January 26, 2005

Stock Market Report Market Analysis for Period Ending Friday, January 21, 2005

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 21 at 6996.56. The index has fallen 3.5 percent since the beginning of the year, and it has risen 55.9 percent since hitting its low on March 12, 2003. The National Association of Securities Dealers Composite Index (Nasdaq Index) closed at 2034.27. The index has fallen 6.4 percent year-to-date and is up 56.0 percent since March 11, 2003 (figure 1). Figures 2, 3, and 4 present some technical indicators commonly cited by stock market analysts.

The relative strength index for the NYSE Composite has settled in the middle of neutral territory (figure 2, upper panel). The number of stocks making new 52-week highs declined sharply in January while the number of new lows remained close to zero (figure 3, upper panel). The middle panel shows that momentum (overbought/oversold oscillator) moved down to oversold territory in January but has lately climbed into overbought territory again. The Market Breadth indicator has been lagging, implying a narrow rally (figure 3, bottom panel). For the Nasdaq Index, the relative strength index has remained in neutral territory (figure 2). The number of new highs dropped while the number of new lows increased slightly in January (figure 4, upper panel). The momentum indicator stayed in oversold territory during the month while Nasdaq composite prices were declining (figure 4, middle panel). The Market Breadth indicator has remained flat, suggesting a narrow rally (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 volatility indicators rose slightly in January. Put/Call ratios appear in figure 6. Monthly data are shown from January 1997 through August 2004.

The CBOE individual equity put/call ratio has remained in neutral territory. The S&P 100 put/call ratio has moved to territory normally identified as bullish. 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.

Returns on eight of the ten S&P 500 economic sectors have been negative since the start of the year. The energy sector, which had the largest average returns over the past five years, has increased 0.89 percent year-to-date. Information Technology and Telecommunications, the worst performers between 1999 and 2004, have seen the largest decline so far (figure 7, top panel). The Wilshire 5000 and the German DAX had positive average returns of about 1 percent over the last five years. Japan’s Nikkei 225 and the U.K.’s FTSE both experienced negative annual returns on average. All four geographic indices have recorded a decrease year-to-date. The Wilshire 5000 is down 3.9 percent, Germany’s DAX fell 1 percent, Nikkei 225 dropped by 2.2 percent, and U.K.'s FTSE 100 declined 0.2 percent (figure 7, middle panel). The Russell 2000 Small-Cap index and the Russell Value index had positive average returns between 1999 and 2004, while the Russell Large-Cap and the Russell 1000 Growth experienced losses on average. All four Russell Style Index recorded a decrease year-to-date. The Russell 2000 Small-Cap Index fell by 6.2 percent. The Russell 1000 Value index is down 3.2 percent, the Russell Large-Cap Index 3.7 percent, and the Russell 1000 Growth 4.3 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 graphs the current and previous earnings forecasts for several calendar years in the top panel, and lists the current and previous growth of earnings forecasts for each S&P 500 sector in the two tables. Figure 10 shows three measures of historical and future valuation: historical PE ratios in the top panel, forward and

trailing PE ratios using analysts' estimates of operating earnings in the middle panel, and strategists’ two-year forecasts of earnings growth in the lower panel.

