June 21, 2006 Stock Market Report Market Analysis for Period Ending Friday, June 16, 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, June 16 at 7933.86, with a return of 2.3 percent year-to- date. The Index reached an all-time high of 8651.74 on May 9, 2006. The National Association of Securities Dealers Composite Index (Nasdaq Index) closed Friday, June 16 at 2129.95, with a loss of 3.4 percent since the beginning of 2006. The Index has dropped 10.2 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 June 16, the relative strength index for the NYSE Composite Index had a value of 41.46 percent, in neutral territory (figure 2, upper panel). The number of stocks making new 52-week highs tumbled in May and remains low, while the number of new lows has trended upward over the past several weeks (figure 3, upper panel). The middle panel shows that momentum (overbought/oversold oscillator) was mostly in oversold territory over the past six weeks. The gap between NYSE's Market Breadth indicator and Price Index narrowed towards the end of May before diverging a bit in early June (figure 3, bottom panel). The relative strength index for the Nasdaq Index had a value of 41.09 percent on June 16, in neutral territory (figure 2). The number of new highs fell in May, while the number of new lows rose. Since mid May, the number of new lows has outpaced the number of new highs (figure 4, upper panel). The momentum indicator is currently in oversold territory (figure 4, middle panel). The gap between Nasdaq's Market Breadth indicator and Price Index widened somewhat towards the end of May and in early June, but has recently narrowed (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 have risen over the past several weeks, suggesting that volatility has increased. Put/Call ratios appear in figure 6. Monthly data are shown from January 1997. The CBOE individual equity put/call ratio was 0.6 in May, at the border line of neutral and bullish territory. The S&P 100 put/call ratio rose to 1.25 in May, and moved into bullish territory in June. 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 June 16, eight of the ten S&P 500 economic sectors recorded positive returns year-to-date. The two exceptions were in the information technology and health care sectors. The information technology sector reported the lowest year-to-date return, at negative 6.1 percent and the health care sector was down 4.65 percent. The telecommunications sector, which had the lowest average return over the past five years, was leading on June 16 with a year-to-date return of 11.0 percent, followed by the industrials sector, with a return of 4.7 percent (figure 7, top panel). Two out of the four geographic indices recorded positive returns year-to-date. The Wilshire 5000 increased 0.6 percent, and Germany’s DAX was up by 0.6 percent. The U.K.'s FTSE 100 fell 0.4 percent, and Japan’s Nikkei 225 dropped 7.6 percent (figure 7, middle panel). Three out of the four Russell Style Indices recorded an increase year- to-date. The Russell 2000 Small-Cap Index rose 2.9 percent. The Russell 1000 Value Index increased 3.0 percent and the Russell Large- Cap Index was up by 0.4 percent. In contrast, the Russell 1000 Growth Index fell 2.4 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. The PE ratio for the energy sector was the lowest, at 10.1 on June 16. The consumer discretionary and information technology sectors currently have the highest PE ratios of 27.2 and 22.5, 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 has been revised slightly upward to 6.7 percent in the first quarter of 2006 (Figure 9). Breadth of the S&P 500 During the first quarter of 2006, 82.5 percent of stocks in the S&P 500 had price increases from a year ago (figure 10, middle panel). The year-on- year median price percent change was negative for three deciles in the first quarter 2006 (figure 10, top). The median price earnings ratio decreased across the board in the first quarter of 2006, especially for the bottom decile, which fell 32.0 percent. The median price earnings ratio remains above the historical average price earnings ratio of 14.4 for six deciles (figure 10, bottom). Comparative Returns The earnings-price ratio increased 5.7 percent in the first quarter of 2006, the same increase as seen in the fourth quarter of 2005. The dividend-price ratio, an indication of the yield investors receive through dividends by holding stocks, was 1.8 percent during the first quarter of 2006, in line with its rate during the fourth quarter (figure 11). The operating profit payout rate for nonfinancial corporations rose to 52.8 in the first quarter of 2006, from 25.3 in the fourth quarter of 2005. This compares to payout rates of 23.0, 37.2, and 42.8 in the third quarter, second quarter, and first quarter of 2005, respectively (figure 12, lower panel). Moody's downgraded a higher dollar amount of Investment Grade Securities and Speculative Grade Securities than it upgraded in May (figure 14, top and middle panels). The default rate on junk bonds decreased slightly to 4.0 percent in May, after rising to 4.1 percent in April (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. Figure 1 Daily Trends of Major U.S. Stock Exchanges New York Stock Exchange index price millions of shares 9000 4000 NYSE Composite Price Index 3500 200-day moving average 1 8500 (left scale) daily volume 50-day moving average 1 3000 (right scale) 2500 8000 2000 7500 1500 1000 7000 500 6500 0 01/05/05 03/22/05 06/06/05 08/18/05 11/01/05 01/18/06 04/03/06 06/16/06 Nasdaq Stock Market index price millions of shares 2400 4000 Nasdaq Composite Price Index 200-day moving average 1 (left scale) 3500 2300 daily volume 50-day moving average 1 (right scale) 3000 2200 2500 2100 2000 1500 2000 1000 1900 500 1800 0 01/05/05 03/22/05 06/06/05 08/18/05 11/01/05 01/18/06 04/03/06 06/16/06 Source: Bloomberg, L.P. Figure 2 Moving Averages and Relative Strength New York Stock Exchange index price 8800 8600 9-day moving average 2 8400 NYSE Composite Price Index 8200 8000 18-day moving average 2 7800 7600 Relative Strength Index 3 percent 100 80 Overbought 60 40 20 Oversold 0 01/05/06 02/15/06 03/28/06 05/08/06 06/16/06 Nasdaq Stock Market index price 2400 2350 9-day moving average 2 2300 2250 18-day moving average 2 2200 Nasdaq Composite 2150 Price Index 2100 2050 Relative Strength Index 3 percent 100 80 Overbought 60 40 20 Oversold 0 01/05/06 02/15/06 03/28/06 05/08/06 06/16/06 Source: Bloomberg, L.P. Figure 3 Index Breadth and Momentum Indicators - New York Stock Exchange New Highs and New Lows 4 index price number of stocks 8800 300 8600 New Highs 250 (right scale) 8400 200 8200 150 New Lows 8000 NYSE Composite price 100 (right scale) (left scale) 7800 50 7600 0 01/03/06 01/31/06 02/28/06 03/27/06 04/24/06 05/19/06 06/16/06 Momentum Oscillator 5 1000 1000 750 750 Overbought 500 500 250 250 0 0 -250 -250 -500 -500 Oversold -750 -750 -1000 -1000 01/03/06 01/31/06 02/28/06 03/27/06 04/24/06 05/19/06 06/16/06 Market Breadth 6 index price number of stocks 8800 130000 8600 NYSE Price Index (left scale) 125000 8400 8200 120000 8000 Cumulative Advances - Declines 115000 7800 (right scale) 7600 110000 01/03/06 01/31/06 02/28/06 03/27/06 04/24/06 05/19/06 06/16/06 Source: Bloomberg, L.P.