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Breakfast With Dave 092910

Breakfast With Dave 092910

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Published by: Tikhon Bernstam on Sep 29, 2010
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David A. Rosenberg Chief Economist & Strategist drosenberg@gluskinsheff.

com + 1 416 681 8919

September 29, 2010 Economic Commentary

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave
DUE TO BUSINESS TRAVEL, BREAKFAST WITH DAVE WILL NOT BE PUBLISHED TOMORROW, BUT RETURNS ON FRIDAY WHILE YOU WERE SLEEPING The big news is still that asset classes that traditionally move inversely are now moving in tandem — stock prices, bond prices, and the gold price. As far as the latter is concerned, have a look at Martin Wolf’s column today on page 11 of the FT — Currency Wars in an Era of Chronically Weak Demand — and also see Currency Wars: A Fight to be Weaker on page C1 of the WSJ. Perhaps all three are strengthening on the same prospect — the Fed’s strong hint of another round of quantitative easing (QE). The Fed, after all, would be buying Treasuries so it is perfectly understandable why they would rally. More money printing means more U.S. dollar depreciation, which would obliviously be positive for gold (have a look at Gold Forecast $1,450/oz on page 25 of the FT. The equity market seems to be the odd man out but we would surmise that it is rising on hopes that QE2 will be successful yet in stimulating final demand growth. From our lens, the jury is out on the efficacies of lower interest rates in an environment of contracting credit, especially considering what little impact the sharp plunge in yields and radical expansion of the central bank balance sheet have already exerted. A record low 0.64% yield on the 10-year TIPS strongly suggests that the bond market is sniffing out a renewed contraction and the pace of economic activity before too long. We have long been of the view that the trauma that hit the U.S. household balance sheet — the largest balance sheet on the planet — has led to a dramatic shift in consumer attitudes towards spending, credit and homeownership. With that in mind, it is somewhat comforting to see society moving from denial to acceptance as it pertains to the secular changes in spending and saving behaviours that is truly underway. For a real life view of the challenges that lie ahead have a look at the front page article of the USA Today titled Recession’s Impact on Us: Lifestyle Changes Deep, Long Term. IN THIS ISSUE • While you were sleeping: the big news is that of asset classes that traditionally move inversely are now moving in tandem — stock prices, bond prices, and the gold price • Lack of confidence: the Conference Board’s consumer confidence index sagged to 48.5 in September from 53.2 in August • It wasn’t just consumer confidence that’s in a funk, business sentiment slips too in Q3 • House prices dip in the U.S.: the Case-Shiller Composite-20 index fell 0.1% MoM in July — first decline in four months and is likely the re-emergence of its primary downward trend • Richmond, poor man: the litany of softer regional economic reports continues unabated

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

September 29, 2010 – BREAKFAST WITH DAVE

CHART 1: RECORD IMPLOSION IN HOUSEHOLD NET WORTH
United States: Household Net Worth (three-year percent change)
60

40

20

0

-20

-40

55

60

65

70

75

80

85

90

95

00

05

10

Shaded region represent periods of U.S. recession. Source: Haver Analytics, Gluskin Sheff

LACK OF CONFIDENCE It is now so clear that we never did have an organic recovery on our hands. Growth is vividly slowing down in North America, and deflation, not inflation, is the primary risk. After all, if disinflation was the primary trend for 30 years amidst a secular credit expansion, it surely stands to reason that as credit contracts, and with the underlying inflation below 1% and a huge output gap of 6.5%, deflation is a totally realistic scenario. The bond market is signalling some deflationary event of great magnitude (could be an unexpected stock market shock?). Bond yields will follow the 2-year note yield and will completely melt before this interest rate cycle is complete. In September, U.S. consumer confidence (according to the Conference Board) sagged to 48.5 from 53.2 in August — the consensus was expecting 52.0. This takes us all the way back to February and the fact that it slipped so badly in a month that saw the equity market surge must be telling us that something, somewhere else is not going well at all — most likely, in the labour market. Indeed, the spread between the “jobs hard to get” and “jobs are plentiful” series, which gapped up to a six-month high of 42.3 from 41.5 in August. This foreshadows a rise in the unemployment rate, to 9.7% from 9.6% currently. CHART 2: CONFERENCE BOARD EMPLOYMENT INDICATOR POINTING TO AN INCREASE IN THE JOBLESS RATE
United States
Conference Board Employment Indicator
(percent, thin line, right hand side scale) 60 40 20 8 0 6 -20 -40 -60 70 75 80 85 90 95 00 05 10 4 12 (Jobs Hard to Get minus Jobs Plentiful, percentage points: thick line, left hand s

It is now clear that we never did have an organic recovery on our hands in the U.S. — growth is slowing down and deflation, not inflation, is the primary risk

