David A.

Rosenberg May 12, 2010

Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

DUE TO BUSINESS TRAVEL, THE NEXT RELEASE OF BREAKFAST WITH DAVE
WILL BE ON THURSDAY, MAY 20 IN THIS ISSUE
• While you were sleeping:
WHILE YOU WERE SLEEPING little action in global
markets overnight; gold is
Little action in global markets overnight: Asian equities were soft — off 0.2% and
making new highs;
now down in seven of the past eight sessions. Emerging markets fell 0.5% — the Canadian dollar going for
Shanghai index ended the day unchanged (but is 22% below its nearby peak). par again; weak GDP
European equities are broadly higher, however, on the back of improved numbers out of Germany
earnings results. and France
• Bazooka bust: take a read
Gold is making new highs — helped today with a slightly softer tone to the of the article on page 2 of
greenback. The Canadian dollar is staging a rebound and looks set to challenge yesterday’s FT — Blast of
par again and is firming against a slate of other global currencies (it is back in Relief as Bazooka Finds its
overvalued terrain, however). U.S. Treasuries are a tad on the defensive side Target
ahead of today’s $24 billion 10-year Treasury note auction. Banking sector • Gold glitters: gold is no
stress is still evident in Libor-OIS spreads (19bps) and the TED spread (27bps). longer trading just as part
of the resource sector but
On the data front, the best the German economy could do in Q1 was eke out a is now taking on the
meagre 0.2% advance and in France it was +0.1%. Ho hum. characteristics of a
currency
BAZOOKA BUST • Good news, bad news.
It was almost comical to read this headline yesterday on page 2 of the FT — The good news, U.S. small
business sentiment is at
Blast of Relief as Bazooka Finds its Target. The word “bazooka”, in this context,
its best level since
was coined by former Treasury Secretary Hank Paulson back on July 15, 2008 to September 2008; the bad
describe his weaponry to safeguard Fannie and Freddie. The stock market news, at the current level
rallied that day by over 1%, to 1,215 on the S&P 500, and the short-covering it is still below the trough
rally took the index above 1,300 by early August. Little did anyone know that we of the previous three
had almost 50% to go on the downside before the interim lows were turned in. recessions
Beware of bazookas; they don’t always work. • It is still deflation:
throwing good money
Speaking of the GSEs, it really is so encouraging to see that a week after Freddie after bad, as the world’s
went cap-in-hand to the Treasury for a $10.6 billion cash infusion, Fannie had to governments are busy
doing, does not create
go begging for $8.4 billion to cover its burgeoning losses. These two wards of
inflation
the state have now drained $148bln of aid out of taxpayer pocketbooks since
the mid-2008 bailout (the size of the entire deficit before the recession began). • More labour angst in the
U.S. than meets the eye
And what a housing mess it still is — Fannie reported that its delinquency rate • U.S. home prices at risk
still rose to 5.47% in Q1 from 5.38% the quarter before. What is happening now
is that a growing number of people who can in fact pay their mortgage have
stopped making their payments out of “anger” — according to a disturbing article
that showed up on page A4 of yesterday’s WSJ (Emotion Drives Many Defaults).

Please see important disclosures at the end of this document.

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms. Founded in 1984 and focused primarily on high net
worth private clients, we are dedicated to meeting the needs of our clients by delivering strong, risk-adjusted returns together with the highest
level of personalized client service. For more information or to subscribe to Gluskin Sheff economic reports, visit www.gluskinsheff.com
May 12, 2010 – BREAKFAST WITH DAVE

Why it’s disturbing is that it cites research showing that 12% of mortgage
defaults are now “strategic” and that somehow this is now okay on our What happened during this
increasingly hedonistic society. In fact, a law professor is quoted as lamenting recent round of intense
why people are “throwing their money away on a home in which they may never European-led volatility and
have equity.” Wow. Look how far we have progressed. We used to be told “why financial market weakness
throw your money away on rent? Why don't you own?” Now it’s “why throw your was that gold rallied even in
money away on a house?" Maybe because you signed a contract — now why U.S. dollar terms
should that matter.

