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Making Sense of the Extreme Relationship Between Value and Sentiment
- Correlation between value and sentiment has reached its lowest point since the dot-com bubble.
- When extremes like this occur, it’s important for investors to be wary.
There’s a lot of disagreement in the market right now about what is cheap, and what has positive market sentiment. These themes represent important complementary characteristics that we look for when building equity portfolios. When there’s a lot of disagreement between these themes, the pool of companies that are attractive in aggregate becomes smaller.
This disagreement can be expressed as cross-sectional correlation (i.e., the degree of alignment)between the two themes. On average, this relationship has a correlation of around -0.1, and since 1998 we have observed a range of -0.2 to 0 in most periods.1 Right now, the correlation is -0.4. The only time in the past that we’ve observed such low correlation between value and sentiment was during the dot-com bubble.