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This study examines the non-linear effect of market-wide investor mood on the stock returns of commercial banks in South Africa. Even though investor sentiment is considered one of the main factors that drive the financial markets, the effect of it on banks in unstable emerging economies is still mostly unknown and the majority of existing research has been conducted using linear models that assume fixed relationships. This paper contributes to that discussion by analysing the change of the impact between bull and bear market regimes. The study runs a two-state Markov Regime-Switching (MRS) model on monthly data from September 2008 to March 2025 and utilize a comprehensive investor sentiment index that was earlier constructed for the South African market. The outcomes depict a vivid asymmetry: in the case of bull markets, investor sentiment exerts a strong and statistically significant positive effect on bank returns. Nevertheless, the impact moves to near zero or becomes insignificant during the more extended bear market phases which, are characterized by long durations especially for some banks. The research discovers that the link between sentiment and return is fundamentally dependent on the state, which is a very important factor that linear models fail to uncover. The article contributes to behavioural finance by confirming the necessity of a regime-switching approach in emerging markets. The results are to be welcomed by investors in portfolio optimization and for the regulators in the design of counter-cyclical financial policies that help stabilise the economy.
