Stock
Market
Report
Federal Reserve Bank of Boston




                                 federal reserve
                  ...
January 24, 2007


Stock Market Report
                      Market Analysis for Period Ending Friday, January 19, 2007

 ...
of NASDAQ stocks hitting new highs on January 19 was 91, down from
its fourth quarter average of 111. The number of new lo...
ratios in the top panel and strategists’ two-year forecasts of earnings growth in the
lower panel.

    The price-earnings...
Figure 1
Daily Trends of Major U.S. Stock Exchanges

 New York Stock Exchange
 index price                                ...
Figure 2
Moving Averages and Relative Strength
   New York Stock Exchange
  index price
  9500
                           ...
Figure 3
  Index Breadth and Momentum Indicators -
  New York Stock Exchange
    New Highs and New Lows                   ...
Figure 4
Index Breadth and Momentum Indicators -
Nasdaq Stock Market

   New Highs and New Lows                 4
index pr...
Figure 5
  Volatility 7
      S&P100 and CBOE's OEX Volatility Index                   8
      index price
      680      ...
Figure 6
Put / Call Ratio
      CBOE Index and Individual Equity Put/Call Ratios                            10
     index ...
Figure 7
S&P 500 Economic Sectors - Index Returns
              5-Year Annualized Performance                             ...
Figure 8
S&P 500 Economic Sectors - Earnings Growth
           PE Ratios for S&P 500 Economic Sectors
     70
     60     ...
Figure 9
PE Ratios and the Growth of Earnings

  Price-Earnings Ratios

  Percent                                         ...
Figure 10
Breadth of the S&P 500
      One-Year Price Changes for Companies
      (median percentage change for each decil...
Figure 11
 Comparative Returns
       Dividend-Price Ratio 12 for the S&P 500 and the Real Corporate Bond Rate 13
   11.0 ...
Figure 12
Dividend Yields




    Dividend Yields for S&P 500 and Components
Percent                                      ...
Figure 13
Economic Measures of Equity
Valuation
        Real Rate of Return on Nonfinancial Corporate Equity
        (from...
Figure 14
Ratings and Default Rates
                                                                                      ...
Figure 15
Margin Debt and Expected Returns
                   Margin Debt and Stock Volatility
           40              ...
Figure 16
Foreign and Domestic Holdings
    $ billions   Outstandings                                                     ...
Endnotes
Relationships described in these notes represent the thinking of those analysts who commonly cite these
indicator...
goal of the indicator is to show whether an index is gaining or losing momentum,
       so the size of the moves are more ...
study market conditions and historical price action to forecast volatility. Since
           forecasts vary, there is no s...
simultaneously buy the Nasdaq 100 tracking stock (AMEX: QQQ). Her belief is
       that the Nasdaq 100 will rise, hence th...
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Stock Market Report- January 24, 2007

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Stock Market Report- January 24, 2007

  1. 1. Stock Market Report Federal Reserve Bank of Boston federal reserve bank of bostonTM
  2. 2. January 24, 2007 Stock Market Report Market Analysis for Period Ending Friday, January 19, 2007 This document presents technical and fundamental analysis commonly used by investment professionals to interpret direction and valuation of equity markets, as well as tools commonly used by economists to determine the health of financial markets and their impact on the domestic United States economy. The purpose is to provide a synopsis of equity markets from as many disciplines as possible, but is in no way an endorsement of any one mode of study or source of advice on which one should base investment decisions. Definitions of terms and explanations of indicator interpretation follow the charts in the Endnotes section. Technical Trends Figure 1 presents price trends and daily volumes for the New York Stock Exchange and NASDAQ Composite Indices. The New York Stock Exchange Composite Index (NYSE Index) closed Friday, January 19 at an all time high of 9179.53, with a return of 18.4 percent since the beginning of 2006. The index has risen 0.4 percent since the beginning of 2007. The National Association of Securities Dealers Composite Index (NASDAQ Index) closed Friday, January 19 at 2451.31, with a gain of 11.2 percent since the beginning of 2006. The index has risen 1.5 percent so far this year, and has dropped 2.1 percent since its recent high of 2502.82 reached on November 22 (Figure 1). Figures 2, 3, and 4 present some technical indicators commonly cited by stock market analysts. On January 19, the relative strength index for the NYSE Composite Index had a value of 62.1 percent, in neutral territory (figure 2, upper panel). The number of NYSE stocks making new 52-week highs ended January 19 at 153, down from the average of 206 seen during the fourth quarter of 2006. The number of NYSE stocks making new 52-week lows ended January 19 at 13, in line with the average of 11 seen over the past three months (figure 3, upper panel). The middle panel shows the momentum indicator (overbought/oversold oscillator) continued to spend most of its time in overbought territory over the past several weeks. The gap between NYSE's Market Breadth indicator and Price Index has remained relatively constant (figure 3, bottom panel). The relative strength index for the NASDAQ Index had a value of 51.5 percent on January 19, in neutral territory (figure 2). The number
