Predictive ability of investor sentiment for the stock market

This study investigates investor sentiment’s ability to forecast future stock returns in the short and long terms. We run predictive regressions to examine whether investor sentiment and macroeconomic variables predict stock returns. Investor sentiment forecasts stock returns for at least one month, but it loses its predictive ability after two months. Stock prices overvalued by investor sentiment revert to their intrinsic values after one month. The term spread negatively predicts stock prices, and this predictive ability persists in the long term. The results of an out-of-sample test show that investor sentiment generally has greater predictive power than a set of macroeconomic variables, indicating that investor sentiment can be a key factor in forecasting stock returns.