A PLS value factor and investor sentiment: Evidence from China

We explore the value premium in China's Shanghai-A and Shenzhen-A stock markets, and how to exploit it using a new investor sentiment index. Using data from 2000 to 2021, we evaluate book to market (BM), earnings to price (EP) and sales to price (SP) factors. Consistent with evidence from other countries, BM generates a stronger value premium among small-cap stocks, whereas EP generates a larger value premium among large-cap stocks. Using partial least squares (PLS), we construct a novel value factor that outperforms all other value factors in terms of higher portfolio returns. We also explore the relationship between the value premium and investor sentiment. In China, unlike most developed countries, value stocks outperform growth stocks in bull markets. Our results suggest that long-term investing in value stocks is more (less) profitable when market sentiment is lower (higher).