  3. 3. of NASDAQ stocks hitting new highs on January 19 was 91, down from its fourth quarter average of 111. The number of new lows was 36 on January 19, in line with its average seen over the past three months (figure 4, upper panel). The middle panel shows the momentum indicator stayed in overbought territory over the past several weeks (figure 4, middle panel). The gap between NASDAQ's Market Breadth indicator and Price Index has widened somewhat over the past several weeks (lowest panel, figure 4). Volatility Indicators of market volatility are shown in figure 5. The Chicago Board of Options Exchange (CBOE) provides daily measures of volatility for the S&P 100 (VIX) and for the NASDAQ 100 (VXN). Both indices point to decreased volatility, compared to movements seen last summer. Put/Call ratios appear in figure 6. Monthly data are shown from January 1997. The CBOE individual equity put/call ratio held steady at 0.59 in December, at the upper end of neutral territory. The S&P 100 put/call ratio rose slightly in December to 1.41, from November's ratio of 1.38. Sector Performance Figure 7 compares the performance of the various economic sectors within the S&P 500 as well as other international and style indices. As of January 19, seven of the ten S&P 500 economic sectors recorded positive returns year-to-date. The health care sector posted the highest gain at 3.5 percent, followed by consumer discretionary with a gain of 3.3 percent. The energy sector posted the largest drop, at negative 4 percent (figure 7, top panel). All four geographic indices recorded positive returns year-to-date. The Wilshire 5000 posted the largest gain, rising 2.3 percent, following by Germany's DAX at 0.9 percent. Japan's Nikkei 225 rose 0.5 percent, and the U.K.'s FTSE 100 rose 0.3 percent (figure 7, middle panel). Three of the four Russell Style Indices recorded increases year-to- date. Leading the way was the Russell 1000 Growth Index, with a gain of 2.1 percent, followed by the Russell Large-Cap Index, with a gain of 1.1 percent. The Russell 1000 Value Index rose 0.2 percent, while the Russell 2000 Small-Cap Index fell 0.3 percent (figure 7, bottom panel). Valuation Figure 8 displays historical and current price-earnings ratios for the S&P 500 economic sector groups described above in the top panel, and analyzes earnings growth in 5-year, 3-year, and 1-year increments for each sector in the bottom two panels. Figure 9 shows two measures of historical and future valuation: historical PE
  4. 4. ratios in the top panel and strategists’ two-year forecasts of earnings growth in the lower panel. The price-earnings ratios so far in 2006 continue to resemble last years’ observations for most S&P 500 economic sectors. On January 19, the PE ratio for the energy sector was the lowest at 9.8. The consumer cyclical and information technology sectors had the highest PE ratios of 30.1 and 24.6, respectively (figure 8, top panel). The macro projections from strategists for the growth of earnings for the Standard and Poor’s 500 index over the next two years rose to 6.4 percent in the fourth quarter of 2006, from a revised 4.7 percent in the third quarter (Figure 9). Breadth of the S&P 500 During the fourth quarter of 2006, median price changes on a year-over- year basis were positive for eight of the ten deciles (figure 10, top). Overall, 74.8 percent of stocks in the S&P 500 had price increases from a year ago (figure 10, middle panel). During the third quarter, the median price earnings ratio was above the historical average price earnings ratio of 14.4 for six deciles (figure 10, bottom). Comparative Returns The dividend-price ratio, an indication of the yield investors receive through dividends by holding stocks, was 1.8 during the fourth quarter of 2006, down slightly from its third quarter rate of 1.9. The earnings-price ratio was 6.1 in the third quarter of 2006, following a rate of 5.8 in the second quarter (figure 11). The dividends percent of profit for nonfinancial corporations dipped to 43.2 percent in the third quarter, from 45.2 percent in the second quarter. The personal dividend payout rate was 6.7 percent in the third quarter, in line with its growth during the second quarter (figure 12, lower panel). Moody's upgraded a higher dollar amount of Investment Grade Securities in October, compared to the dollar amount downgraded. However, the opposite was true for Speculative Grade Securities (figure 14, top and middle panels). The default rate on junk bonds fell to 1.7 percent in October, down from 1.8 percent in September (figure 14, lower panel). The Stock Market Report is now available to the general public. The current issue, as well as previous editions, can be found at our public website, http://www.bos.frb.org/economic/smr/smr.htm. Please contact Delia Sawhney for questions and comments at Delia.R.Sawhney@bos.frb.org, or by phone at (617) 973-3542.
