Morning Review - 083010 | Behavioral Economics | Exchange Traded Fund

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

Stocks rallied Friday, with the 3 major US indexes all up 1.7%, as Fed Chairman Ben Bernanke said the central bank is prepared to take necessary steps to help strengthen the recovery, though he offered little in terms of specific actions. The day’s economic data were mixed, with a rise in consumer sentiment and a downward revision in 2nd quarter GDP. The University of Michigan’s consumer sentiment index rose to 68.9 in its final August reading from 67.8 in July, though it fell short of expectations for 69.6. In the latest estimate, 2nd quarter GDP rose 1.6% on an annual basis, down from the previously reported 2.4% but ahead of the 13% economists had expected. A speech from St. Louis Fed President Bullard as well as the personal income/spending report are on deck for Monday.

Morning Markets Briefing
Market Commentary: August 30th, 2010 A snapshot of the markets through the lens of ConvergEx.

Still Just a Rat in a Cage
Summary: The financial turmoil of the last 2 years has given behavioral economics a leg up over the “Classical” version of the dismal science. Whether markets are efficient is debatable, but there is no doubt that humans regularly make irrational economic choices. Many of the bedrock concept of behavioral finance started life in a psychology lab with rats and monkeys as subjects, rather than humans. Today we review two studies – one old and one new – that highlight just how hard-wired the challenge of good investment decision-making might be. Rats, when trained to push a lever for food, will hammer away far longer if the rewards have been given after a random number of taps than a consistently required action. Monkeys, as it turns out from a recent Yale study, have the same trouble as humans in evaluating potential gains/losses in games of chance. Both studies should speak to human traders, where taking a loss in a random, trendless market is especially difficult – but critical to long term success. The “nature/nuture” debate in psychology is probably as old as any other existential question in human history. It appears everywhere from ancient Greek tragedy to Enlightenment period writings to pop culture today. Do humans act because of solely animal instincts, hard-wired into our psyche? Or can we learn to act more intelligently than our biology seems to demand? And which side of the fence is the dominant one in our lives? That’s not just the stuff of classroom debate anymore, thanks to the extraordinary events in financial markets of the last two years. Policymakers from Brussels to Washington to Beijing struggle with the question of how much freedom to give financial markets relative to just how well those institutions can possibly serve their nation’s society. The guiding light of post World War II economics, dubbed the “Classical” school, posited that free markets improve upon the irrational decisionmaking of any group of individuals by allowing the people with the “best” information to set the marginal price. Markets are therefore “efficient” – they set prices dispassionately with the best information available.

Market Commentary – Pages 1-2, Equities/Conferences & Earnings – Page 3, Fixed Income – Page 4, Options – Page 5, Exchange-Traded Funds/Indexes – Page 6, Social Media & Internet Blogs Top Stories – Page 7

