Stock Market Report- September 13, 2006

StockMarketReportFederal Reserve Bank of Boston

federal reserve bank of bostonTM

September 13, 2006

Stock Market Report Market Analysis for Period Ending Friday, September 8, 2006

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, September 8 at 8294.64, with a return of 6.2 percent year-to-date. The Index reached an all-time high of 8646.96 on May 9, 2006 and has dropped 4.1 percent since. The National Association of Securities Dealers Composite Index (NASDAQ Index) closed Friday, September 8 at 2165.79, with a loss of 2.2 percent since the beginning of 2006. The Index has dropped 8.7 percent since its recent high of 2370.88 reached on April 19. (Figure 1). Figures 2, 3, and 4 present some technical indicators commonly cited by stock market analysts. On September 8, the relative strength index for the NYSE Composite Index had a value of 48.99 percent, in neutral territory (figure 2, upper panel). The number of NYSE stocks making new 52-week highs ended September 8 at 115, in line with their second quarter average of 119, but down from their first quarter average of 181. The number of NYSE stocks making new 52-week lows ended September 8 at 15, only one third of their average level seen so far this year (figure 3, upper panel). The middle panel shows the momentum indicator (overbought/oversold oscillator) has spent most of its time in overbought territory over the past several weeks. The gap between NYSE's Market Breadth indicator and Price Index has been widening somewhat over the past six weeks (figure 3, bottom panel). The relative strength index for the NASDAQ Index had a value of 55.94 percent on September 8, in neutral territory (figure 2). The

number of NASDAQ stocks hitting new highs on September 8, was in line with its average seen since May; however, it was only about half the average seen during the first four months of the year. The number of new lows continued their downward trend in August (figure 4, upper panel). The middle panel shows the momentum indicator was mostly in overbought territory over the past several weeks (figure 4, middle panel). The gap between NASDAQ's Market Breadth indicator and Price Index has been growing (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 recent months. Put/Call ratios appear in figure 6. Monthly data are shown from January 1997.

The CBOE individual equity put/call ratio was 0.67 in August, at the low end of bullish territory. The S&P 100 put/call ratio rose slightly in August to 1.38, from July's ratio of 1.19. 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 September 8, nine of the ten S&P 500 economic sectors recorded positive returns year-to-date. The only exception was the information technology sector, which reported a negative 2.9 percent return year-to-date. Telecommunications posted the highest gain at 18.4 percent, followed by consumer staples at 9.0 percent (figure 7, top panel). Three out of the four geographic indices recorded positive returns year-to-date. Japan's Nikkei 225 was the one exception, posting a drop of -0.2 percent. The Wilshire 5000 increased 3.8 percent, Germany’s DAX was up by 7.2 percent, and the U.K.'s FTSE 100 rose 4.6 percent (figure 7, middle panel). Three out of the four Russell Style Indices recorded increases year-to-date. The Russell 2000 Small-Cap Index rose 5.2 percent. The Russell 1000 Value Index increased 8.6 percent and the Russell Large-Cap Index was up by 3.7 percent. In contrast, the Russell 1000 Growth Index fell 1.0 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 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 September 8, the PE ratio for the energy sector was the lowest at 9.6. The consumer cyclicals and information technology sectors had the highest PE ratios of 28.1 and 23.1, 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 fell to a revised 5.8 percent in the second quarter of 2006, from a revised 6.1 percent in the first quarter (Figure 9). Breadth of the S&P 500 During the second quarter of 2006, median price changes on a year-over-year basis were positive for seven of the ten deciles (figure 10, top). Overall, 65.8 percent of stocks in the S&P 500 had price increases from a year ago (figure 10, middle panel). 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 1.1 percent during the second quarter of 2006, in line with its rate during the first quarter. The earnings-price ratio increased a revised 5.8 percent in the second quarter of 2006, up slightly from the 5.7 percent increase seen in the first quarter (figure 11). The percent of profit for nonfinancial corporations rose to 42.6 in the second quarter of 2006, from 41.9 in the first quarter. During the fourth quarter of 2005, the dividend payout rate was only 14.9 (figure 12, lower panel). Moody's upgraded a higher dollar amount of Investment Grade Securities in July, 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 held steady at 4.1 percent in July (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 [email protected], or by phone at (617) 973-3542.