  5. 5. Figure 1 Daily Trends of Major U.S. Stock Exchanges New York Stock Exchange index price millions of shares 9500 4000 NYSE Composite Price Index 3500 9000 daily volume (left scale) 50-day moving average 1 (right scale) 3000 200-day moving average 1 8500 2500 8000 2000 1500 7500 1000 7000 500 6500 0 07/15/05 11/01/05 02/22/06 06/12/06 09/28/06 01/19/07 Nasdaq Stock Market index price millions of shares 2600 4000 Nasdaq Composite Price Index 2500 (left scale) 50-day moving average 1 3500 200-day moving average 1 daily volume (right scale) 3000 2400 2500 2300 2000 2200 1500 2100 1000 2000 500 1900 0 07/15/05 11/01/05 02/22/06 06/12/06 09/28/06 01/19/07 Source: Bloomberg, L.P.
  6. 6. Figure 2 Moving Averages and Relative Strength New York Stock Exchange index price 9500 NYSE Composite Price Index 9-day moving average 2 9000 8500 8000 18-day moving average 2 7500 Relative Strength Index 3 percent 100 Overbought 80 60 40 20 Oversold 0 07/21/06 09/05/06 10/18/06 12/01/06 01/19/07 Nasdaq Stock Market index price 2600 2500 9-day moving average 2 2400 Nasdaq Composite Price Index 2300 2200 18-day moving average 2 2100 2000 1900 Relative Strength Index 3 percent 100 80 Overbought 60 40 20 Oversold 0 07/21/06 09/05/06 10/18/06 12/01/06 01/19/07 Source: Bloomberg, L.P.
  7. 7. Figure 3 Index Breadth and Momentum Indicators - New York Stock Exchange New Highs and New Lows 4 index price number of stocks 9500 300 New Highs (right scale) 250 9000 NYSE Composite price (left scale) 200 8500 150 New Lows 100 8000 (right scale) 50 7500 0 07/21/06 09/05/06 10/18/06 12/01/06 01/19/07 Momentum Oscillator 5 1000 1000 750 Overbought 750 500 500 250 250 0 0 -250 -250 -500 Oversold -500 -750 -750 -1000 -1000 07/21/06 09/05/06 10/18/06 12/01/06 01/19/07 Market Breadth 6 index price number of stocks 9500 150000 Cumulative Advances - Declines (right scale) 140000 9000 NYSE Price Index (left scale) 130000 8500 120000 8000 110000 7500 100000 07/21/06 09/05/06 10/18/06 12/01/06 01/19/07 Source: Bloomberg, L.P.
  8. 8. Figure 4 Index Breadth and Momentum Indicators - Nasdaq Stock Market New Highs and New Lows 4 index price number of stocks 2600 200 NASDAQ, New Lows 2500 NASDAQ Composite Price Index (right scale) (left scale) 150 2400 2300 100 2200 NASDAQ, New Highs 2100 (right scale)2 50 2000 1900 0 07/21/06 09/05/06 10/18/06 12/01/06 01/19/07 Momentum Oscillator 5 600 600 400 Overbought 400 200 200 0 0 -200 -200 -400 -400 Oversold -600 -600 -800 -800 07/21/06 09/05/06 10/18/06 12/01/06 01/19/07 Market Breadth 6 index price number of stocks 2600 -264000 2500 NASDAQ Composite Price Index -266000 (left scale) 2400 -268000 2300 -270000 2200 -272000 2100 Cumulative Advances - Declines -274000 (right scale) 2000 -276000 1900 -278000 07/21/06 09/05/06 10/18/06 12/01/06 01/19/07 Source: Bloomberg, L.P.
  9. 9. Figure 5 Volatility 7 S&P100 and CBOE's OEX Volatility Index 8 index price 680 25 660 S&P100 Price Index 20 640 (left scale) 620 15 600 580 VIX 10 (right scale) 560 540 5 01/03/06 02/14/06 03/28/06 05/09/06 06/20/06 08/01/06 09/12/06 10/23/06 12/04/06 01/19/07 Nasdaq 100 and CBOE's NDX Volatility Index 9 index price 1900 28 Nasdaq 100 Price 26 1800 Index (left scale) 24 1700 22 20 1600 18 VXN 16 1500 (right scale) 14 1400 12 01/03/06 02/14/06 03/28/06 05/09/06 06/20/06 08/01/06 09/12/06 10/23/06 12/04/06 01/19/07 S&P500 Index Return and Implied Volatility percent 25 22 1-year average Returns Implied Volatility 20 20 (left scale) (right scale) 18 15 16 10 14 12 5 10 0 8 01/03/06 02/14/06 03/28/06 05/09/06 06/20/06 08/01/06 09/12/06 10/23/06 12/04/06 01/19/07 Source: Bloomberg, L.P.