You really can’t make this stuff up.

GOLD GLITTERS
In the aftermath of the Lehman collapse, gold faltered as there was a huge
margin call everywhere and investors seeking liquidity sold off their winners.
The secular bull market for bullion did not end at the time, no long-term
trendline was violated, and gold did rise in non-U.S. dollars and far outperformed
other currencies. But what happened during this recent round of intense
European-led volatility and financial market weakness was that gold rallied even
in U.S. dollar terms, which is significant seeing as there were large-scale safe-
haven inflows into greenbacks. So this time, gold has managed to hit new highs
in all currencies, and gold rallied even with the overall commodity complex
slipping noticeably over the past few weeks.

This is a sign. Of what, you may ask? That gold is no longer trading just as part of
the resource sector but is now taking on the characteristics of a currency. While
the U.S. dollar has gained ground since late last year, there is no doubt that an
Administration that has a stated policy of doubling exports in the next five years to
“support” two million jobs absolutely craves a depreciating greenback.

Meanwhile, a new socialist government in Japan wants a weaker yen. Sterling

has only one way to go in an environment of heightened political uncertainty and
a balance sheet that is at least as extended as Greece. And the ECB just gave Gold is no longer trading just
notice with its agreement to buy sovereign and corporate debt that it is willing to as part of the resource
distort the pricing of risk in the bond market for the greater good of helping sector but is now taking on
profligate countries to avoid either defaulting or certainly help them finance their the characteristics of a
obligations at a subsidized cost. The Bundesbank, this is not. currency

So gold is no government’s liability and the shape and shift in its supply curve is
the shape would seem to be a little easier to make out than fiat currency. We
may end up being overly conservative on our peak gold price forecast of $3,000
an ounce.

GOOD NEWS, BAD NEWS

The good news is that we saw a thaw in the National Federation of Independent
Business (NFIB) small business diffusion index in April, to 90.6 from 86.8. That
is the best level since September 2008. Good stuff.

Page 2 of 8
May 12, 2010 – BREAKFAST WITH DAVE

CHART 1: TODAY’S LEVEL IN SMALL BUSINESS SENTIMENT IS STILL

LOWER THAN THE BOTTOM OF THE THREE PREVIOUS RECESSIONS
United States: National Federation of Independent Business Small Business
Optimism Index
(percent)

110

105

100

95

90

85

80
85 90 95 00 05

Shaded region represent periods of U.S. recession.

Source: Haver Analytics, Gluskin Sheff

Alas, despite tremendous government stimulus, the current level of 90.6 is still
lower than the low we saw at the depths of the 2001, 1990 and 1981/82
recessions. In addition, the current level of the NFIB small business optimism We welcome any good news
index is still below the average of the recessions going back to 1975; the and the recent pop in the
average during recessions is 92.0. And, at 90.6, it is nowhere near what is NFIB index is a move in the
right direction. But the NFIB
deemed as an expansion (average during expansions is 100.2) or even the end
index, based on our
of a recession (average at the end of the recession is 96.9).
simulations, is consistent
with real GDP growth of 0%
We welcome any good news and the recent pop in the NFIB index is a move in
the right direction. But the NFIB index, based on our simulations, is consistent
with real GDP growth of 0%. We reiterate that outside of the lagged impact of
the bailout, fiscal and monetary stimulus, together with the arithmetic bounce
from the inventory component of the GDP accounts, the U.S. economy is still
contracting. The contraction in State and local government spending,
commercial construction and even housing three years into its meltdown are all
posing significant drags on the pace of overall economic activity.

Consumers only seem to be able to spend on the back of recurring government

handouts and subsidies and the export picture has all of a sudden become
muddled as the Eurozone economy will soon be contracting again on the back of
dramatic fiscal austerity in at least 15% of the region. Capex is really the only
bright spot but unfortunately it only comprises 6.5% of GDP.

To be sure, the coincident economic indicators have quite been firm, but the
leading indicators have already peaked out and rolled over. A second half
growth relapse similar to what we saw in 2002 cannot be ruled out — and the
market is as much priced for this prospect today as it was back then.

