Alternative Data: Reddit Sentiment Reflects Optimism

Adam Gould, CFA
Key Takeaways
  • We update our Reddit-based sentiment indicator which proxies for the attitude of retail investors toward the market. Historically, the sentiment indicator has been an effective contra-indicator for the market.
  • The sentiment indicator has recently reflected extreme optimism among Reddit users. Should historical trends hold, a short-term downturn in the market over the next week is likely.

Reddit-Based Sentiment

We have built a proprietary database of comments from the WallStreetBets sub-reddit extending back over two years. In this research note, we update our short-term market indicator[1] based on aggregate sentiment toward the S&P 500.

The short-term market indicator proxies for retail sentiment in the market. It has shown to be an effective contra-signal over short-term holding periods. We construct the indicator by assigning a sentiment score to each comment about the S&P 500, then aggregating those sentiment scores at a daily frequency. When the sentiment indicator gives a low reading (below -1 in Fig. 1) there is more pessimism among Reddit users. When readings are high (above +1 in Fig. 1), Redditors are generally more sanguine about the market. Fig. 1 shows that most recently, the sentiment proxy has reflected optimism among Reddit users.

Fig. 1 – Reddit-based Sentiment Indicator

Source: Reddit, FactSet, Fundstrat analysis.Alternative Data: Reddit Sentiment Reflects Optimism
Note: Shows overall sentiment for comments on the SPY. Sentiment is computed using a rolling 63-day z-score. Higher values indicate more positive sentiment. Period of analysis is from August 30, 2020 through February 24, 2023.

Fig. 2 shows the subsequent 5-day return of the SPDR S&P 500 ETF Trust (ticker SPY) as a function of the sentiment indicator. The market has performed best following periods of negative sentiment. Specifically, in the 5 days following a negative sentiment reading, the market returns 0.8% on average. On the other hand, the market tends to decline following a positive reading in the sentiment – on average, the market falls by 0.3% in the 5 days following a positive sentiment reading. Currently, the sentiment indicator remains near the top of its range. As a result, we may see a minor correction in the market over the next week.

Fig. 2 – Subsequent 5-Day S&P 500 Return Conditioned on Sentiment Score

Source: Reddit, FactSet, Fundstrat analysis.Alternative Data: Reddit Sentiment Reflects Optimism
Note: Shows the average subsequent 5-day return for the SPY after periods when the sentiment is negative, neutral, and positive. Sentiment is classified as positive (negative) when the current sentiment reading is greater (less) than +1 (-1). Sentiment is computed using a rolling 63-day z-score. Number of observations is given below each category. Returns are measured using a one-day delay following the sentiment observation. Period of analysis is from August 30, 2020 through February 24, 2023. Transaction costs are not considered.

Conclusion

In this research note, we update our Reddit-based sentiment proxy for the market. Currently, the sentiment indicator reflects optimism among Reddit users toward the market. As the sentiment indicator acts as a contra-indicator for the market, this positive reading would indicate an increased likelihood for a minor correction in the market over the next week.

[1] Alternative Data: Sentiment from Social Media

Disclosures (show)