  10. 10. Figure 6 Put / Call Ratio CBOE Index and Individual Equity Put/Call Ratios 10 index price ratio 1600 0.9 Excessive Put Buying = High Put/Call Ratio = Overly Pessimistic = Bullish Sign 1500 0.8 1400 S&P 500 Price Index (left scale) 0.7 1300 1200 0.6 1100 0.5 1000 Ratio for Individual Equity Options 0.4 900 (right scale) 800 0.3 Excessive Call Buying = Low Put/Call Ratio = Overly Optimistic = Bearish Sign 700 0.2 Jan-97 Jun-99 Nov-01 Apr-04 Dec-06 Nasdaq 100 Price Index and Put/Call Ratio index price ratio 5000 4.0 3.5 Ratio 4000 Index Price (right scale) 3.0 (left scale) 2.5 3000 2.0 2000 1.5 1.0 1000 0.5 0 0.0 Jan-97 Jun-99 Nov-01 Apr-04 Dec-06 S&P 100 Price Index and Put/Call Ratios index price ratio 1600 1.8 1500 Index Price Ratio 1400 (left scale) (right scale) 1.5 1300 1200 1.3 1100 1000 1.0 900 800 0.8 700 Jan-97 Jun-99 Nov-01 Apr-04 Dec-06 Source: Haver Analytics.
  11. 11. Figure 7 S&P 500 Economic Sectors - Index Returns 5-Year Annualized Performance Year-to-Date Performance (as of 1/19) of S&P 500 Economic Sectors of S&P 500 Economic Sectors percent percent 17.8 Energy -4 11.1 Materials 2.6 7.9 Financials 0.4 7.4 Utilities -1.7 6.7 Consumer Discretionary 3.3 5.9 Industrials 1.4 4.4 Consumer Staples 1.9 3.8 Info Technology 0.7 1.3 Telecommunications -1.6 0.8 Health Care 3.5 0 5 10 15 20 -5 -3 -1 0 1 3 5-Year Annualized Performance Year-to-Date Performance (as of 1/19) of Selected Geographical Indexes of Selected Geographical Indexes percent percent 10.7 Nikkei 225, Japan 0.5 5.5 Wilshire 5000, U.S. 2.3 4.6 DAX, Germany 0.9 2.7 FTSE 100, U.K. 0.3 0 2 4 6 8 0 2 5-Year Annualized Performance Year-to-Date Performance (as of 1/19) of Selected Russell Style Indexes of Selected Russell Style Indexes percent percent 13.6 2000 Small-Cap -0.3 12.1 1000 Value 0.2 8.3 1000 Large-Cap 1.1 4.5 1000 Growth 2.1 0 5 10 15 -0.5 0 0.5 1 1.5 2 2.5 Source: Bloomberg, L.P.
  12. 12. Figure 8 S&P 500 Economic Sectors - Earnings Growth PE Ratios for S&P 500 Economic Sectors 70 60 2003:Q4 2005:Q4 2006:Q4 1/19/2007 50 2004:Q4 40 30 20 10 0 h m s e ls ls ls 0 s es gy le al c ar 50 ia ia ria co Te it i er ap lic C nc er til st le P En fo yc St at lth U na du S& Te In M C ea s Fi In on s H on C C Earnings Growth for S&P 500 Economic Sectors (annualized percent change) 30 100 25 (179.6) 5-YEAR 3-YEAR 1-YEAR 80 (99.4) 20 60 40 15 20 10 0 5 -20 0 -40 0 50 h m e ls ls s s ls s gy al le e c ar P ia ia ria co Te iti er ap lic S& C nc er til st le En fo yc at St lth U na du Te In M C ea s Fi In on s H on C C Operating Earnings Growth for S&P 500 Economic Sectors (annualized percent change) 30 100 25 5-YEAR 3-YEAR 1-YEAR 80 20 60 15 40 10 20 5 0 0 -20 0 ch m al s e ls ls ls s gy 50 le e ar ia ia ria lic co Te iti er ap C nc er P yc til st le En fo S& St at lth U na du Te C In M ea s Fi s In on on H C C Source: Standard & Poor's Compustat, Bloomberg, L.P.
