Market States, Expectations, Sentiment and Momentum: How Naive are Investors?

Abstract

Following Cooper et al. 2004 we test whether market states are relevant for predicting UK momentum profits. However, rather than simply categorizing up/down markets based on actual prices as Cooper et al. 2004, we suggest investors may view expectations and/or sentiment as important. Contrary to the findings for the US, we find that momentum returns are not related to Cooper et al. 2004-defined market states. Similar findings hold for an expectations-based split. In contrast, for the whole sample period, construction and retail sentiment indicators explain differences in momentum profits. However, robustness tests suggest their explanatory power is driven by the post-subprime crisis period.

Keywords: momentum, futures, expectations, sentiment, market states

JEL Classification: G1, G10, G14