Page 3 of 8
May 12, 2010 – BREAKFAST WITH DAVE

We’ve said it before and we shall say it again, real final sales since output
bottomed in Q2 of last year has averaged a mere 1.38% at an annual rate. It By maintaining a policy of
does not get weaker than that in the context of a post-recession recovery. So, ensuring that risk assets get
remove the inventory contribution and the V-shaped bounce in the economy is mis-priced and that capital
nothing more than an illusion. gets mis-allocated, it is more
likely that deflation
IT’S STILL DEFLATION pressures will intensify
Throwing good money after bad, as the world’s governments are busy doing (this
will cost Ms. Merkel her job) does not create inflation. By maintaining a policy of
ensuring that risk assets get mis-priced and that capital gets mis-allocated, it is
more likely that deflation pressures will intensify.

If you haven’t noticed, real M2 is down YoY now for the first time in 15 years. A
reconstituted real M3 is deflating now YoY for the first time in 50 years.

Wake us up in 2015 when the inflation comes.

MORE LABOUR ANGST THAN MEETS THE EYE

The U.S. ADP survey showed only 32k private sector jobs being created with the
key small business sector stagnating. Moreover, the four-week moving average
in initial jobless claims have been stuck around 460k now since late February —
claims have basically stopped falling and are still nowhere near levels in the
past that were consistent with sustained job creation.

CHART 2: YOU CALL THIS LABOUR MARKET IMPROVEMENT?

United States: National Federation of Independent Business Small Business
Survey: Percentage of Firms with One or More Jobs Open
(percent)

35

30

25

20

15

10

5
85 90 95 00 05

Shaded region represent periods of U.S. recession.

Source: Haver Analytics, Gluskin Sheff

Page 4 of 8
May 12, 2010 – BREAKFAST WITH DAVE

The labour force is only going up because benefits are starting to expire after 99
weeks on the dole. The really important, and unnoticed, data-point last Friday The U.S. labour force is only
was the 255k bulge in the ranks of the unemployed — and there are still 5.6 of going up because benefits
them vying for each job opening, a competitive pressure that is forcing the trend are starting to expire after
in wages down to historic lows. Governments around the world are in clear 99 weeks on the dole
bailout mode but as we saw in the 1930s, and again in Japan since its credit
collapse began in 1990, waging war against deflationary forces is no easy task.

CHART 3: YOU CALL THIS LABOUR MARKET IMPROVEMENT?

United States: Job Openings and Labor Turnover Survey (JOLTS): Job Openings
(thousands)

5250

4500

3750

3000

2250
00 01 02 03 04 05 06 07 08 09

Shaded region represent periods of U.S. recession.

Source: Haver Analytics, Gluskin Sheff

CHART 4: STILL NEARLY SIX UNEMPLOYED COMPETING

FOR EVERY JOB OPENING …
United States: Total Number of Unemployed/Total Number of Job Openings
(ratio)

1
00 01 02 03 04 05 06 07 08 09

Shaded region represent periods of U.S. recession.

Source: Haver Analytics, Gluskin Sheff

Page 5 of 8
May 12, 2010 – BREAKFAST WITH DAVE

CHART 5: … WHICH IS WHY WAGE RATES ARE DECLINING

United States: Average Hourly Earnings: Total Private Industries
(year-over-year percent change)

4.0

3.6

3.2

2.8

2.4

2.0

1.6
07 08 09

Source: Haver Analytics, Gluskin Sheff

HOME PRICES AT RISK

I had the pleasure of debating Jim Paulsen yesterday at a Club X conference in
Montreal. During his presentation, I found a snippet in one of his slides needed
to be updated — U.S. home prices are up eight months in a row. Indeed, this is
what most investors want to believe, like how they wanted to believe in the tech
bubble and how they wanted to believe in the credit bubble. Illusions are one
thing, reality is another, and it’s the latter that bites in the end.

Home prices WERE up eight months in a row, until the Case-Shiller 20-city index
decided to take a 0.1% MoM (seasonally adjusted) dip in March. And, on a raw
basis, prices were down 0.9% on the month and have actually been deflating
now each of the past five months (raw as in not seasonally adjusted — and the
CS officials have confirmed that the seasonal factors did give an upward skew to
the data in prior months).