03/15/05 06/30/05 10/17/05 02/03/06 05/23/06 09/08/066500

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Nasdaq Composite Price Index(left scale)

daily volume(right scale)

NYSE Composite Price Index(left scale)

50-day moving average 1


Figure 1Daily Trends of Major U.S. Stock Exchanges

New York Stock Exchange

Nasdaq Stock Market



daily volume(right scale)

Source: Bloomberg, L.P.

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Figure 2Moving Averages and Relative Strength

New York Stock Exchange


03/20/06 05/02/06 06/14/06 07/27/06 09/08/060

20406080

100percentRelative Strength Index 3

Overbought

Oversold

Nasdaq CompositePrice Index



Nasdaq Stock Market

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Overbought

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Overbought

Oversold

Momentum Oscillator 5

Cumulative Advances - Declines(right scale)

NYSE Price Index(left scale)

NYSE Composite price(left scale)

Figure 3Index Breadth and Momentum Indicators - New York Stock Exchange

New Highs and New Lows 4

Market Breadth 6


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Overbought

Oversold

Cumulative Advances - Declines(right scale)

NASDAQ Composite Price Index(left scale)

Figure 4Index Breadth and Momentum Indicators - Nasdaq Stock Market

NASDAQ Composite Price Index(left scale)

New Highs and New Lows 4

Momentum Oscillator 5

Market Breadth 6


09/12/05 10/17/05 11/21/05 12/28/05 02/03/06 03/13/06 04/18/06 05/23/06 06/28/06 08/03/06 09/08/060

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S&P100 Price Index(left scale)

VIX(right scale)

Figure 5Volatility 7

09/12/05 10/17/05 11/21/05 12/28/05 02/03/06 03/13/06 04/18/06 05/23/06 06/28/06 08/03/06 09/08/061400

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Nasdaq 100 Price Index (left scale)

VXN(right scale)

S&P100 and CBOE's OEX Volatility Index 8

Nasdaq 100 and CBOE's NDX Volatility Index 9

S&P500 Index Return and Implied Volatility

1-year average Returns(left scale)

Implied Volatility(right scale)


Jan:1997 Dec:1998 Nov:2000 Oct:2002 Sep:2004 Aug:2006700800900

1000110012001300140015001600index price

0.8

1.0

1.3

1.5

1.8ratio

Figure 6Put / Call Ratio


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Ratio for Individual Equity Options(right scale)

CBOE Index and Individual Equity Put/Call Ratios 10


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Ratio(right scale)

Nasdaq 100 Price Index and Put/Call Ratio

Index Price(left scale)

S&P 500 Price Index(left scale)

Source: Haver Analytics.

Excessive Put Buying = High Put/Call Ratio = Overly Pessimistic = Bullish Sign

Excessive Call Buying = Low Put/Call Ratio = Overly Optimistic = Bearish Sign

Ratio(right scale)

S&P 100 Price Index and Put/Call Ratios

Index Price(left scale)

10.98.23.72.62.30.4

-2.4-2.9-2.9-7.9

-10 -5 0 5 10 150

Year-to-Date Performance (as of 09/08) of S&P 500 Economic Sectors

Energy

Telecommunications

Industrials

Consumer Staples

Financials

Info Technology

Consumer Discretionary

Health Care

Utilities

Materials

percent

5.28.63.7

-1.0-2 0 2 4 6 8 100

Year-to-Date Performance (as of 09/08)of Selected Russell Style Indexes

2000 Small-Cap

1000 Value

1000 Large-Cap

percent

8.222.9

1.344.921.169.04

8.1-2.942.6218.4

-5 5 150

5-Year Annualized Performance of S&P 500 Economic Sectors

percent

1000 Growth

10.46.52.7

-1.4-2 0 2 4 6 8 10 120

5-Year Annualized Performance of Selected Russell Style Indexespercent

Year-to-Date Performance (as of 09/08)of Selected Geographical Indexes

5-Year Annualized Performance of Selected Geographical Indexes

-0.23.87.24.6

-1 1 3 5 70

DAX, Germany

FTSE 100, U.K.

