Morning Review - 081110

Nicholas Colas (Chief Market Strategist): 212 448 6095 or ncolas@convergex.
com
Christine Clark: 212 448 6085 or cclark@convergex.com
Beth Reed: 212 448 6096 or breed@convergex.com
On Tuesday stocks pared some of their morning losses after the Fed released the summary of its latest Morning Markets Briefing
FOMC meeting, but still ended the day in negative territory (S&P 500 –0.6%, Dow –0.5%, Nasdaq –
1.2%). As expected the Fed left interest rates unchanged near zero, but announced new steps to
Market Commentary: August 11th, 2010
lower borrowing costs amid a “more modest” economic recovery than previously expected. The
central bank will reinvest proceeds from its maturing mortgage bonds and buy additional government A snapshot of the markets through the
debt. The U.S. Labor Department reported that a bigger increase in hours worked than in output lens of ConvergEx.
resulted in a 0.9% quarterly drop in nonfarm productivity and put an end to 5 consecutive quarters of
growth. Labor costs rose 0.2% after 3 continuous quarters of declines.
Food Myths Debunked: Twinkies and their Ties to Inflation Expectations
Summary: All the talk about wheat shortages and the potential for spiking food prices led us to the question: how much do consumers “anchor” overall inflation
expectations on what they see in food inflation. Not much, as it turns out… Not any more, anyway. The correlation between consumer expectations of future inflation
(as measured by the University of Michigan’s monthly consumer survey) and CPI food inflation have been declining for +30 years. It looks to us like big box retailers,
membership clubs, and ever more efficient supermarket distribution have effectively given consumers so many options to “bob and weave” around food inflation that
they no longer use it to anchor overall inflationary expectations. Were the U.S .economy not so close to deflation, we would call this a good thing. But super-low interest
rates seem to point to a real risk of deflation, so we must put this datapoint in the “warning signs” bucket. It sure is getting crowded in there.
The humble Twinkie turned 80 this year, and it is safe to say that no other food has engendered more Internet myths than this humble crème filled yellow
sponge cake. Chief among them is that they stay “fresh” forever, housed in their cellophane sarcophagus and essentially mummified for eternity. Or until you get the
munchies, whichever comes first. Twinkies were even put in the U.S.’s millennium time capsule in 2000, with the clear implication that they will be just as delicious in
100 years when future generations open the collection of late 1900s memorabilia.
The truth is that Twinkies do have a longer-than-average shelf life, but only about 25 days. That’s better than most baked products because they do not have any
dairy-based ingredients. But hardly the +20 years that some sources claim. Other “Twinkie trivia”:
Market Commentary – Pages 1-5, Equities/Conferences & Earnings – Page 6, Fixed Income – Page 7, Options – Page 8, Exchange-Traded Funds/Indexes – Page 9, Social
Media & Internet Blogs Top Stories – Page 10
1
1
Nicholas Colas (Chief Market Strategist): 212 448 6095 or ncolas@convergex.com
• The original product was filled with a banana flavored filling, but the start of World War II made the tropical fruit hard to get, so the bakery substituted vanilla
flavoring.
• The ultimate symbol of American epicurean decadence, the fried Twinkie, was invented at the Texas State Fair.
• The original price was two for a nickel, back in 1930. Now you can buy 20 for $13 on Amazon and have them shipped to your door. That is $0.65 per Twinkie,
or 4.2% inflation over the intervening 80 years. That rate of change actually outstrips overall inflation. Such is the allure of the Twinkie…
That tie to inflation is also the touchstone for this note.
With the recent spike in wheat prices I wondered how much consumers use food prices to “anchor” their expectations for overall inflation in future. The linkage
is, at the very least, intuitive. Most consumers shop for food several times a week and make repeated purchases of the same products (milk, eggs, cereal, meat and the
like). That allows them to see prices rise and fall and may well set their expectations for inflation/deflation in other purchases they make less regularly. The Consumer