The LoanPerformance national home price index is also down now for three
months running. The FHFA home prices series is also down three months in a
row. And, the total unsold housing inventory, when accurately calculated, is
running between 16 and 21 months’ supply, and it is this imbalance that is still
exerting downward pressure on residential real estate valuation in the U.S. If we
end up truly reverting to the mean this cycle, in classic Bob Farrell Rule #1
fashion, then there is 20% downside potential to home prices from here.

We had said that the two biggest risks to Mr. Market’s nirvana view of the world
was a reversal in both the unemployment rate and home values … and the latest
data do suggest that this is on track.

Page 6 of 8
May 12, 2010 – BREAKFAST WITH DAVE

Gluskin Sheff at a Glance

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms.
Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to the
prudent stewardship of our clients’ wealth through the delivery of strong, risk-adjusted
investment returns together with the highest level of personalized client service.

OVERVIEW INVESTMENT STRATEGY & TEAM

As of March 31, 2010, the Firm managed
assets of $5.6 billion.
Gluskin Sheff became a publicly traded
corporation on the Toronto Stock
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remains 54% owned by its senior
management and employees. We have
public company accountability and
governance with a private company
commitment to innovation and service.
Our investment interests are directly
aligned with those of our clients, as
Gluskin Sheff’s management and
employees are collectively the largest
client of the Firm’s investment portfolios. shareholder-minded management and a
We offer a diverse platform of investment
strategies (Canadian and U.S. equities,
Alternative and Fixed Income) and
investment styles (Value, Growth and
1 31, 2010 versus $5.7
Income).
The minimum investment required to
establish a client relationship with the
Firm is $3 million for Canadian investors
and $5 million for U.S. & International
investors.
PERFORMANCE
$1 million invested in our Canadian Value which we have the highest conviction.
Portfolio in 1991 (its inception date)
would have grown to $11.7 million on
2
We have strong and stable portfolio
management, research and client service
teams. Aside from recent additions, our Our investment
Portfolio Managers have been with the interests are directly
Firm for a minimum of ten years and we
aligned with those of
have attracted “best in class” talent at all
our clients, as Gluskin
levels. Our performance results are those
Sheff’s management and
of the team in place.
employees are
We have a strong history of insightful collectively the largest
bottom-up security selection based on client of the Firm’s
fundamental analysis.
investment portfolios.
For long equities, we look for companies
with a history of long-term growth and
stability, a proven track record,
$1 million invested in our
Canadian Value Portfolio
share price below our estimate of intrinsic
in 1991 (its inception
value. We look for the opposite in
date) would have grown to
equities that we sell short.
$11.7 million2 on March
For corporate bonds, we look for issuers
with a margin of safety for the payment
million for the S&P/TSX
of interest and principal, and yields which
Total Return Index over
are attractive relative to the assessed
the same period.
credit risks involved.
We assemble concentrated portfolios —
our top ten holdings typically represent
between 25% to 45% of a portfolio. In this
way, clients benefit from the ideas in
Our success has often been linked to our

long history of investing in under-

March 31, 2010 versus $5.7 million for the
followed and under-appreciated small
S&P/TSX Total Return Index over the
and mid cap companies both in Canada
same period.
and the U.S.
$1 million usd invested in our U.S.
Equity Portfolio in 1986 (its inception PORTFOLIO CONSTRUCTION
date) would have grown to $8.7 million In terms of asset mix and portfolio For further information,
usd on March 31, 2010 versus $6.9
2
construction, we offer a unique marriage please contact
million usd for the S&P 500 Total between our bottom-up security-specific
Return Index over the same period. questions@gluskinsheff.com
fundamental analysis and our top-down
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Unless otherwise noted, all values are in Canadian dollars.
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2. Returns are based on the composite of segregated Value and U.S. Equity portfolios, as applicable, and are presented net of fees and expenses. Page 7 of 8
May 12, 2010 – BREAKFAST WITH DAVE
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