The rebound in earnings has caused price-earnings ratios to stabilize at values consistent with past observations for most S&P 500 economic sectors. The PE for the energy sector, despite recent price gains, has been cut from 39.5 to 13.95, due to strengthened earnings. The telecommunication sector has the highest PE ratio of 39.64 (figure 8, top panel). Over the last five years, earnings per share for the S&P 500 has increased an average of 6.3 percent per year, and operating earnings per share has increased 5.1 percent per year. Earnings for energy have been the strongest, while telecom saw the largest average annual decline in earnings. During 2003, the energy sector saw the biggest increase in both earnings and operating earnings per share, while health care had the biggest decline. As-reported earnings for the consumer cyclical sector increased 64.5 percent in 2003, but operating earnings declined 2.8 percent for the year. Overall, earnings per share increased 24.0 percent in 2003, and operating earnings per share increased 10.7 percent (figure 8, middle and lower panels). The analysts surveyed by Thomson Financial/First Call predict a 15.1 percent increase in earnings for the S&P 500 in the fourth quarter of 2004, and a 19.4 percent increase for calendar year 2004. The largest gains are expected to come from the materials and energy sectors, while the telecom sector is expected to show a collective loss. In the first quarter of 2005, earnings are projected to rise by 7.7 percent, with the materials and energy sectors being again the biggest contributors (figure 9). The macro projections from strategists for the growth of earnings for the Standard and Poor’s 500 index over the next two years have been revised upward to a positive 1.6 percent in the fourth quarter of 2004. The S&P 500 trailing price-earnings ratio decreased to 18.4 in the first quarter of 2005 from 18.9 in the fourth quarter of 2004. The 2005 first quarter forecast for the S&P 500 forward price-to-operating-earnings ratio, using bottom-up forecasts from analysts, is 16.6, down from 17 in the fourth quarter (figure 10). Breadth of the S&P 500 During 2003, prices rose from a year ago for 91.8 percent of stocks in the S&P 500, and in the third quarter of 2004 that trend continued, as 78.0 percent of S&P 500 stocks were above their third quarter 2003 levels (figure 11, middle panel). The price increases were consistent for both 2003 and the third quarter of this year, as the median price change for eight of ten deciles of companies rose (figure 11, top). The median

price earnings ratio for nine of the ten deciles remained flat during calendar year 2003 and three quarters of 2004. The median price earnings ratio for the top decile decreased slightly in 2003 and during the first two quarters of 2004, increasing again in the third quarter (figure 11, bottom). Comparative Returns The earnings-price ratio decreased to 5.1 percent in the fourth quarter of 2004 from 5.2 percent in the third quarter. The dividend-price ratio, an indication of the yield investors receive through dividends by holding stocks, decreased to 1.67 percent in the fourth quarter from 1.74 percent in the third quarter of 2004, remaining substantially below the bond rate (figure 12). As dividends have increased more rapidly than earnings, the operating profit payout rate for nonfinancial corporations has risen, from 41.4 in the second quarter of 2004 to 42.9 in the third quarter of 2004 (figure 13, lower panel). Moody's downgraded a high number and upgraded a small number of Investment Grade Securities in December. A greater number of Speculative Grade Securities were upgraded than downgraded (figure 15, top and middle panels). The default rate on junk bonds increased in December to 2.3 (figure 15, 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 Maria Giduskova for questions and comments at Maria.Giduskova@bos.frb.org, or by phone at (617) 973-3198.

08/01/2003 10/16/2003 01/02/2004 03/19/2004 06/04/2004 08/20/2004 11/04/2004 01/21/20055000

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millions of shares

Nasdaq Composite Price Index(left scale)

daily volume(right scale)

NYSE Composite Price Index(left scale)

50-day moving average 1200-day moving average 1

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

New York Stock Exchange

Nasdaq Stock Market

50-day moving average 1200-day moving average 1

daily volume(right scale)

Source: Bloomberg, L.P.

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NYSE Composite Price Index

9-day moving average 2

18-day moving average 2

Figure 2Moving Averages and Relative Strength

New York Stock Exchange

Source: Bloomberg, L.P.

08/02/2004 08/25/2004 09/20/2004 10/13/2004 11/05/2004 12/01/2004 12/27/2004 01/20/20050

20406080

100percentRelative Strength Index 3

Overbought

Oversold

Nasdaq CompositePrice Index

9-day moving average 2

18-day moving average 2

Nasdaq Stock Market

08/02/2004 08/25/2004 09/20/2004 10/13/2004 11/05/2004 12/01/2004 12/27/2004 01/20/20050

20406080

100percentRelative Strength Index 3

Overbought

Oversold

08/02/2004 08/30/2004 09/28/2004 10/26/2004 11/23/2004 12/22/2004 01/21/20056000

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New Highs(right scale)

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Overbought

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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

Source: Bloomberg, L.P.

