Tuesday, January 24, 2006

Is Google a Bellwether?

Note: My personal site will be adding additional information re: my volatility research and will be updating over the next few days.

Google's dramatic decline on Friday was followed by two solid gains on Monday and Tuesday, leaving GOOG up over 10% thus far this week. That led me to ask the question: How good of a bellwether is GOOG when it is up or down sharply in the short-term?

Going back to August, 2004 (N = 353), we find 30 days in which GOOG has shown a gain of over 5% in a two day period. Three days later, the S&P 500 Index (SPY) is up by an average .56% (20 up, 10 down). This is quite a bit better than the average two-day gain of .12% (206 up, 147 down) for the sample overall.

I also found 21 days in which GOOG was down by 4% or more over a two-day period. Five days later, SPY was up by an average .96%, with an amazing 19 occasions up, 2 down. This is quite a bit better than the average five-day change of .20% (208 up, 145 down) for the sample overall.

Interestingly, the near-term outlook is good for SPY when GOOG is very strong and when it's very weak. Score this one for the bulls with respect to the current market. (Note: Other factors lead me to be concerned about the present market's upside potential; I will outline those on my site tonight). When GOOG is strong, it means that the market's speculative sentiment is alive, and that carries over to near-term market trade. When GOOG sells off strongly, speculative froth is exiting the marketplace, and that puts in a short-term market bottom. Such may have been the case on Friday.

Of course, all speculative leaders end up eventually becoming laggards, so these patterns can't continue forever. In this bull market so far, however, GOOG has been a worthy bellwether.

Keep an eye on the Trading Markets site: I hope to extend the GOOG research in an article.

4 comments:

jontait said...

Brett,

This is a very interesting correlation study you have done, particularly your conclusion that extreme moves in GOOG mark changes in speculative sentiment within the current market uptrend.

Indicators like this just give you one more piece of the puzzle, so I wonder how much clearer of a picture we can get by also correlating with a couple of other stocks? I think gold or oil would make interesting candidates, but they may just muddy up GOOG's correlation.

-Jon

Brett Steenbarger, Ph.D. said...

Hi Jon,

Thanks for your note. I agree with your idea of looking at gold, oil, etc. and other speculative instruments. My article for Trading Markets today found that GOOG is a better upside indicator when gold stocks are also strong on the day. It seems to capture general speculative sentiment.

Brett

stoxwatcher said...

Being a long term gold and silver bullion buyer and former day trader. Comparing GOOG, to gold bullion or the gold/silver producers is not indicative of what is occurring under most people's radar. The amount of people investing in gold or silver bullion is almost nonexistant. People are getting suckered into paper assets like GM (bankrupt) again, yet the Federal Reserve keeps infusion billions of dollars weekly into the money supply. GOOG is just showing the insane asset inflation and post-bubble mentality of people, trying to make up for exponential losses a few years ago. When gold really starts shining, it will leave all other paper assets in the dust, including GOOG. The hype on GOOG with the day traders and brokerage houses all over the stock is what is moving it, nothing else.

Brett Steenbarger, Ph.D. said...

Thanks for the perspective, Stoxwatcher. I agree that the gold-Goog comparison is not on people's radar; hence the low correlation between the two. What interested me is that the two became correlated during periods of extreme price performance by GOOG--and that the combination of the two led to favorable expectations for stocks over the next couple of days. Many relationships between assets, I find, are nonlinear; i.e., occur within only one portion of their range of values (usually extremes). In general, this can lead to very successful modeling.

I find your observation re: gold *very* interesting and wonder if it is also an observation re: coming dollar weakness.

Brett