Wilshire 5000, U.S.

percent

Nikkei 225, Japan62.11.5

-0.6-2 0 2 4 6 80

percent


Figure 7S&P 500 Economic Sectors - Index Returns

Figure 8S&P 500 Economic Sectors - Earnings Growth

Source: Standard & Poor's Compustat, Bloomberg, L.P.

Energy

Materia

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Indus

trials

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Health

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5-YEAR 3-YEAR 1-YEAR

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5-YEAR 3-YEAR 1-YEAR

Earnings Growth for S&P 500 Economic Sectors(annualized percent change)

Operating Earnings Growth for S&P 500 Economic Sectors(annualized percent change)

S&P 500

0

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30

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702000:Q42002:Q4

2004:Q4 2005:Q4 9/8/06

PE Ratios for S&P 500 Economic Sectors

(227.6) (103.2)

1968:Q11971:Q3

1975:Q11978:Q3

1982:Q11985:Q3

1989:Q11992:Q3

1996:Q11999:Q3

2003:Q10

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2003:Q10

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percent

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S&P Smallcap 600

Russell 2000

Wilshire 5000

Price-Earnings Ratio (left scale) 2 yr Growth of Earnings11

(right scale)

2006:Q2

2006:Q2

Source: Thomson Financial/First Call, Global Insight, Bloomberg L.P., Frank Russell Company, and Haver Analytics.

Price-Earnings Ratios

S&P500 Price-Earnings Ratio and the Growth of Earnings

Percent Percent

Percent

PE Ratios and the Growth of EarningsFigure 9

Figure 10Breadth of the S&P 500

Source: Standard & Poor's Compustat.

1968 1972 1976 1980 1984 1988 1992 1996 2000 20040

20

40

60

80

100

14.4

One-Year Price Changes for Companies(median percentage change for each decile, ranked by performance)

Price-Operating Earnings Ratios for Companies(median ratio for each decile, ranked by PE ratio)

PE=14.4

Proportion of the S&P 500 Stocks Whose Price Increased Over One Yearpercent

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004-100

-50

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150

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1968 1972 1976 1980 1984 1988 1992 1996 2000 20040

102030405060708090

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2006Q1 Q2

2006Q1 Q2

2006Q1 Q2

Figure 11Comparative Returns

1982:Q1 1986:Q1 1990:Q1 1994:Q1 1998:Q1 2002:Q1 2006:Q10.01.02.03.04.05.06.07.08.09.0

10.011.0

0.01.02.03.04.05.06.07.08.09.010.011.0

Yield on A-Corporate Bonds Less Inflation Expectations

DP Ratio

Earnings-Price Ratio 12 for the S&P 500 and the Real Corporate Bond Rate

Growth of Real Earnings for S&P 500(average rate of growth for 2 years forward)

1982:Q1 1986:Q1 1990:Q1 1994:Q1 1998:Q1 2002:Q1 2006:Q10.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Yield on A-Corporate Bonds Less Inflation Expectations

EP Ratio

Dividend-Price Ratio 12 for the S&P 500 and the Real Corporate Bond Rate 13

1982:Q1 1986:Q1 1990:Q1 1994:Q1 1998:Q1 2002:Q1 2006:Q1-40.0

-20.0

0.0

20.0

40.0

60.0

0.0

-40.0

-20.0

0.0

20.0

40.0

60.0

0.0

Source: Haver Analytics, FAME.

2006:Q2

2006:Q2

2006:Q2

Percent Percent

Figure 12Dividend Yields

1960:Q1 1965:Q4 1971:Q3 1977:Q2 1983:Q1 1988:Q4 1994:Q3 2000:Q2 2006:Q10.0

2.0

4.0

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8.0

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Composite

Industrials

Dividend Yields for S&P 500 and Components

Utilities

Financials

Transports

1960:Q1 1965:Q4 1971:Q3 1977:Q2 1983:Q1 1988:Q4 1994:Q3 2000:Q2 2006:Q110.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

2.0

3.0

4.0

5.0

6.0

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8.0

Nonfinancial Corporate Dividends(percent of profits, left scale)

Nonfinancial Corporate Dividend Expenditures and Personal Dividend Income

Personal Dividend Income(percent of disposable income, right scale)

Source: Haver Analytics.