08/02/2004 08/30/2004 09/28/2004 10/26/2004 11/23/2004 12/22/2004 01/21/20051700

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NASDAQ New Highs(right scale) NASDAQ

New Lows(right scale)

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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

Source: Bloomberg, L.P.

01/02/2004 02/20/2004 04/07/2004 05/25/2004 07/14/2004 08/30/2004 10/15/2004 12/02/2004 01/20/20050

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S&P100 Price Index(left scale)

VIX(right scale)

Figure 5Volatility 7

01/02/2004 02/20/2004 04/07/2004 05/25/2004 07/14/2004 08/30/2004 10/15/2004 12/02/2004 01/20/20051200

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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)

Source: Bloomberg, L.P.

Figure 6Put / Call Ratio

Jan:1997 Aug:1998 Mar:2000 Oct:2001 May:2003 Dec:2004700

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1600index price

0.2

0.3

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0.9ratio

Ratio for Individual Equity Options(right scale)

CBOE Index and Individual Equity Put/Call Ratios 10

Jan:1997 Aug:1998 Mar:2000 Oct:2001 May:2003 Dec:20040

1000

2000

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5000index price

0

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1

1.5

2

2.5

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4ratio

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

Jan:1997 Aug:1998 Mar:2000 Oct:2001 May:2003 Dec:2004700800900

1000110012001300140015001600index price

0.75

1

1.25

1.5

ratio

Ratio(right scale)

S&P 100 Price Index and Put/Call Ratios

Index Price(left scale)

Figure 7S&P 500 Economic Sectors - Index Returns

7.86.55.44.23.23.13.01.0

-11.2-14.0

-20 -15 -10 -5 0 5 100

Year-to-Date Performance (as of 01/21) of S&P 500 Economic Sectors

Energy

Telecommunications

Health Care

Industrials

Materials

Consumer Cyclicals

Utilities

Info Technology

Consumer Staples

Financials

percent

-6.2-3.2-3.7-4.3

-7 -6 -5 -4 -3 -2 -1 0 10

Year-to-Date Performance (as of 01/21)of Selected Russell Style Indexes

2000 Small-Cap

1000 Value

1000 Large-Cap

percent

0.89-3.26-1.22-4.12-2.67-5.140.16

-4.68-6.8

-6.41-8 -6 -4 -2 0 2 40

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

percent

1000 Growth

8.916.49

-0.12-6.94

-10 -5 0 5 100

5-Year Annualized Performance of Selected Russell Style Indexespercent

Year-to-Date Performance (as of 01/21)of Selected Geographical Indexes

5-Year Annualized Performance of Selected Geographical Indexes

-3.9-1.0-0.2-2.2

-5 -4 -3 -2 -1 0 10

FTSE 100, U.K.

Nikkei 225, Japan

DAX, Germany

percent

Wilshire 5000, U.S.1.100.98

-1.62-3.88

-5 -4 -3 -2 -1 0 1 20

percent

Source: Bloomberg, L.P.

Figure 8S&P 500 Economic Sectors - Earnings Growth

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

Energy

Materia

ls

Indus

trials

Cons C

yclic

al

Cons S

taples

Health

Care

Financ

ials

InfoT

ech

Teleco

m

Utilitie

s-30-20-10

010203040

0

5-YEAR 3-YEAR 1-YEAR

Energy

Materia

ls

Indus

trials

Cons C

yclica

l

Cons S

taples

Health

Care

Financ

ials

InfoT

ech

Teleco

m

Utilities

-40-20

020406080

100

0

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

5

10

15

20

25

30

S&P 500

0

2

4

6

8

10

12

(316.8)(316.8)

S&P 500

Energy

Materia

ls

Indus

trials

Cons C

yclic

als

Cons S

taples

Health

Care

Financ

ials

InfoT

ech

Teleco

m

Utilities

0

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20

30

40

50

60

70Q4 98Q4 00

Q4 02Q4 04

01/21/04

PE Ratios for S&P 500 Economic Sectors

(88.8)(88.8)