1 1

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

There’s nothing like a crisis for upsetting conventional wisdom, and the last two years have put a real stick in the spokes of the Classical school. Now, behavioral economics is seeing a rising tide, since it incorporates human frailties into its explanation of economic decision-making and market behaviors. According to this school of thought humans – solely, or in groups - have many problems making sound, welfare-maximizing decisions. Proposed solutions range from “nudges” (making you “opt-out” of your company’s 401(k) plan, rather than “opt-in”) to much more forceful (carbon taxes to increase a country’s energy efficiency). Since the bedrock of behavioral economics is the belief that genetics drives much of our economic destiny, it should be no surprise that psych-lab experiments inform much of that discipline’s worldview. And it is not just human subject experiments that fill the catalog here; since we share a lot of our genetic code with animals like rats and primates, the academic literature is rich with efforts to tie animal behavior with that of human decision-making. Rats, it turns out, hang onto bad situations in exactly the same way as a trader with a losing position. B.F. Skinner, one of the founders of behavioral psychology, found he could develop a fairly complex decision-making process in lab rats using a food pellet as the ultimate reward. In one experiment he trained two groups of rats to push a lever to get some tasty rat-treats. One group had to push the lever a fixed number of times to get their reward. The other group’s lever was set to “random” – sometimes it took one push to get food, other times it took several rat-taps to receive the reward. Once trained, Skinner eliminated the food reward. The rats with a fixed number of taps quickly lost interest in the exercise. But the ones with the variable taps get jamming away on the lever, seemingly convinced that just a few more would get the desired result. Lest you think that rats just aren’t that bright, consider that more recent work with these animals shows that they actually “know what they don’t know” (see http://www.sciencedaily.com/releases/2007/03/070308121856.htm). It strikes me that traders could learn a bit from our friend the rat. Even losing positions go up some days, in pretty much the same way that a random number of taps on a lever look at a rat’s eye level. But that randomness makes us hold out hope that just a few more profitable days will put the position back in the black. In reality the market cares as much about your P&L as Skinner cared about his rats’ increasing frustration with their dry well of food pellets. More recently Yale researcher Laurie Santos has done some truly eye-opening economic research with monkeys. Turns out, it is pretty easy to get monkeys to use currency. They trade tokens for food quite readily – not amongst themselves, of course, but with human “salespeople.” When offered a choice of more food for the money, they tend to chose wisely and go for better deals. They also never save currency and will steal monkey-token money indiscriminately. Most importantly, monkeys seem to be wired for risk aversion. Behavioral psychologists have noticed that people are unwilling to take losses, preferring to take a risk for the chance of a breaking even result. Turns out monkeys do the same thing. See the whole video here – it’s entertaining as well as compelling: http://www.ted.com/talks/laurie_santos.html. So traders, beware… Taking a loss may well be hard-wired into your psychology. The breed of monkeys in the study noted above, Capuchins, split off from the human evolutionary path some 35 million years ago. Both the monkeys and humans, however, carry the same biases even though they have obviously taken different roads to get to the present day. The implications of much of the research behind behavioral economics - that humans are simply wired for suboptimal economic decision-making - also argues for regulation over free-market principles. It should be no surprise that this school of thought is getting more traction in the wake of the 2008 financial crisis. If societies regularly cycle between self-confidence (markets-based structures) and self-doubt (incremental regulation to curb perceived excess), then the behavioral branch of economics is well positioned for the current mood of many countries.

2

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

U.S. EQUITIES Shares of TIF (-3.2%) were down despite a solid earnings report that showed higher profit and an increase in same-store sales. The jeweler also raised its full-year outlook. Meanwhile, JCG dropped 7.2% after posting earnings outlooks for the 3rd quarter and full year that trailed analysts’ expectations. In M&A news, HPQ (-0.6%) raised its bid for PAR (+24.7%) to $30 a share from $18, trumping DELL’s (+1.2%) latest offer of $24.30 a share. Despite weaker demand for PCs, INTC (+1.1%) lowered its 3rd quarter revenue forecast to $10.8-$11.2 billion from its previous estimate of $11.2-$12.0 billion. BA (+3.0%) again delayed delivery of its first 737 Dreamliner by several weeks, though its shares were up on the day.
Important Earnings Today (with Estimates) From… DCI: $0.64 WINN: $0.13
Source: Bloomberg

S&P Futures
One Day (High –1063.75; Low – 1037.25):

Important Conferences/Corporate Meetings Today:
None

Prior Day SPX (High – 1065.21; Low – 1039.70; Close – 1):

Three Day (High – 1063.75; Low – 1037.00):

Source: Thomson ONE
3

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

FIXED INCOME Treasuries tumbled Friday, pushing 10-year note yields up the most since May after Fed Chairman Ben Bernanke said the central bank will do what is needed to stimulate the recovery. The benchmark 10-year note yield rose 17 bps intraday to 2.64%. Meanwhile, 2-year note yields had their biggest weekly gain since late April after touching a record low 0.4542% on August 24th. Last week’s 2-, 5- and 7-year debt auctions all drew record low yields as investors took refuge amid a flurry of weak economic data.