Unemployment Rate

10

2

Source: Haver Analytics, Gluskin Sheff

Page 2 of 7

September 29, 2010 – BREAKFAST WITH DAVE

Putting the headline 48.5 reading into perspective, consumer confidence averages 72.9 in recessions and 100.2 in expansions. Maybe the National Bureau of Economic Research jumped the gun. The chart of the “present situation” does indeed flag no recovery, down nearly two points in September, to 23.1, and in fact, is back to levels prevailing in April 2009 (pre-green shoots!!). CHART 3: PRESENT SITUATION INDEX DOES NOT FLAG A RECOVERY
United States: Conference Board Present Situation Index (1985 = 100)
200

160

120

Home-buying plans in the U.S. flirting near all-time lows, according to the Conference Board Consumer Confidence Survey

80

40

0 70 75 80 85 90 95 00 05 10

Shaded region represent periods of U.S. recession Source: Haver Analytics, Gluskin Sheff

Moreover, home-buying plans slipped from 2.1 to 1.9 in September — flirting near all-time lows. CHART 4: HOME BUYING INTENTIONS FLIRTING WITH ALL-TIME LOWS
United States: Conference Board Consumer Confidence Survey: Plans to Buy a Home Within Six Months (percent respondents)
6.00 5.25

4.50

3.75

3.00

2.25

1.50 70 75 80 85 90 95 00 05 10

Shaded region represent periods of U.S. recession Source: Haver Analytics, Gluskin Sheff

Page 3 of 7

September 29, 2010 – BREAKFAST WITH DAVE

Auto buying plans have stagnated at a putrid 4.7 level now for three months running. So, if taking rates from 5.5% to zero could not revive credit-sensitive spending, and if tripling the size of the Fed’s balance sheet could not revive credit-sensitive spending, then why is it that we should believe that QE2 will be any different? Finally, what sort of “recovery” is this when 46.1% of consumers see business conditions as “bad” while a mere 8.1% see them as “good”? BUSINESS SENTIMENT SLIPS TOO It wasn’t just the consumer in a deep funk, the Conference Business Roundtable CEO poll plunged for the first time in a year — down eight points to 86 in Q3. In case anyone is wondering why the labour market indicators were so weak in the consumer confidence index, well, hiring intentions in the CEO business survey took a dive. Only 31% of respondents plan to hire in the next six months, well below the 39% print the last time the poll was taken in June. HOUSE PRICES DIP Well, we didn’t really need the Case-Shiller (CS) home price index to know that residential real estate prices are dipping again — we already got that from the recent FHFA, resale and new home sale reports. The CS Composite 20 series dipped 0.1% MoM in July — the first decline in four months and quite likely the re-emergence of the primary trendline … which is down. RICHMOND, POOR MAN The litany of softer regional economic reports continues unabated. The Richmond Fed index, if taken at face value, is pointing to a renewed contraction in industrial activity. The index slid from +11 in August to -2 in September, the weakest reading since the beginning of this year. Shipments slipped to -4 from +11 and order volumes fell off the proverbial cliff: +41 in April, to +36 in May, to +25 in June, to +13 in July, to +10 in August, to a big fat ZERO in September. In economics land, we would typically call that a trend. Capiche! If you think that’s bad, backlogs went from zero to -11 — it was +16 in May. Again, it is abundantly clear that labour market conditions deteriorated in September — down to -3, a seven-month low, from +12 in August and +15 in July. The average workweek also shrunk from +14 to zero.

Wondering why the labour market indicators were so weak in the consumer confidence index? Well, hiring intentions in the CEO business survey took a dive in Q3

The Richmond Fed manufacturing index, if taken at face value, is pointing to a renewed contraction in industrial activity

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September 29, 2010 – BREAKFAST WITH DAVE

CHART 5: LABOUR MARKET CONDITIONS IN THE MANUFACTURING SECTOR DETERIORATED IN SEPTEMBER
United States: Federal Reserve Bank of Richmond Manufacturing Survey: Number of Employees Diffusion Index (percent)
20

0

-20

-40

-60 95 00 05 10

Shaded region represent periods of U.S. recession Source: Haver Analytics, Gluskin Sheff

The inflation metrics were superb — if you are a bond bull, that is. Wages fell to a five-month low of 8 from 13. Prices-paid receded to 1.31 from 2.19 in August, and prices-received slid to 1.06 — the lowest in seven months — from 1.45 in both July and August. The service sector didn’t fare much better — according to the Richmond Fed, revenues in the service sector came in at -5 in September from -10 in August. This was the first back-to-back decline since the start of this year. Yet again, the employment index was a notable blemish, and again, take a look at the pattern: +10 in May, to +2 in June, to -6 in July, -8 in August and -12 in September. A pattern to be sure. And again, disinflation pressure was underscored by the ultra-low reading of 0.34, with respect to the pricing subindex. CHART 6: DITTO FOR THE SERVICE SECTOR
United States: Federal Reserve Bank of Richmond Service Sector Survey: Number of Employees (percentage increasing)
20 10

0

-10 -20

-30

-40 95 00 05 10

Shaded region represent periods of U.S. recession Source: Haver Analytics, Gluskin Sheff

Page 5 of 7

September 29, 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
As of June 30, 2010, the Firm managed assets of $5.5 billion.

