Market states, expectations, sentiment and momentum: How naive are investors?

•We test whether market states are relevant for predicting UK momentum profits.•We propose that expectations and sentiment may impact on the momentum/state relationship.•Sentiment based splits yield profit differences: price/expectation splits do not.•Results are driven by the post-subprime crisis period.•Unlike the US, market states, however categorised, do not impact momentum profits.

Following Cooper et al. (CGH) 2004 we test whether market states are relevant for predicting UK momentum profits. However, rather than simply categorising up/down markets based on actual prices as CGH, we suggest that investors may view expectations and/or sentiment as important. Contrary to the findings for the US, we find that momentum returns are not related to CGH-defined market states. Similar findings hold for an expectations-based split. In contrast, for the whole sample period, construction and retail sentiment indicators explain differences in momentum profits. However, robustness tests suggest that their explanatory power is driven by the post-subprime crisis period.