Price Index (CPI) allocates a 15% weighting for food purchases in the basket of good and services it uses to tracks inflation, and that percentage has changed very little
over the years. Since consumers come into contact with the volatility of this segment more often than most other transactions, it may “punch over its weight class” in
terms of impact on expected price increases in the system as whole.
To test the theory, we collected the price levels for the “food and beverage” category of the CPI and compared them to the University of Michigan’s “inflations
expectations” responses from their monthly survey of consumer confidence. We are trying to measure just how much consumers shift their belief in future inflation
as a result of what they pay at the Wal-Mart, Kroger, or Piggly Wiggly.
The answer, supported by the points below, is that food inflation has historically been a good indicator of how much overall inflation consumers think will occur
in the near future. This relationship, however, has declined considerably in the last 30 years, as the attached charts clearly show.
• The late 70s through the 1980s – a strong correlation of 81% between food prices and inflation expectations. If you grew up on TV dinners watching
Starsky and Hutch or The Love Boat, you heard a lot about food inflation from your parents. Everything seemed to cost more – food, gas, cars… And the data
through 1990 shows a very tight relationship between observed food inflation and what consumers told the University of Michigan survey takers about their
expectations for future inflation.
• 1990 – 2000. The food price/inflation expectations relationship weakens with a 61% correlation. There was plenty of inflation in the 1990s, but it was
primarily in asset prices. Tech stocks first soared, then crashed. The broad outlines of how consumers tie inflationary pressures with food prices still existed, but
only in the most general sense. There was, for example, a real bout of food inflation in 1996-97, but the Michigan survey takers didn’t see any of it in their data
about consumer expectations for future systematic price increases.
• 2001 – Present Day. Food/inflation expectations now only 34% correlated. Inflation expectations were in an uptrend for much the last decade, even as food
prices largely declined.
The conclusion we reach is that even if food prices do start to move higher, the impact on consumers’ perspectives on future inflation are not likely to follow
suit. You might wonder about the reasons for this slow disconnection between two factors that should be more closely linked. The simple reason for this could well be
that food distribution and sale is much more efficient now than in the 1980s or 1990s.
2
• The entry of big-box retailers/membership clubs and the consolidation of regional supermarkets over the past 10-15 years have transformed the way
food goes to market in the U.S. Yes, we saw the notice that Wal-Mart is “raising prices” in the press yesterday morning. We have seen the same headline
pretty much every 5-7 years, invariably on the way to lower prices.
• Consumers have more choices in terms of price points, serving quantities, and product variety. Even when prices do rise, they have more options to either
scale back (spend less) or scale over (buy in bulk or private brand). That lessens the impression that there is rampant food inflation.
There are probably other reasons, but you get the idea - something structural has clearly occurred, and nothing short of rampant food inflation is likely to really
shock the American consumer into thinking that overall price levels are set to rise. Follow that thread down one more level, and it points to a greater threat of
deflation. Food prices do tend to rise over time; remember our Twinkie example. If Americans have stopped thinking of rising food prices as an anchor for system-wide
inflation, then one more support for inflationary expectations seems to have eroded.
We are not ringing the alarm bell just yet, but this is something to watch. There are simply very few anchors to the inflation story. Housing (40% of the CPI)? Nope.
Food (15%)? Not so much, as we have just seen. That is over half the CPI right there. And if consumers are so inured to food price volatility that they feel safe ignoring it,
then deflationary consumer sentiment may be closer than at any point in the past 30 years.
3
Food Inflation vs Consumer Inflation Expectations: 1979-1989