  13. 13. Figure 9 PE Ratios and the Growth of Earnings Price-Earnings Ratios Percent Percent 80 80 70 S&P Smallcap 600 70 Wilshire 5000 60 60 S&P 500 Russell 2000 50 50 40 40 30 30 20 20 10 10 0 0 1968:Q1 1975:Q1 1982:Q1 1989:Q1 1996:Q1 2003:Q1 1971:Q3 1978:Q3 1985:Q3 1992:Q3 1999:Q3 2006:Q4 S&P500 Price-Earnings Ratio and the Growth of Earnings Percent percent 50 100 Price-Earnings Ratio 80 40 (left scale) 2 yr Growth of Earnings11 (right scale) 60 30 40 20 20 0 10 -20 0 -40 1968:Q1 1975:Q1 1982:Q1 1989:Q1 1996:Q1 2003:Q1 1971:Q3 1978:Q3 1985:Q3 1992:Q3 1999:Q3 2006:Q4 Source: Thomson Financial/First Call, Global Insight, Bloomberg L.P., Frank Russell Company, and Haver Analytics.
  14. 14. Figure 10 Breadth of the S&P 500 One-Year Price Changes for Companies (median percentage change for each decile, ranked by performance) 150 100 50 0 -50 -100 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2006 2006:Q4 Q1 Q2 Q3 Q4 Proportion of the S&P 500 Stocks Whose Price Increased Over One Year percent 100 90 80 70 60 50 40 30 20 10 0 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2006:Q3 2006 Q1 Q2 Q3 Q4 Price-Operating Earnings Ratios for Companies (median ratio for each decile, ranked by PE ratio) 100 80 60 40 20 PE= 14.4 14.4 0 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2006 2006 Q1 Q2 Q3 Source: Standard & Poor's Compustat.
  15. 15. Figure 11 Comparative Returns Dividend-Price Ratio 12 for the S&P 500 and the Real Corporate Bond Rate 13 11.0 11.0 10.0 10.0 9.0 Yield on A-Corporate Bonds Less Inflation Expectations 9.0 8.0 8.0 7.0 7.0 6.0 6.0 5.0 5.0 4.0 4.0 3.0 3.0 2.0 DP Ratio 2.0 1.0 1.0 0.0 0.0 1982:Q1 1986:Q1 1990:Q1 1994:Q1 1998:Q1 2002:Q1 2006:Q1 2006:Q4 Earnings-Price Ratio 12 for the S&P 500 and the Real Corporate Bond Rate 14.0 14.0 12.0 12.0 10.0 10.0 EP Ratio 8.0 8.0 6.0 6.0 4.0 4.0 2.0 Yield on A-Corporate Bonds Less Inflation Expectations 2.0 0.0 0.0 1982:Q1 1986:Q1 1990:Q1 1994:Q1 1998:Q1 2002:Q1 2006:Q1 2006:Q4 Growth of Real Earnings for S&P 500 (average rate of growth for 2 years forward) Percent Percent 60.0 60.0 40.0 40.0 20.0 20.0 0.0 0.0 -20.0 -20.0 -40.0 -40.0 1982:Q1 1986:Q1 1990:Q1 1994:Q1 1998:Q1 2002:Q1 2006:Q1 2006:Q4 Source: Haver Analytics, FAME.
  16. 16. Figure 12 Dividend Yields Dividend Yields for S&P 500 and Components Percent Percent 12.0 12.0 10.0 Utilities 10.0 8.0 8.0 Financials 6.0 6.0 Composite 4.0 4.0 2.0 Transports 2.0 Industrials 0.0 0.0 1960:Q1 1965:Q4 1971:Q3 1977:Q2 1983:Q1 1988:Q4 1994:Q3 2000:Q2 2006:Q1 2006:Q4 Nonfinancial Corporate Dividend Expenditures and Personal Dividend Income Percent Percent 80.0 8.0 Personal Dividend Income 70.0 7.0 (percent of disposable income, right scale) 60.0 Nonfinancial Corporate Dividends 6.0 (percent of profits, left scale) 50.0 5.0 40.0 4.0 30.0 20.0 3.0 10.0 2.0 1960:Q1 1965:Q4 1971:Q3 1977:Q2 1983:Q1 1988:Q4 1994:Q3 2000:Q2 2006:Q1 2006:Q3 Source: Haver Analytics.