Source: Bloomberg

Source: Bloomberg

Today’s Important Economic Indicators/Events (with Consensus):
Personal Income and Outlays (8:30am EST) o Personal Income: 0.3% o Personal Consumption Expenditures: 0.3% o Core PCE Price Index: 1.4%

4

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

U.S. EQUITY OPTIONS SPX- Better than expected comments by the FED Friday morning triggered an initial sell off which brought the SPX down to 1040 level. However the market rebounded nicely finishing up +1.65% on what looked like buyers covering short positions as well as buyers of protection. After seeing sellers all week, we saw a what might be closing buyer of the Sep 1000/1075/1150 call fly 4,000 times as well as a closing seller of the Sep 1075 calls 5,000 times outright. An interesting trade to note was a buyer of the Nov 950/ Jan 900 / Mar 850 diagonal put fly 12,000 times, in which the Jan 900 puts were bought. Finally, we saw a buyer of the Nov 775 puts 5,000 times. ETF- Following an initial selloff, the market rallied higher over the course of the day to close up ~1.65%. Options trading was brisk as total volume exceeded expectations by 3 million contracts. US Natural Gas Fund, UNG, saw 3.6 times its usual volume with one investor selling 6,689 Sep 6 puts and a total of 65,327 Oct 6 puts being sold on the day. Traders in the fund are likely calling a bottom and looking for it to hold around the current levels in the weeks ahead. In Financial ETF, XLF, paper bought the Sep 13/14 strangle 15,000 times, while in GLD an investor sold volatility through the Oct 21 straddle 5,000 times delta neutral. Lastly in the VIX, one investor bought 10,000 Sep 32.5 puts vs. 28.10, while in a separate trade paper sold the Sep / Oct 30 call spread 6,500 times.
Rank
1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 1 7 1 8 1 9 20 21 22 23 24 25

8/23/2010
Q SCG ARG MKC NOVL FDO AMAT SBUX AAPL WIN FRX PLL KR MO LM WHR NRG HRB L AMZN NTRS PX MOLX LMT CPB LO STZ CTL APOL WMB MRK RDC SAI FTR HSY

CURRENT IMPLIED VOLATILITY / CURRENT HISTORICAL VOLATILITY 8/24/2010 8/25/2010 8/26/2010 8/27/2010 30-Day Implied Vol
Q ARG NOVL FDO CTL AAPL SBUX MO WIN FRX STZ AMAT KR PX PLL NSM LM WHR NKE MRK VLO LMT PM DIS LUV CPB MOLX NTRS AMZN L HRB NRG MKC SCG Q ARG NOVL FDO CTL FRX AAPL STZ PX MO WIN DIS LM KR LUV STR AMAT GS CPB VLO PM NSM NKE CAM TIF MRK WHR PLL SBUX Q ARG NOVL FDO FRX CTL PX LM C LMT CB TIF MO DIS BBT BMY NKE STZ HRB PLL WIN PNW PM BAC MRK CAM NSM VLO CPB GS AMAT STR LUV KR AAPL Q ARG NOVL FRX HRB FDO CTL BMY AAPL BAC MO NKE MSFT LM GS NVLS LMT STZ KR C AMAT MCK PX PM SAI MRK PNW WIN PLL BBT CB TIF DIS 34.17 19.86 46.37 35.33 36.85 30.61 14.01 24.03 31.60 35.46 16.53 25.19 26.19 39.54 31.12 36.22 20.67 26.28 26.93 36.58 33.96 26.60 22.59 20.72 27.53

BIGGEST MOVERS
Top 10 Q HRB ETR WY DNB FTR TDC AEE APOL CTXS 18.49% 17.00% 11.38% 8.64% 8.55% 7.44% 5.73% 5.15% 5.05% 4.87% 30-Day Implied Vol 34.17 36.85 24.01 36.63 21.15 23.99 37.54 26.38 48.75 38.49 Bottom PNW FIS TIF BRK/B OXY NBL TMK USB NU BIG 10 -26.59% -25.50% -22.87% -19.49% -18.22% -17.79% -16.32% -16.29% -15.94% -15.76% 30-Day Implied Vol 22.01 18.94 35.03 22.92 29.79 30.56 28.77 30.04 20.51 31.01

We ranked the S&P 500 companies from the highest to lowest 30 day implied to historical volatility ratio. Above we identify the 10 most positive and negative movers. The table to the left represents the 25 highest 30 day implied to historical volatility ratios within the S&P 500 companies. The green represents names new to the list while the red represents names that have fallen out.