14
14%
12
12%
10
10%
U Michigan
8
8%
CPI
6% 6
4% 4
2% 2
0% 0
Oct-87
Jul-82
Dec-81
Mar-87
Oct-80
Feb-83
May-81
Dec-88
Jun-85
Mar-80
Aug-79
Sep-83
Jul-89
May-88
Jan-79
Aug-86
Apr-84
Jan-86
Nov-84
CPI Food Y/Y Monthly % Change, NSA U Mich Inflation Expectations
Food Inflation vs Consumer Inflation Expectations: 2001-Jan 2010

8% 8
7
6% 6
5
U Michigan
4% 4
CPI
3
2% 2
1
0% 0
Jul-02
Jul-03
Jul-05
Jul-07
Jan-02
Jul-01
Jan-03
Jan-05
Jan-07
Jul-06
Jul-09
Jul-08
Jul-04
Jan-01
Jan-06
Jan-09
Jan-08
Jan-04
Jan-10
-1
-2% -2
CPI Food Y/Y Monthly % Change, NSA U Mich Inflation Expectations
4
5-Year Price Charts for Select Food Commodities
Corn Soybean
Wheat Rice
5
U.S. EQUITIES
Research company IT jumped 10.5% as it increased its 2010 earnings forecast, while FOSL added 7.9% to reach its highest ever intraday price after it
predicted Q3 profit would exceed analysts’ current estimates. RIMM added 1.1% after it got a reprieve from a threatened ban on BlackBerry services in
Saudi Arabia, and private equity firm KKR (-0.6%) cancelled plans for a $500 million public common offering that it had announced in May. Shares of
semiconductors faltered as Barclays downgraded INTC (-4.0%) and AMD (-8.0%) to “Equalweight” from “Overweight,” citing soft trend in the PC market.
NFLX gained 6.9% after reaching an agreement to have certain movies available to customers 3 months after they appear on pay television.
Important Earnings Today (with Estimates) From…

CSCO; $0.37 TK: $-0.05 S&P Futures
CSC: $0.90 Source: Bloomberg One Day (High –1124.00; Low – 1110.00):
M: $0.28
SRX: $0.33
Important Conferences/Corporate Meetings Today:

Canaccord Adams Global Growth Conference – Boston, MA
Citi ASEAN Investor Conference - Singapore
Jefferies Global Industrial and A&D Conference – New York, NY
Morgan Keegan Security and Defense Conference – New York, NY
Morgan Keegan Technology Conference – New York, NY
Oppenheimer & Co. Telecommunication, Media & Tech Conference – Boston, MA
Prior Day SPX (High – 1127.16; Low – 1111.58; Close – 1121.06): Three Day (High – 1126.75; Low – 1110.00):
Source: Thomson ONE

6
FIXED INCOME
The Treasury’s $34 billion 3-year note auction commanded strong demand, with the bid-to-cover ratio coming in at 3.31, the second highest since the
return of the 3-year securities to the market. The yield awarded was a record low 0.844%, more than one full basis point below the 1:00 bid. On the less
positive side, buyside interest was soft with dealers holding 44% of the notes, compared with an average of 38%. At 41%, foreign interest as measured
through indirect bidders was below the historical average of 47.6%. Wednesday the government will sell $24 billion of 10-year debt, followed by $16
billion in 30-year bonds on Thursday.
Source: Bloomberg Source: Bloomberg
Today’s Important Economic Indicators/Events:

MBA Purchase Applications
International Trade: $-42.5 billion
Treasury Budget: $-170.0 billion
7
U.S. EQUITY
OPTIONS
SPX – The index was negative in early trading prior to the FOMC Announcement, selling off as much as 1.4%. This extended the perceived state of risk that developed yesterday in implied
volatility, with the VIX rising during early trading today by as much as 9.5%. After the FOMC Announcement, the Index recovered some of its early losses, but failed to register any gains
on the day. This muted recovery from the early selloff was enough to reverse the early rise in the VIX, with it ending almost unchanged on the day. There was quite a bit of option
premium sold prior to the FMOC Announcement. The August 1025 and 1125 puts were sold outright several thousand times. There were also separate sellers of over 5,000 each August
1050/1125 and August 1100/1125 put spreads. The Sept 1110 calls were sold vs. buying the August 1120 calls, receiving a net $18.70 about 8,000 times. After the announcement, a trader
took advantage of the lower premium levels buying the September 1100/1150 strangle 2,500 times.
ETF – Many investors looked to sell premium ahead of the FOMC announcement. The biggest trade of the day occurred in XLF(Financials) where an investor sold over 50,000 Jan 9 puts
(57,000 traded on the day). In GLD one investor sold 14,000 Sep 100 Puts, while another investor sold Sep 117 Strangles (sell puts and sell calls) 4,000 times. Aside from the premium
sellers, significant trading occurred before the Fed announcement in EUO ( ProShares UltraShort Euro) which traded 15x the expected volume. The activity was led by call buyers in Aug 21
and Sep 21, with the volumes of roughly 2,500 and 13,000 contracts respectively - more than exceeding open interest in both lines. This spike in activity is perhaps a bullish sign for the
dollar as this fund tracks the inverse relationship of the daily performance of the dollar to euro price (in this case call buyers: positive on dollar, negative on euro).
CURRENT IMPLIED VOLATILITY / CURRENT HISTORICAL VOLATILITY