  17. 17. Figure 13 Economic Measures of Equity Valuation Real Rate of Return on Nonfinancial Corporate Equity (from National Income and Flow of Funds Accounts) Percent Percent 13.0 13.0 12.0 12.0 11.0 11.0 10.0 10.0 9.0 9.0 8.0 8.0 7.0 7.0 6.0 6.0 5.0 5.0 4.0 4.0 3.0 3.0 1958 1968 1978 1988 1998 2005 Tobin's q 14 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 1952:Q1 1958:Q4 1965:Q3 1972:Q2 1979:Q1 1985:Q4 1992:Q3 1999:Q2 2006:Q1 2006:Q3 Profits of Nonfinancial Corporations Percent of GDP Percent of GDP 12.0 12.0 11.0 11.0 10.0 Earnings Before Interest Payments 10.0 9.0 9.0 8.0 8.0 7.0 7.0 6.0 6.0 5.0 5.0 4.0 Profits 4.0 3.0 3.0 2.0 2.0 1958:Q1 1963:Q4 1969:Q3 1975:Q2 1981:Q1 1986:Q4 1992:Q3 1998:Q2 2004:Q1 2006:Q3 Source: Haver Analytics, NYSE Fact Book, Flow of Funds Accounts.
  18. 18. Figure 14 Ratings and Default Rates 15 Changes in Moody's Ratings of Investment Grade Securities $ billion and the S&P 500 PE Ratio 90 50 Downgrades (145.9) (107.9) 80 SP500 PE Ratio 45 (left scale) 70 (right scale) 40 Upgrades 60 (left scale) 35 50 30 40 25 30 20 20 10 15 0 10 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 15 Changes in Moody's Ratings of Speculative Grade Securities $ billion and the S&P 500 PE Ratio 70 50 Downgrades (135.5) (79.9) 60 45 (left scale) Upgrades 40 50 SP500 PE Ratio (left scale) 35 40 (right scale) 30 30 25 20 20 10 15 0 10 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Moody's Junk Bond Default Rate percent and the S&P 500 PE Ratio 25 50 45 20 40 SP500 PE Ratio 35 15 (right scale) 30 10 25 Default Rate 20 5 (left scale) 15 0 10 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Source: Credqual database, Board of Governors of the Federal Reserve System.
  19. 19. Figure 15 Margin Debt and Expected Returns Margin Debt and Stock Volatility 40 1.5 35 VIX Outstanding Margin Debt Relative to 1.4 (left scale) Total Market Value of Equities 1.3 30 (right scale) 1.2 25 1.1 20 1 0.9 15 0.8 10 0.7 5 0.6 1987:Q1 1990:Q2 1993:Q3 1996:Q4 2000:Q1 2003:Q2 2006:Q4 Gross New Issuance and the S&P 500 PE Ratio ratio 50 0.7 New Equity Security Issuance 0.6 40 Relative to Total Market Value (right scale) 0.5 30 0.4 20 0.3 0.2 10 PE Ratio (left scale) 0.1 0 0 1987:Q1 1990:Q2 1993:Q3 1996:Q4 2000:Q1 2003:Q2 2006:Q4 Gross New Issuance of Securities by Nonfinancial Corporations $ billions 150 35 Bonds 30 25 100 Equity 20 15 50 10 5 0 0 1996:Q1 1998:Q1 2000:Q1 2002:Q1 2004:Q1 2006:Q2 Apr-06 Jun-06 Aug-06 Sources: Haver Analytics, FAME.
  20. 20. Figure 16 Foreign and Domestic Holdings $ billions Outstandings $ billions 4000 4000 3000 3000 2000 2000 Foreign Holdings of US Securities US Resident Holdings of Foreign Securities 1000 1000 0 0 1985:Q1 1989:Q2 1993:Q3 1997:Q4 2002:Q1 2006:Q3 Foreign Holdings of U.S. Equity Securities Relative to index price percent Total Market Value of U.S. Equity 14 2000 13 12 1500 11 10 Foreign Holdings of U.S. Securities 1000 9 (left scale) 8 S&P 500 500 7 (right scale) 6 5 0 1985:Q1 1989:Q2 1993:Q3 1997:Q4 2002:Q1 2006:Q3 2006:Q4 U.S. Resident Holdings of Foreign Equity Securities Relative to index percent Total Market Value of U.S. Equity price 20 300 DJ World Stock Index, 250 15 Excluding U.S. (right scale) 200 U.S. Resident Holdings of 10 Foreign Securities (left scale) 150 5 100 0 50 1985:Q1 1989:Q2 1993:Q3 1997:Q4 2002:Q1 2006:Q4 2006:Q3 Source: Haver Analytics, FAME, Flow of Funds Accounts of the United States.
