How investor sentiment and trade conflicts affect the stock markets

Recently, the trade conflict between the United States and China has become an international area of interest and a hot topic. This study wants to investigate the impacts of trade conflicts on both countries' stock markets. This research measures the changes in stock market prices from the perspective of behavioral finance. After eliminating the influence of macroeconomics through its representative indicators, this paper constructs an index reflecting investor sentiment using the principal component analysis. This work builds a regression model considering investor sentiment and the intensity of trade conflicts. The results show that there is an asymmetric influence of Chinese investor sentiment on the performance of the stock market. Comparatively, U.S. investor sentiment has a weaker impact on market performance. In order to denote the intensity of trade conflicts, this paper collects the frequencies of trade conflicts from newspapers and Google Trends. We find that trade conflicts have negative impacts on both stock markets and their major industries. Among the four selected industries, the market performance of the Chinese manufacturing industry was the most affected among all by trade conflicts, while the most affected market in the U.S. was the scientific research industry. This indicates that in the currently globalized field of production, the supply chains of the two countries are highly connected and raising tariffs will adversely affect the performance of industries in which the two countries are tightly correlated. In addition, this paper predicts the stock prices and returns of both stock markets in the future based on Ito's process. The results show that the stock performances with high trade conflict intensity behaves badly compared to those with low intensity.