Rank 8/4/2010 8/5/2010 8/6/2010 8/9/2010 8/10/2010 30-Day Implied Vol
1 MIL Q ARG Q ARG 19.59
2 XTO ARG Q ARG Q 24.88 BIGGEST MOVERS
3 Q PTV PTV PTV PTV 50.39 Top 10 30-Day Implied Vol Bottom 10 30-Day Implied Vol
4 PTV NOVL NOVL NOVL NOVL 38.85
5 ARG CFN EL NU CFN 40.45
WY 556.96% 38.55 Q -78.58% 25.80
6 NOVL EL CFN CFN KR 25.62 PSA 146.15% 50.39 PBCT -59.02% 22.67
7 BIG KR MJN FLIR CRM 44.48 PBI 131.44% 32.85 PTV -51.50% 31.22
8 MJN SWN KR EL SWN 35.85
9 EL MJN FLIR KR MJN 32.81 PXD 108.28% 24.88 SWY -37.86% 23.19
10 CFN FLIR AMAT MJN LMT 19.30 STT 99.65% 22.17 RDC -36.15% 39.67
SAI AMAT SAI SAI PLL 32.90
PCLN 92.45% 28.50 SLE -35.48% 42.77
11
12 FLIR SAI SWN AMAT DE 33.42

13 PCS SJM SJM CPB AMAT 34.20 QLGC 89.76% 32.52 VAR -32.76% 24.68
14 SWN PLL FRX INTU EL 31.49 PLD 78.99% 32.90 TMK -31.67% 22.90
15 KR INTU MRK SWN INTU 25.93
16 AMAT AIG PLL SLE FLIR 27.74
NOV 76.63% 38.85 NU -30.82% 27.94
17 SLE MRK SLE CRM CPB 18.09 SYMC 72.09% 18.82 NSM -28.35% 34.02
18 TSN CLX CPB SJM RDC 38.35
19 FRX TGT INTU PLL LO 19.22
20 CPB TGT NSM NSM 32.83
21 AIG FRX TSN FRX STZ 22.17 We ranked the S&P 500 companies from the highest to lowest 30 day implied to
22 ROST NSM CRM MCK SLE 23.91 historical volatility ratio. Above we identify the 10 most positive and negative
23 SJM MCK NSM MDT CPWR 34.43 movers.
24 MRK SLE MCK RDC AAPL 27.89
25 CLX AZO CLX BIG 21.71 The table to the left represents the 25 highest 30 day implied to historical
PCLN CLX AZO CLX BIG volatility ratios within the S&P 500 companies. The green represents names
CAH MRK AIG TSN MDT new to the list while the red represents names that have fallen out.
PBI ROST TGT MCK
MCK PPL MRK MRK
FIS TSN NU
BIG FRX
MIL
8
Exchange-Traded Funds/Indexes
Prior Day Peformance of Largest ETFs by Assets S&P 500 Sector ETFs
Name (Net Assets*) Ticker Category Daily Return Sector Ticker 1-Day Perf YTD Perf Sector Ticker 1-Day Perf YTD Perf
SPDRs SPY Large Blend -0.55% Energy XLE -0.82% -2.81% Telecomm IYZ -0.53% 2.50%
SPDR Gold Shares GLD N/A 0.28% Health XLV 0.23% -3.89% Technology XLK -1.03% -3.18%
iShares MSCI Emerging Markets Index EEM Diversified Emerging Mkts -1.37% Industrials XLI -0.71% 10.83% Consumer Discretionary XLY -0.87% 7.69%
iShares MSCI EAFE Index EFA Foreign Large Blend -0.80% Utilities XLU 0.58% 0.84% Financials XLF -0.87% 2.29%
iShares S&P 500 Index IVV Large Blend -0.50% Consumer Staples XLP 0.22% 3.10% Materials XLB -1.07% -1.97%
Prior Day Top Volume ETFs Currency ETFs
Name Ticker Category Shares Traded Currency Ticker 1-Day Perf YTD Perf Currency Ticker 1-Day Perf YTD Perf
SPDRs SPY Large Blend 235,456,664 Australian Dollar FXA -0.38% 1.48% Mexican Peso FXM 0.37% 3.50%