  21. 21. Endnotes Relationships described in these notes represent the thinking of those analysts who commonly cite these indicators. While many analysts consider these to be commonly used indicators, they are not necessarily endorsed as the prevailing tools used by the analyst community, and have not been validated by anyone at the Federal Reserve Bank of Boston. 1. 50-Day, 200-Day Moving Average: Moving averages represent the average price investors pay for securities over a historical period, and present a smoothed picture of the price trends, eliminating the volatile daily movement. Because these lines offer a historical consensus entry point, chartists look to moving average trend lines of index prices to define levels of support or resistance in the market. When a chart trend is predominantly sideways, moving averages and the underlying series frequently cross, but during a time of prolonged increase or decrease the daily prices of a security typically are above or below the trailing average. Moving above or below the 50-day moving average is sometimes associated with rallies or corrections. Similarly, prolonged movements, such as bull and bear markets can be represented by securities remaining above or below their 200-day moving average for prolonged periods of time. 2. 9-Day, 18-Day Moving Averages: The 9-day and 18-day moving averages are often used together to provide buy and sell signals. Buy signals are indicated by the 9-day average crossing above the 18-day when both are in an uptrend. The reverse, the 9-day crossing below the 18-day while both moving averages are declining, is a sign to sell. However, this simple tool can often be misleading because of its dependence on trending markets and its inability to capture quick market turns. 3. Relative Strength Index (RSI): This momentum oscillator measures the velocity of directional price movements. When prices move rapidly upward it may indicate an overbought condition, generally assumed to occur above 70 percent. Oversold conditions arise when prices drop quickly, producing RSI readings below 30 percent. 4. New Highs, New Lows: A straightforward breadth indicator, this is the 10-day moving average of the number of stocks on a given index or exchange making new 52-week highs or lows each day. This indicator also demonstrates divergence. If an index makes a new low, but the number of stocks in the index making new lows declines, there is positive divergence. Technical analysts refer to this as a lack of downside conviction, or a situation where stocks generally fell on a given day, but not by a significant margin that would indicate intense selling pressure and further declines. Conversely, in rising markets if an index makes a new high but the number of individual stocks in that index making new highs does not increase the rally may not be sustained. 5. Momentum Oscillator: Also known as the overbought/oversold oscillator, this indicator is calculated by taking the 10-day moving average of the difference between the number of advancing and declining issues for a given index. The
  22. 22. goal of the indicator is to show whether an index is gaining or losing momentum, so the size of the moves are more important than the level of the current reading. This is first affected by how the oscillator changes each day, by dropping a value ten days ago, and adding one today. If the advance-decline line read minus 300 ten days ago, and minus 100 today, even though the market is down again, the oscillator will rise by 200 because of the net difference of the exchanged days' values. This scenario suggests a trough. On the other hand, if today's reading was minus 500, it would demonstrate an acceleration of across the board selling. The magnitude in moves is useful when compared with divergence to the index price. If the Dow peaks at the same time the oscillator peaks in overbought territory, it suggests a top. If the index then makes a new high but the oscillator fails to make a higher high, divergence is negative and momentum is declining. If the index at this point declines and the oscillator moves into oversold territory it may again be time to buy. If the index rises but does not make new highs, but the oscillator continues to rise above a previous overbought level, upside momentum exists to continue the rally. 6. Cumulative Advance - Decline Line: Referred to as market breadth, the indicator is the cumulative total of advancing minus declining issues each day. When the line makes new highs a rally is considered widespread, but when lagging a rally is seen as narrow. 7. Volatility: With regard to stock price and stock index level, volatility is a measure of changes in price expressed in percentage terms without regard to direction. This means that a rise from 200 to 202 in one index is equal in volatility terms to a rise from 100 to 101 in another index, because both changes are 1 percent. Also, a 1 percent price rise is equal in volatility terms to a 1 percent price decline. While volatility simply means movement, there are four ways to describe this movement: 1. Historic volatility is a measure of actual price changes during a specific time period in the past. Mathematically, historic volatility is the annualized standard deviation of daily returns during a specific period. CBOE provides 30 day historical volatility data for obtainable stocks in the Trader's Tools section of this Web site. 2. Future volatility means the annualized standard deviation of daily returns during some future period, typically between now and an option expiration. And it is future volatility that option pricing formulas need as an input in order to calculate the theoretical value of an option. Unfortunately, future volatility is only known when it has become historic volatility. Consequently, the volatility numbers used in option pricing formulas are only estimates of future volatility. This might be a shock to those who place their faith in theoretical values, because it raises a question about those values. Theoretical values are only estimates, and as with any estimate, they must be interpreted carefully. 3. Expected volatility is a trader's forecast of volatility used in an option pricing formula to estimate the theoretical value of an option. Many option traders