5

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

Exchange-Traded Funds/Indexes
Prior Day Peformance of Largest ETFs by Assets
Name (Net Assets*) Ticker Category Daily Return Sector Ticker 1-Day Perf

S&P 500 Sector ETFs
YTD Perf Sector Ticker 1-Day Perf YTD Perf

SPDRs SPDR Gold Shares iShares MSCI Emerging Markets Index iShares MSCI EAFE Index iShares S&P 500 Index
Name

SPY GLD EEM EFA IVV

Large Blend N/A Diversified Emerging Mkts Foreign Large Blend Large Blend

1.55% -0.07% 2.20% 1.96% 1.53%
Shares Traded

Energy Health Industrials Utilities Consumer Staples
Currency

XLE XLV XLI XLU XLP

2.60% 0.95% 2.06% 1.90% 0.64%

-8.61% -8.11% 3.45% 0.39% 0.83%
YTD Perf

Telecomm Technology Consumer Discretionary Financials Materials
Currency

IYZ XLK XLY XLF XLB

0.95% 1.20% 1.62% 2.16% 3.05%

0.45% -8.29% 3.09% -4.65% -4.88%

Prior Day Top Volume ETFs
Ticker Category Ticker 1-Day Perf

Currency ETFs
Ticker 1-Day Perf YTD Perf

SPDRs PowerShares QQQ iShares MSCI Emerging Markets Index Financial Select SPDR iShares Russell 2000 Index
Name

SPY QQQQ EEM XLF IWM

Large Blend Large Growth Diversified Emerging Mkts Specialty - Financial Small Blend

220,444,584 91,354,147 73,332,562 68,314,279 67,747,605
Daily Return

Australian Dollar British Pound Sterling Canadian Dollar Euro Japanese Yen
Name

FXA FXB FXC FXE FXY

1.30% -0.15% 0.38% 0.03% -1.10%

0.12% -4.18% -0.38% -11.21% 8.80%
YTD Perf

Mexican Peso Swedish Krona Swiss Franc USD Index Bearish USD Index Bullish
Bonds

FXM FXS FXF UDN UUP

0.12% 0.55% -0.63% -0.16% 0.17%

0.11% -2.84% 0.32% -6.50% 4.29%

Prior Day Top Performers
Ticker Category

VIX ETNs
Ticker 1-Day Perf

Fixed Income ETFs
Ticker 1-Day Perf YTD Perf

PowerShares DB 3x Short 25+ Year Treas Bond Direxion Daily Latin America Bull 3X Shares Direxion Daily 30 Yr Treas Bear 3X Shares ProShares UltraPro Russell2000 Direxion Daily Small Cap Bull 3X Shares

SBND LBJ TMV URTY TNA

N/A Latin America Stock Bear Market Small Blend Small Blend

10.03% 9.23% 8.96% 8.07% 7.92%

iPath S&P 500 VIX VXX Short-Term Futures ETN iPath S&P 500 VIX VXZ Mid-Term Futures ETN

-6.11%

-36.89%

-3.39%

17.33%

Aggregate Investment Grade High Yield 1-3 Year Treasuries 7-10 Year Treasuries 20+ Year Treasuries
ETF