PowerShares QQQ QQQQ Large Growth 72,537,121 British Pound Sterling FXB -0.39% -2.10% Swedish Krona FXS -0.97% -0.24%
iShares MSCI Emerging Markets Index EEM Diversified Emerging Mkts 68,718,502 Canadian Dollar FXC -0.55% 1.56% Swiss Franc FXF 0.08% -1.41%
Financial Select SPDR XLF Specialty - Financial 65,581,953 Euro FXE -0.33% -8.06% USD Index Bearish UDN -0.19% -4.50%
iShares Russell 2000 Index IWM Small Blend 58,621,757 Japanese Yen FXY 0.62% 8.82% USD Index Bullish UUP 0.21% 1.91%
Prior Day Top Performers VIX ETNs Fixed Income ETFs
Name Ticker Category Daily Return Name Ticker 1-Day Perf YTD Perf Bonds Ticker 1-Day Perf YTD Perf
ELEMENTS MLCX Biofuels Index TR ETN FUE N/A 8.55% iPath S&P 500 VIX VXX 1.04% -37.48% Aggregate AGG 0.17% 4.48%
Direxion Daily Semicondct Bear 3X Shares SOXS N/A 7.61% Short-Term Futures ETN Investment Grade LQD -0.13% 6.20%
Direxion Daily China Bear 3X Shares CZI Bear Market 5.91% High Yield HYG -0.03% 0.39%
UltraShort Semiconductor ProShares SSG Bear Market 5.75% iPath S&P 500 VIX VXZ 0.78% 9.53% 1-3 Year Treasuries SHY 0.05% 1.52%
Direxion Daily Small Cap Bear 3X Shares TZA Bear Market 5.53% Mid-Term Futures ETN 7-10 Year Treasuries IEF 0.51% 9.88%
20+ Year Treasuries TLT 0.21% 11.18%
Others
ETF Ticker 1-Day Perf YTD Perf ETF Ticker 1-Day Perf YTD Perf
Gold GLD 0.28% 9.71% Crude Oil USO -1.81% -8.68%
Silver SLV 0.11% 8.65% EAFE Index EFA -0.80% -3.44%
Natural Gas UNG -0.55% -27.98% Emerging Markets EEM -1.37% 0.53%
SPDRs SPY -0.55% 0.84%
Major Index Changes:

None
ETFs in the Headlines and Blogs:

Is the Dollar Bullish ETF Doomed? - http://seekingalpha.com/article/219723-is-the-dollar-bullish-etf-doomed
New ETFs: Emerging Market Debt, Smartphones - http://www.etftrends.com/2010/08/new-etfs-emerging-market-debt-smartphones/
9
Top Online Social Networking Stories
Latest Popular Digg.com Business Stories:

Why Public Employees Are the New Welfare Queens - http://www.tnr.com/blog/jonathan-cohn/76884/why-your-fireman-has-better-pension-you
How rich is rich? What would you need to feel wealthy? - http://www.cleveland.com/business/index.ssf/2010/08/how_rich_is_rich.html
Calculated Risk
NFIB: Small Business Optimism Declines - http://www.calculatedriskblog.com/2010/08/nfib-small-businesses-optimism-declines.html
REO Inventory including private-label RMBS - http://www.calculatedriskblog.com/2010/08/reo-inventory-including-private-label.html
Rail Traffic increases 4.1% in July compared to July 2009 - http://www.calculatedriskblog.com/2010/08/rail-traffic-increases-41-in-july.html
“Buy and Bail” Again - http://www.calculatedriskblog.com/2010/08/buy-and-bail-again.html
The Big Picture