  23. 23. study market conditions and historical price action to forecast volatility. Since forecasts vary, there is no specific number that everyone can agree on for expected volatility. 4. Implied volatility is the volatility percentage that explains the current market price of an option; it is the common denominator of option prices. Just as p/e ratios allow comparisons of stock prices over a range of variables such as total earnings and number of shares outstanding, implied volatility enables comparison of options on different underlying instruments and comparison of the same option at different times. Theoretical value of an option is a statistical concept, and traders should focus on relative value, not absolute value. The terms "overvalued" and "undervalued" describe a relationship between implied volatility and expected volatility. Two traders could differ in their opinion of the relative value of the same option if they have different market forecasts and trading styles. 8. CBOE Volatility Index (VIX): The VIX, introduced by CBOE in 1990, measures the Volatility of the U.S. equity market. It provides investors with up-to-the-minute market estimates of expected volatility by using real-time S&P 100 (AMEX: OEX) index option bid/ask quotes. This index is calculated by taking a weighted average of the implied volatilities of eight OEX calls and puts. The chosen options have an average time to maturity of 30 days. Consequently, the VIX is intended to indicate the implied volatility of 30-day index options. Some traders use it as a general indication of index option implied volatility. (Source: CBOE) 9. CBOE Nasdaq 100 Volatility Index (VXN): Like the VIX, the VXN measures implied volatility, but in this case for Nasdaq 100 (NDX) index options, thereby representing an intraday implied volatility of a hypothetical at-the-money NDX option with thirty calendar days to expiration. Both the VXN and the VIX are used as sentiment indicators for the Nasdaq 100 and for the broader market, respectively. Higher readings and spikes generally occur during times of investor panic and at times coincide with market bottoms. Low readings suggest complacency and often occur around tops in index prices. 10. Put / Call Ratios: These ratios are used as contrary sentiment indicators. Unusually high ratio values, indicating much more put buying than call buying, occur when investors are extremely pessimistic and believe the market will continue to fall dramatically, at times from already low levels, and are often considered by analysts to indicate overly pessimistic sentiment. Because so many investors believe prices will continue to fall assets can become undervalued by contemporary valuations, and prices can move quickly back up. This phenomenon in capital markets is exacerbated by the volatility and leverage associated with derivative securities like options. The CBOE index ratios track put and call option trade volume for exchange- traded index options like the S&P 500 and Nasdaq 100. These ratios reflect sentiment of professional and institutional strategies because they are typically used as hedging tools by professional money managers. For example, a trader may purchase Nasdaq 100 puts as protection against loss if she also chose to
  24. 24. simultaneously buy the Nasdaq 100 tracking stock (AMEX: QQQ). Her belief is that the Nasdaq 100 will rise, hence the outright purchase of shares, but has hedged her bet by purchasing puts option contracts, which cost a fraction of the underlying asset. Because of this institutional presence there is more put buying of index options compared with individual equity options, and the index put-call ratios are typically above 1. Index readings above 1.25 indicate much put buying and often occur when institutional investors are very pessimistic, and can lead to a short-term rally in response to this extreme negativity. Conversely, index ratios below 0.75 show very optimistic sentiment. The CBOE equity ratio, however, is composed of trade volume for individual equity options. While both retail and institutional investors purchase individual equity options, this ratio is considered by technical analysts to be an indicator of retail investor sentiment. Because there is less of the large volume put buying associated with institutional hedging, many analysts believe this is a more sensitive indicator of sentiment, especially among individual investors who may be purchasing puts when they actually believe the price of a particular stock will fall rather than as a hedge to a long position in that stock. Readings above 0.6 suggest a rally may occur because too many investors are pessimistic. Traders believe readings below 0.3 show complacent investor psychology and that prices may decline in the future. 11. 2-Year Growth of Earnings: Growth of earnings over subsequent 8 quarters. Current observations use forecast of earnings from macro projections. 12. Earnings and Dividend Price Ratios: These ratios represent an investor's yield from earnings and dividend payments. Historically, the EP ratio often has exceeded the real return on bonds, reflecting the greater risk to shareholders for choosing equity investments. In recent quarters, the EP ratio has fallen below the return on bonds. Traditionally, the EP ratio has fallen below this real bond rate when earnings are expected to rise dramatically. 13. Real Bond Rate: Moody's composite yield of A-rated corporate bonds less the expected rate of inflation over the next 10 years as measured by the consumer price index from the Survey of Professional Forecasters, published by the Federal Reserve Bank of Philadelphia. 14. Tobin's q: The ratio of the market value of equity plus net interest bearing debt to current value of land, inventories, equipment, and structures. 15. Moody's Ratings: Denotes the change in dollar amount of investment grade (above BA1) or speculative grade (BA1 or below) securities outstanding for a particular company if that company is up/downgraded during a given month. For example, if company XYZ was upgraded, and they had bonds rated AA2 for $10, AA1 for $2, and A3 for $15, this company's contribution to the chart value is $27.

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