price of oil is likely to settle lower.  As a result, some Oil-related ETFs like IEZ are likely to underperform the market going forward.

LONGS
Biotech (IBB)  tops our "Most Hated" sector list for Monday.  Combined with its recent underperformance, it is set up psychologically for an upside move.  Over the past month we've seen a dramatic increase in our investor dissatisfaction scores in the Biotech sector.   Health care (XLV) is in a similar position.

Another one to two week long idea we have is in the homebuilders (XHB).  As you might imagine, we're seeing the highest negativity in this sector, and XHB tops our pessimism ranking.  While it may seem self-evident that investors are pessimistic about housing, we have observed that extreme levels of pessimism as we're seeing in the housing sector often precede a reversal.