The Rise of the Permabears? - http://www.ritholtz.com/blog/2010/08/the-rise-of-the-permabears/
Corporate Taxes as Percentage of GDP - http://www.ritholtz.com/blog/2010/08/tax-base-as-of-gdp/
Robert Reich’s Blog

The Jobs Emergency - http://robertreich.org/post/927885469/the-jobs-emergency
Greenspan, Rubin, and Herbert Hoover - http://robertreich.org/post/924181375/greenspan-rubin-and-herbert-hoover
Why the Views of the Wall Street Journal’s Letter Writers Are Far From This World - http://robertreich.org/post/915138887/why-the-views-of-the-wall-street-
journals-letter
The Becker-Posner Blog

Germany vs. US: Two Different Approaches to the Recession (Becker) - http://www.becker-posner-blog.com/2010/08/germany-vs-us-two-different-
approaches-to-the-recession-becker.html
German Employment (Posner) - http://www.becker-posner-blog.com/2010/08/german-employmentposner.html
Zero Hedge
US Productivity Falls for First Time Since 2008 as Labor Costs Increase Less Than Expected - http://www.zerohedge.com/article/us-productivity-falls-first-
time-2008-labor-costs-increase-less-expected
NFIB Survey Indicates Small Business Capitulates: “Owners Have No Confidence That Economic Policies Will ‘Fix’ The Economy” -
http://www.zerohedge.com/article/nfib-survey-indicates-small-business-capitulates-owners-have-no-confidence-economic-policies
Bespoke Investment Group

Down on Fed Day Mornings - http://www.bespokeinvest.com/thinkbig/2010/8/10/down-on-fed-day-mornings.html
10
GENERAL DISCLOSURES
This presentation discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions. It is
provided for general informational purposes only and should not be relied on for any other purpose. It is not, and is not intended to be, research, a
recommendation or investment advice, nor an offer to sell or the solicitation of offers to buy any BNY ConvergEx Execution Solutions LLC (“ConvergEx”)
product or service in any jurisdiction. It does not take into account the particular investment objectives, restrictions, tax and financial situations or other
needs of any specific client or potential client. Please consult with your financial and other advisors before buying or selling any securities or other
assets. This presentation is for qualified investors and NOT for retail investors.
Please be advised that options carry a high level of risk and are not suitable for all investors. To receive a copy of the Options Disclosure Document
please contact the ConvergEx Compliance Department at (800) 367-8998.
The opinions and information herein are current only as of the date appearing on the cover. ConvergEx has no obligation to provide any updates or
changes to such opinions or information. The economic and market assumptions and forecasts are subject to high levels of uncertainty that may affect
actual performance. Such assumptions and forecasts may prove untrue or inaccurate and should be viewed as merely representative of a broad range
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The opinions expressed in this presentation are those of various authors, and do not necessarily represent the opinions of ConvergEx or its affiliates.
This material has been prepared by ConvergEx and is not a product, nor does it express the views, of other departments or divisions of BNY ConvergEx
Group, LLC and its affiliates.
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Nicholas Colas (Chief Market Strategist): 212 448 6095 or ncolas@convergex.

Food Myths Debunked: Twinkies and their Ties to Inflation Expectations

That tie to inflation is also the touchstone for this note.

Food Inflation vs Consumer Inflation Expectations: 1979-1989

CPI Food Y/Y Monthly % Change, NSA U Mich Inflation Expectations

Food Inflation vs Consumer Inflation Expectations: 2001-Jan 2010

CPI Food Y/Y Monthly % Change, NSA U Mich Inflation Expectations

5-Year Price Charts for Select Food Commodities

Important Earnings Today (with Estimates) From…

Important Conferences/Corporate Meetings Today:

Source: Thomson ONE

Source: Bloomberg Source: Bloomberg

Today’s Important Economic Indicators/Events:

CURRENT IMPLIED VOLATILITY / CURRENT HISTORICAL VOLATILITY

12 FLIR SAI SWN AMAT DE 33.42

Major Index Changes:

ETFs in the Headlines and Blogs:

Top Online Social Networking Stories

Latest Popular Digg.com Business Stories:

The Big Picture

Robert Reich’s Blog

The Becker-Posner Blog

Bespoke Investment Group

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