6/26/98 12/25/98 6/25/99 12/31/99 6/30/00 12/29/00 6/29/01 12/28/01 6/28/02 12/31/02 6/27/03 12/26/03 6/25/04 12/31/04-20

-10

0

10

20

30

Calendar Year 1999

Calendar Year 2000

Calendar Year 2001 Calendar Year 2002

Growth of Earnings - Quarterly Pattern

Growth of Earnings - Calendar Year

Figure 9S&P 500 Economic Sectors - Earnings Forecast

Source: Thomson Financial/First Call

S&P 500 Operating Earnings

(4-quarter percent change)

(4-quarter percent change)

(Year-over year percent change)

Calendar Year 2003

Calendar Year 2004 Calendar

Year 2005

SectorCurrent 04Q4

Dec-04 04Q4

Nov-04 04Q4

Oct-04 04Q4

Current 05Q1

Nov-04 05Q1

Oct-04 05Q1

Current 05Q2

Dec-04 05Q2

Nov-04 05Q2

Current 05Q3

Oct-04 05Q3

Consumer Cyclicals

7% 8% 10% 15% 4% 18% 19% 9% 8% 14% 20% 17%

Consumer Staples

8% 8% 8% 10% 8% 8% 9% 8% 9% 9% 10% 12%

Energy 72% 66% 58% 39% 17% 18% -2% -4% -2% -1% -5% -15%

Financials 9% 10% 11% 13% 0% 0% 1% 7% 7% 8% 20% 18%

Health Care

9% 9% 8% 13% 4% 8% 10% 8% 9% 9% 9% 14%

Industrials 13% 14% 14% 14% 15% 15% 13% 15% 15% 15% 20% 17%

Materials 70% 75% 75% 74% 41% 38% 36% 22% 19% 14% 19% 12%

Technology 15% 13% 15% 16% 14% 13% 15% 11% 10% 11% 10% 17%

Telecom 0% 1% 3% -7% 8% 3% -3% 8% 6% 3% 2% 6%

Utilities 3% 6% 7% 3% 8% 8% 10% 11% 14% 8% 19% 12%

Total 15.1% 15.0% 15.7% 15.5% 7.7% 9.3% 7.9% 8.1% 8.4% 8.8% 13.1% 12.3%

SectorCurrent04CY

Dec-0404CY

Sep-0404CY

Jul-0404CY

Apr-04 04CY

Jan-04 04CY

Current 05CY

Dec-04 05CY

Oct-04 05CY

Consumer Cyclicals 24% 24% 27% 27% 19% 18% 14% 15% 14%

Consumer Staples 10% 10% 11% 11% 9% 10% 10% 10% 11%

Energy 51% 47% 35% 21% -1% -15% -4% -4% -6%

Financials 12% 11% 14% 14% 13% 11% 11% 11% 12%

Health Care 10% 11% 13% 13% 13% 15% 9% 11% 12%

Industrials 19% 20% 20% 19% 15% 15% 18% 17% 17%

Materials 73% 84% 81% 72% 57% 49% 24% 22% 22%

Technology 43% 40% 40% 43% 37% 37% 13% 13% 13%

Telecom -9% -9% -14% -15% -9% -2% 5% 3% 1%

Utilities 0% 0% 2% 4% 2% 4% 13% 12% 12%

Total 19.4% 19.1% 19.1% 18.2% 14.2% 12.7% 10.5% 10.7% 10.6%

Price-Earnings Ratios

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

S&P500 Price-Operating Earnings Ratio

Source: Thomson Financial/First Call, Global Exchange (formerly DRI), Bloomberg L.P., Frank Russell Company, Haver Analytics

1968:Q1 1973:Q2 1978:Q3 1983:Q4 1989:Q1 1994:Q2 1999:Q3 2004:Q40

5

10

15

20

25

30

35

1968:Q1 1973:Q2 1978:Q3 1983:Q4 1989:Q1 1994:Q2 1999:Q3 2004:Q40

10

20

30

40

50

60

70

80

1968:Q1 1973:Q2 1978:Q3 1983:Q4 1989:Q1 1994:Q2 1999:Q3 2004:Q40

10

20

30

40

50

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0

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40

60

80

100

0

percent

S&P 500

S&P Smallcap 600

Russell 2000

Wilshire 5000

4-qtr Trailing Earnings

4-qtr Forward Earnings

Price-Earnings Ratio (left scale)

