Valuation ratio style investing and economic sentiment: evidence from major Eurozone markets

This paper explores the role of sentiment in style investing for a sample of eight Eurozone markets and makes a distinction between fundamentals-driven sentiment and sentiment based on non-fundamental information. The findings indicate that style portfolio returns are statistically and economically significant, however, their return differential is not. Style portfolio returns are sensitive to changes in sentiment with value portfolios exhibiting higher sensitivity, and sentiment variance explains a significant percentage of style portfolio return variance. For example, for Germany during the US financial crisis the variance of fundamentals-driven sentiment accounts for 19.65% of the value portfolio variance and the variance of non-fundamental sentiment for a further 24.67%. The results are robust to the choice of valuation ratios in defining investment style. Finally, style portfolio returns tend to be higher, on average, during optimistic months (high sentiment), for the majority of the markets. For instance, during the US crisis, when high non-fundamental sentiment prevails, for five northern Eurozone markets, value portfolio monthly returns range between 2.54 and 3.87%.