What's the link between happy music and stock prices?

Plenty has been written about the role of emotions in leadership. Positive, empathic, expressive leaders make for more engaged, more productive – some might say happier – teams. And it stands to reason. Businesses are run by human beings, after all. But what about markets? Can human emotion affect market performance, too?

Working on something of a hunch about happiness, London Business School’s Alex Edmans has taken a novel approach to determining a possible correlation between feelings and financial return. He teamed with colleagues from Auckland and Audencia Business School to see if positive emotions – the feelings that lead us to listen to “happy music” – are, in turn, correlated with stock market returns. And it turns out that they are. Edmans and co have found that when investors in a given country tune in to more positive tracks on streaming platform Spotify, the market in that country during that given period will actually outperform.

Edmans’ new study may seem somewhat “wacky,” he says, but it addresses a serious question. Economic rationalism holds that stock returns are only influenced by rational factors such as interest rates and unemployment stats. In theory, these fundamentals shouldn’t be impacted in any way by investor sentiment. Yet, Edmans’ study suggests they are. And the findings are robust.

Happy music, happy stock prices

Working with Adrian Fernandez-Perez and Ivan Indriawan of Auckland University of Technology and Alexandre Garel of Audencia Business School, he assessed the “average happiness” of 58,000 songs played on 500 billion Spotify streams. Comparing the sentiment of the songs played over the course of one week in 40 countries with each country’s equity markets, they established that stock price gains were unequivocally correlated to positive listening choices.

'We looked at the United States first and thought that maybe the findings were a fluke. But when we looked at 39 other countries, the results were the same. We then looked at mutual fund flows and found similar effects: Positive music was associated with inflows. We even ran a test with government bonds, which should go in the opposite direction. Optimistic people should buy fewer bonds, because they’re lower risk than equities are, thereby causing bond prices to fall. And in markets that listened to happy songs, they did.'

To test the strength of these findings, Edmans and his co-authors controlled a wealth of other factors such as volatility, macroeconomic policy and world market performance.

'Part of our data was collected before the pandemic and part during it, and we used that as an additional test. In some countries short-selling – borrowing a stock you think is overvalued, selling it, buying it back at a lower price before returning it, and pocketing the difference – was banned for periods during the crisis, so hardheaded rationalists couldn’t counteract the effect of sentiment. In those cases, we expected to see even stronger ties between music and the market, and we did.'

The Echo Nest

Determining the 'happiness quotient' of individual songs was also a matter of scientific rigour, says Edmans. Spotify routinely attributes a positivity score to tracks streamed via its data science team, Echo Nest.

'[Echo Nest] was started at the MIT Media Lab about the same time I was a PhD student at MIT Sloan, and now it’s part of Spotify’s data science group. Every song gets assigned a positivity score between 0 and 1. Human experts scored about 5,000 songs, and that data was used to create a machine-learning algorithm that can be applied to every song. It doesn’t take into account lyrics but uses the sound, the beat, and so on. Take a song like “Pumped Up Kicks.” It’s about a mass shooting, but it’s quite happy sounding. In contrast, “Perfect” by Ed Sheeran has positive lyrics but is actually downbeat. Lyrics are also sometimes ambiguous, which is another reason not to factor them in.'

In order to correlate mood with market performance, Edmans et al had to calculate an 'aggregate happiness score' for each country over the test period. This meant multiplying the Echo Nest ratings by the number of streams and dividing for the weighted average. In the process they unearthed some fascinating insights. Between January 2017 and December 2020, the period of their study, some countries were markedly less cheerful in their listening than others.

The data is fascinating, he says.

'You multiply the rating by the number of streams and then divide for the weighted average. That alone is fascinating. For example, in our study, the United States averaged out at about 0.46 – not too positive. Meanwhile, Mexico was 0.63. Of course, these scores changed over time.'

So what’s going on? Does tuning in to cheerful tunes make people more likely to place better bets? Not quite, says Edmans. It’s more likely that our moods dictate the kind of music we listen to – we listen to tracks that match how we feel. And it’s how we feel – how optimistic or pessimistic we are, and how prone we are to risk-taking – which in turn shapes the decisions we make. It’s these underlying feelings that affect returns – we use music as a measure of these feelings, but these listening choices themselves don’t drive the stock market.

Edmans’ work in behavioural economics is generating plenty of food for thought. One prior paper, for instance, shows that when a country’s football team is eliminated from the World Cup, its stock market returns decline.

'Other studies look at weather or seasonal affective disorder. Football, weather, and daylight are shocks to mood. But mood depends on many factors—perhaps your country got knocked out of the World Cup, but consumer confidence is rising and Covid restrictions are easing. So rather than studying a single factor that affects mood, we found a measure that reflects it: the music choices that people make that match how they feel. The music you listen to captures mood changes from football, weather, daylight, and a whole host of other factors, so it’s a much more comprehensive measure of sentiment.'

How rational are markets?

Edmans’ findings offer a compelling counterpoint to economic rationalism: the view that markets are always, inherently efficient and therefore cannot be beaten.

The study asks a really big question, he says: does rationality or emotion drive the market? While rationalists might argue that sentiment has no role to play in market performance, both this study and Edmans’ previous work sheds light on certain irrationalities – a sentimentality in markets – that can make them interestingly inefficient.

Then the market might be not only factoring in things that shouldn’t matter, like national mood, but also ignoring things that should.

'I previously wrote a paper on how Fortune’s 100 Best Companies to Work For in America beat the market from 1984 through 2011. That study was recently replicated in the research piece: Employee Satisfaction and Long-Run Stock Returns 1984-2020, and the results still hold even a decade after it was published. Efficient-market proponents would say that once investors learned that employee well-being predicts share-price performance, they’d buy the 100 Best Companies as soon as a new list was announced, so those stocks wouldn’t subsequently outperform. Yet they continued to do so, even after my paper was released.'