2 yr Growth of Earnings 11

(right scale)

PE Ratios and the Growth of EarningsFigure 10

Figure 11Breadth of the S&P 500

Source: Standard & Poor's Compustat 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001

0

20

40

60

80

100

120

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

2004Q1 Q2 Q3

1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001-100

-50

0

50

100

150

0

2004Q1 Q2 Q3

1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 20010

102030405060708090

100110

50

2004Q1 Q2 Q3

Figure 12Comparative Returns

1982:Q1 1985:Q2 1988:Q3 1991:Q4 1995:Q1 1998:Q2 2001:Q3 2004:Q40123456789

1011

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 1985:Q2 1988:Q3 1991:Q4 1995:Q1 1998:Q2 2001:Q3 2004:Q40

2

4

6

8

10

12

14

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 1985:Q2 1988:Q3 1991:Q4 1995:Q1 1998:Q2 2001:Q3 2004:Q4-60

-40

-20

0

20

40

60

80

100

120

0

percent

Source: Haver Analytics, FAME

Figure 13Dividend Yields

1960:Q1 1965:Q3 1971:Q1 1976:Q3 1982:Q1 1987:Q3 1993:Q1 1998:Q3 2004:Q10

2

4

6

8

10

12percent

Composite

Industrials

Dividend Yields for S&P 500 and Components

Utilities

Financials

Transports

1960:Q1 1965:Q3 1971:Q1 1976:Q3 1982:Q1 1987:Q3 1993:Q1 1998:Q3 2004:Q110

20

30

40

50

60

70

80percent

2.5

3

3.5

4

4.5

5

5.5

6percent

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

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

1958 1963 1968 1973 1978 1983 1988 1993 1998 20033456789

10111213percent

1958:Q1 1963:Q4 1969:Q3 1975:Q2 1981:Q1 1986:Q4 1992:Q3 1998:Q2 2004:Q123456789

101112

Profits of Nonfinancial Corporations(percent of GDP)

Tobin's q 14

Earnings Before Interest Payments

Profits

Figure 14Economic Measures of Equity Valuation

1952:Q1 1958:Q3 1965:Q1 1971:Q3 1978:Q1 1984:Q3 1991:Q1 1997:Q3 2004:Q10

0.5

1

1.5

2

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

2

Jul-98 Jun-99 May-00 Apr-01 Mar-02 Feb-03 Jan-04 Dec-040

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50

Upgrades(left scale)SP500 PE Ratio

(right scale)Downgrades(left scale)

$ billion

Jul-98 Jun-99 May-00 Apr-01 Mar-02 Feb-03 Jan-04 Dec-040

5

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15

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SP500 PE Ratio(right scale)

Default Rate(left scale)

percent

Jul-98 Jun-99 May-00 Apr-01 Mar-02 Feb-03 Jan-04 Dec-040

10

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Upgrades(left scale)

SP500 PE Ratio(right scale)

Downgrades(left scale)

$ billion

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

Figure 15Ratings 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

1987:Q1 1989:Q3 1992:Q1 1994:Q3 1997:Q1 1999:Q3 2002:Q1 2004:Q310

15

20

25

30

35

40

0.6

0.7

0.8

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1

1.1

1.2

1.3

1.4

1.5

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

1987:Q1 1989:Q3 1992:Q1 1994:Q3 1997:Q1 1999:Q3 2002:Q1 2004:Q30

50

100

Bonds

$ billions

Equity

1987:Q1 1989:Q3 1992:Q1 1994:Q3 1997:Q1 1999:Q3 2002:Q1 2004:Q30

10

20

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50

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0.2

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

VIX(left scale)

PE Ratio(left scale)