AGG LQD HYG SHY IEF TLT

-0.51% -0.90% -0.01% -0.07% -1.21% -2.83%

4.84% 7.43% -0.91% 1.51% 10.61% 17.20%

Others
ETF Ticker 1-Day Perf YTD Perf Ticker 1-Day Perf YTD Perf

Gold Silver Natural Gas

GLD SLV UNG

-0.07% 0.59% -3.26%

12.77% 13.07% -38.10%

Crude Oil EAFE Index Emerging Markets SPDRs

USO EFA EEM SPY

2.91% 1.96% 2.20% 1.55%

-14.54% -8.61% -2.43% -4.11%

Major Index Changes:
None

ETFs in the Headlines and Blogs:
Gold ETFs Mushroom in India - http://www.moneycontrol.com/news/business/gold-etfs-mushroomindia_481348.html Dividend ETFs Take Divergent Paths - http://www.thestreet.com/story/10844718/1/dividend-etfs-take-divergent-paths.html?cm_ven=GOOGLEN

6

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

Top Online Social Networking Stories
Latest Popular Digg.com Business Stories: Facebook now ‘worth $33 billion’ - http://www.telegraph.co.uk/technology/facebook/7963608/Facebook-now-worth-33-billion.html Treating Customers as Online Equals Boosts Business, Research Finds - http://www.sciencedaily.com/releases/2010/08/100824082226.htm Aisle by Aisle, an App That Pushes Bargains - http://www.nytimes.com/2010/08/17/technology/17app.html?_r=3&scp=1&sq=shopkick&st=cse Calculated Risk Bernanke: The Economic Outlook and Monetary Policy - http://www.calculatedriskblog.com/2010/08/bernanke-economic-outlook-and-monetary.html Analysis: Bernanke paves the way for QE2 - http://www.calculatedriskblog.com/2010/08/analysis-bernanke-paves-way-for-qe2.html Q2 real GDP revised down to 1.6% annualized growth rate - http://www.calculatedriskblog.com/2010/08/q2-real-gdp-revised-down-to-16.html Are lenders “procrastinating” on foreclosures? - http://www.calculatedriskblog.com/2010/08/are-lenders-procrastinating-on.html The Big Picture History of US Interest Rates: 1790-Present - http://www.ritholtz.com/blog/2010/08/history-of-us-interest-rates-1790-present/ No One Left to Sell CDOs To? Sell to Yourself! - http://www.ritholtz.com/blog/2010/08/no-one-left-to-sell-cdos-to-sell-to-yourself/ Google Trends – A fresh look at search frequency - http://www.ritholtz.com/blog/2010/08/google-trends-a-fresh-look-at-search-frequency/ Weakonomics What Fat Ladies in Bikinis Taught Me About Investing - http://weakonomics.com/2010/08/25/what-fat-ladies-in-bikinis-taught-me-about-investing/ Bespoke Investment Group Bullish Sentiment Drops to Lowest Levels Since March 2009 - http://www.bespokeinvest.com/thinkbig/2010/8/27/bullish-sentiment-drops-to-lowest-levelssince-march-2009.html Robert Reich’s Blog Why Boehner’s Blaming Bureaucrats - http://robertreich.org/post/1016548049/why-boehners-blaming-bureaucrats The Two Stories of This Terrible economy, Yet Obama and the Dems Won’t Tell Theirs - http://robertreich.org/post/1020104902/the-two-stories-of-thisterrible-economy-yet-obama-and The Baseline Scenario Democracy in America - http://baselinescenario.com/2010/08/26/democracy-in-america/#comments

7

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

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, as it does not constitute substantive research or analysis, 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. In addition, the information is not intended to provide sufficient basis on which to make an investment decision. 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 of possibilities. They are subject to significant revision and may change materially as market, economic, political and other conditions change. Past performance is not indicative of future results, which may vary significantly. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed, and a loss of principal may occur. The information and statements provided herein do not provide any assurance or guarantee as to returns that may be realized from investments in any securities or other assets. This material does not purport to contain all of the information that an interested party may desire and, in fact, provides only a limited view of a particular market. 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.

8

Sign up to vote on this title
UsefulNot useful