2006:Q2

2006:Q2

Percent Percent

Percent Percent

Real Rate of Return on Nonfinancial Corporate Equity(from National Income and Flow of Funds Accounts)

1958 1968 1978 1988 19983.04.05.06.07.08.09.0

10.011.012.013.0

3.04.05.06.07.08.09.010.011.012.013.0

1958:Q1 1963:Q4 1969:Q3 1975:Q2 1981:Q1 1986:Q4 1992:Q3 1998:Q2 2004:Q12.03.04.05.06.07.08.09.0

10.011.012.0

2.03.04.05.06.07.08.09.010.011.012.0

Profits of Nonfinancial Corporations

Tobin's q 14

Earnings Before Interest Payments

Profits

Figure 13Economic Measures of Equity Valuation

1952:Q1 1958:Q4 1965:Q3 1972:Q2 1979:Q1 1985:Q4 1992:Q3 1999:Q2 2006:Q10.0

0.5

1.0

1.5

2.0

2.5

0.0

0.5

1.0

1.5

2.0

2.5

Source: Haver Analytics, NYSE Fact Book, Flow of Funds Accounts.

2005

Percent Percent

Percent of GDP Percent of GDP

2006:Q2

Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-060

10

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Upgrades(left scale)

SP500 PE Ratio(right scale)

Downgrades(left scale)

$ billion


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Default Rate(left scale)

percent


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Upgrades(left scale)


Downgrades(left scale)

$ billion

Changes in Moody's Ratings of Investment Grade Securitiesand the S&P 500 PE Ratio

Figure 14Ratings and Default Rates

15

(145.9) (107.9)

Changes in Moody's Ratings of Speculative Grade Securitiesand the S&P 500 PE Ratio

15

Moody's Junk Bond Default Rateand the S&P 500 PE Ratio

Source: Credqual database, Board of Governors of the Federal Reserve System.

(135.5) (79.9)

1987:Q1 1990:Q2 1993:Q3 1996:Q4 2000:Q1 2003:Q210

15

20

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30

35

40

0.6

0.7

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1

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Outstanding Margin Debt Relative to Total Market Value of Equities (right scale)

1996:Q1 1998:Q1 2000:Q1 2002:Q1 2004:Q1 2006:Q10

50

100

150

Bonds

$ billions

Equity

1987:Q1 1990:Q2 1993:Q3 1996:Q4 2000:Q1 2003:Q20

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New Equity Security Issuance Relative to Total Market Value (right scale)

VIX(left scale)

PE Ratio(left scale)

Figure 15Margin Debt and Expected Returns

Margin Debt and Stock Volatility

Gross New Issuance and the S&P 500 PE Ratio

Gross New Issuance of Securities by Nonfinancial Corporations

Sources: Haver Analytics, FAME.

2006:Q2

2006:Q2

Aug-05 Dec-05 Apr-060

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1985:Q1 1989:Q2 1993:Q3 1997:Q4 2002:Q1 2006:Q20

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US Resident Holdings of Foreign Securities

Foreign Holdings of US Securities

$ billions

1985:Q1 1989:Q2 1993:Q3 1997:Q4 2002:Q1 2006:Q25

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S&P 500(right scale)

Foreign Holdings of U.S. Securities(left scale)

percent

1985:Q1 1989:Q2 1993:Q3 1997:Q4 2002:Q1 2006:Q20

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150

200

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U.S. Resident Holdings of Foreign Securities(left scale)

DJ World Stock Index,Excluding U.S.(right scale)

percent

indexprice

indexprice

Figure 16Foreign and Domestic Holdings

Source: Haver Analytics, FAME, Flow of Funds Accounts of the United States.

Outstandings

Foreign Holdings of U.S. Equity Securities Relative to Total Market Value of U.S. EquityForeign Holdings of U.S. Equity Securities Relative to Total Market Value of U.S. Equity

U.S. Resident Holdings of Foreign Equity Securities Relative toTotal Market Value of U.S. Equity

$ billions

2006:Q1

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

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

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

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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Stock Market Report- September 13, 2006