Figure 16Margin 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

1985:Q1 1988:Q2 1991:Q3 1994:Q4 1998:Q1 2001:Q2 2004:Q30

500

1000

1500

2000

2500

US Resident Holdings of Foreign Securities

Foreign Holdings of US Securities

$ billions

1985:Q1 1988:Q2 1991:Q3 1994:Q4 1998:Q1 2001:Q2 2004:Q35

6

7

8

9

10

11

0

500

1000

1500

2000

S&P 500(right scale)Foreign Holdings of U.S. Securities

(left scale)

percent

1985:Q1 1988:Q2 1991:Q3 1994:Q4 1998:Q1 2001:Q2 2004:Q30

5

10

15

60

80

100

120

140

160

180

200

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

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

percent

indexprice

indexprice

Figure 17Foreign 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

1985 1988 1991 1994 1997 2000 20030

20

40

60

80

100

1980:Q1 1983:Q3 1987:Q1 1990:Q3 1994:Q1 1997:Q3 2001:Q1 2004:Q30

20

40

60

80

100

Other

Households

State & Private Pension

InsuranceTrusts

percent

percent

Total 2 4 6 8 10

-10

0

10

20

30

40

50

60

0

Equity Bond Short-Term

NYSE

NASDAQ

percent

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 20011

2

3

4

5

6

7

8

9

10

Total Capital Gains

percent

Total Long-Term Capital Gains

Figure 18Demographics

Source: Haver Analytics, Survey of Consumer Finance, Flow of Funds Accounts

Capital Gains Relative to Personal Income

Distribution of Equity Ownership by Sector

NYSE's and Nasdaq's share of the Total Market

(by market value)

Households' Equity Ownershipby New Worth Decile

(percent of net worth)

Endnotes1. 50-Day, 200-Day Moving Average: Moving averages represent the average price

investors paid for securities over a historical period, and present a smoothedpicture of the price trends, eliminating the volatile daily movement. Because theselines offer a historical consensus entry point, chartists look to moving averagetrend lines of index prices to define levels of support or resistance in the market.When a chart trend is predominantly sideways (Figure 1, top chart), movingaverages and the underlying series frequently cross, but during a time ofprolonged increase or decrease (bottom chart) the daily prices of a securitytypically 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 bysecurities remaining above or below their 200-day moving average for prolongedperiods of time.

2. 9-Day, 18-Day Moving Averages: The 9-day and 18-day moving averages areoften used together to provide buy and sell signals. Buy signals are indicated bythe 9-day average crossing above the 18-day when both are in an uptrend. Thereverse, the 9-day crossing below the 18-day while both moving averages aredeclining is a sign to sell. However, this simple can often be misleading becauseof its dependence on trending markets and inability to capture quick market turns.

3. Relative Strength Index: This (RSI) momentum oscillator measures the velocityof directional price movements. When prices move rapidly upward they mayindicate an overbought condition, generally assumed to occur above 70 percent.Oversold conditions arise when prices drop quickly producing RSI readingsbelow 30 percent.

4. New Highs, New Lows: A straightforward breadth indicator, this is the 10-daymoving average of the number of stocks on a given index or exchange makingnew 52-week highs or lows each day. This indicator also demonstratesdivergence. If an index makes a new low, but the number of stocks in the indexmaking new lows declines, there is positive divergence, and in this case a lack ofdownside conviction. Conversely, In rising markets if an index makes a new highbut the number of individual stocks in that index making new highs does notincrease this suggests a false rally.

5. Overbought / Oversold Oscillator: This momentum indicator is calculated by takingthe 10-day moving average of the difference between the number of advancingand declining issues for a given index. The goal of the indicator is to showwhether an index is gaining or losing momentum, so the size of the moves aremore important than the level of the current reading. This is first affected by howthe oscillator changes each day, by dropping a value ten days ago, and adding onetoday. If the advance decline line read minus 300 ten days ago, and minus 100today, even though the market is down again, the oscillator will rise by 200because of the net difference of the exchanged days' values. This suggests a

trough, however, if today's reading was minus 500 it would demonstrate a gain indownside momentum.

The magnitude in moves is useful when compared with divergence to theindex price. If the Dow peaks at the same time the oscillator peaks in overboughtterritory, it suggests a top. If the index then makes a new high but the oscillatorfails to make a higher high, divergence is negative and momentum is declining. Ifthe index at this point declines and the oscillator moves into oversold territory itmay again be time to buy. If the index rises but does not make new highs, but theoscillator continues to rise above a previous overbought level, upside momentumexists to continue the rally.

6. Cumulative Advance / Decline Line: Referred to as market breadth, the indicator isthe cumulative total of advancing minus declining issues each day. When the linemakes new highs a rally is considered widespread, but when lagging a rally isseen as narrow.

7. Volatility: With regard to stock prices and stock index levels, volatility is a measure ofchanges in price expressed in percentage terms without regard to direction. Thismeans that a rise from 200 to 202 in one index is equal in volatility terms to a risefrom 100 to 101 in another index, because both changes are 1 percent. Also, a 1percent price rise is equal in volatility terms to a 1 percent price decline. Whilevolatility simply means movement, there are four ways to describe thismovement:

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 1993, measures theVolatility of the U.S. equity market. It provides investors with up-to-the-minutemarket estimates of expected volatility by using real-time OEX index optionbid/ask quotes. This index is calculated by taking a weighted average of theimplied volatilities of eight OEX calls and puts. The chosen options have anaverage time to maturity of 30 days. Consequently, the VIX is intended toindicate the implied volatility of 30-day index options. It is used by sometraders as a general indication of index option implied volatility. (Source: CBOE)

9. CBOE NASDAQ Volatility Index (VXN): Like the VIX, the VXN measures impliedvolatility, but in this case for NASDAQ 100 (NDX) index options, therebyrepresenting an intraday implied volatility of a hypothetical at-the-money NDXoption with thirty calendar days to expiration. Both the VXN and the VIX areused as sentiment indicators for the NASDAQ 100 and for the broader market,respectively. Higher readings and spikes generally occur during times of investorpanic and at times coincide with market bottoms. Low readings suggestcomplacency and often occur around tops in index prices.

10. Put / Call Ratio: These ratios are used as contrary sentiment indicators. Higher ratiovalues, indicating more put trading, is considered more bullish. The CBOE indexratio tracks trade volume of all exchange traded index options, reflectingsentiment of professional and institutional strategies. The CBOE equity ratio iscomposed of trade volume for individual equity options and a better indicator ofretail investor sentiment. Equity ratio readings 60/100 and 30/100 denote levelsof bullishness and bearishness. Similarly, bullish and bearish boundaries for theS&P 100 are 125/100 and 75/100.

11. 2-Year Growth of Earnings: Growth of earnings over subsequent 8 quarters. Currentobservations use forecast of earnings from macro projections.

12. Earnings and Dividend Price Ratios: These ratios represent an investor's yield fromearnings and dividend payments. Historically, the EP ratio often has exceeded thereal return on bonds, reflecting the greater risk to shareholders for choosing equityinvestments. Recently, the EP ratio has fallen below the return on bonds asinvestors demand uncharacteristically large capital gains to compensate for thelow earnings yield. Historically, the EP ratio has fallen below the real bond rateonly when earnings are expected to rise dramatically.

13. Real Bond Rate: Moody's composite yield of A-rated corporate bonds less theexpected rate of inflation over the next 10 years as measured by the consumerprice index from the Survey of Professional Forecasters, published by the FederalReserve Bank of Philadelphia.

14. Moody's Ratings: Denotes the change in dollar amount of investment grade (aboveBA1) or speculative grade (BA1 or below) securities outstanding for a particularcompany 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.

15. Investor Expectations: Internally generated composite of the Conference Board's12-month forward investor expectations for no change, increase, and decrease inthe stock market. Composite values of 50 indicate neutral expectations. Valuesbelow 50 demonstrate bearish sentiment, though the chart demonstrates that theoutlook of investors is typically bullish.

16. Tobin's q: The ratio of the market value of equity plus net interest bearing debt tocurrent value of land, inventories, equipment, and structures.