INVESTMENT STRATEGY & TEAM

We have strong and stable portfolio management, research and client service teams. Aside from recent additions, our Gluskin Sheff became a publicly traded Portfolio Managers have been with the corporation on the Toronto Stock Firm for a minimum of ten years and we Exchange (symbol: GS) in May 2006 and have attracted “best in class” talent at all remains 54% owned by its senior levels. Our performance results are those management and employees. We have of the team in place. public company accountability and We have a strong history of insightful governance with a private company bottom-up security selection based on commitment to innovation and service. fundamental analysis. Our investment interests are directly aligned with those of our clients, as For long equities, we look for companies Gluskin Sheff’s management and with a history of long-term growth and employees are collectively the largest stability, a proven track record, client of the Firm’s investment portfolios. shareholder-minded management and a share price below our estimate of intrinsic We offer a diverse platform of investment value. We look for the opposite in strategies (Canadian and U.S. equities, equities that we sell short. Alternative and Fixed Income) and investment styles (Value, Growth and For corporate bonds, we look for issuers 1 Income). with a margin of safety for the payment of interest and principal, and yields which The minimum investment required to are attractive relative to the assessed establish a client relationship with the credit risks involved. Firm is $3 million for Canadian investors and $5 million for U.S. & International We assemble concentrated portfolios — investors. our top ten holdings typically represent between 25% to 45% of a portfolio. In this PERFORMANCE way, clients benefit from the ideas in $1 million invested in our Canadian Value which we have the highest conviction. Portfolio in 1991 (its inception date) 2 Our success has often been linked to our would have grown to $10.9 million on long history of investing in under-followed June 30, 2010 versus $5.4 million for the and under-appreciated small and mid cap S&P/TSX Total Return Index over the companies both in Canada and the U.S. same period. $1 million usd invested in our U.S. Equity Portfolio in 1986 (its inception date) would have grown to $10.9 million 2 usd on June 30, 2010 versus $8.6 million usd for the S&P 500 Total Return Index over the same period.
Notes:

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.

$1 million invested in our Canadian Value Portfolio in 1991 (its inception date) would have grown to $10.9 million2 on June 30, 2010 versus $5.4 million for the S&P/TSX Total Return Index over the same period.

PORTFOLIO CONSTRUCTION
In terms of asset mix and portfolio construction, we offer a unique marriage between our bottom-up security-specific fundamental analysis and our top-down macroeconomic view.
For further information, please contact questions@gluskinsheff.com

Unless otherwise noted, all values are in Canadian dollars. 1. Not all investment strategies are available to non-Canadian investors. Please contact Gluskin Sheff for information specific to your situation. 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 6 of 7

September 29, 2010 – BREAKFAST WITH DAVE

IMPORTANT DISCLOSURES
Copyright 2010 Gluskin Sheff + Associates Inc. (“Gluskin Sheff”). All rights reserved. This report is prepared for the use of Gluskin Sheff clients and subscribers to this report and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Gluskin Sheff. Gluskin Sheff reports are distributed simultaneously to internal and client websites and other portals by Gluskin Sheff and are not publicly available materials. Any unauthorized use or disclosure is prohibited. Gluskin Sheff may own, buy, or sell, on behalf of its clients, securities of issuers that may be discussed in or impacted by this report. As a result, readers should be aware that Gluskin Sheff may have a conflict of interest that could affect the objectivity of this report. This report should not be regarded by recipients as a substitute for the exercise of their own judgment and readers are encouraged to seek independent, third-party research on any companies covered in or impacted by this report. Individuals identified as economists do not function as research analysts under U.S. law and reports prepared by them are not research reports under applicable U.S. rules and regulations. Macroeconomic analysis is considered investment research for purposes of distribution in the U.K. under the rules of the Financial Services Authority. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. Securities and other financial instruments discussed in this report, or recommended by Gluskin Sheff, are not insured by the Federal Deposit Insurance Corporation and are not deposits or other obligations of any insured depository institution. Investments in general and, derivatives, in particular, involve numerous risks, including, among others, market risk, counterparty default risk and liquidity risk. No security, financial instrument or derivative is suitable for all investors. In some cases, securities and other financial instruments may be difficult to value or sell and reliable information about the value or risks related to the security or financial instrument may be difficult to obtain. Investors should note that income from such securities and other financial instruments, if any, may fluctuate and that price or value of such securities and instruments may rise or fall and, in some cases, investors may lose their entire principal investment. Past performance is not necessarily a guide to future performance. Levels and basis for taxation may change. Foreign currency rates of exchange may adversely affect the value, price or income of any security or financial instrument mentioned in this report. Investors in such securities and instruments effectively assume currency risk. Materials prepared by Gluskin Sheff research personnel are based on public information. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of Gluskin Sheff. To the extent this report discusses any legal proceeding or issues, it has not been prepared as nor is it intended to express any legal conclusion, opinion or advice. Investors should consult their own legal advisers as to issues of law relating to the subject matter of this report. Gluskin Sheff research personnel’s knowledge of legal proceedings in which any Gluskin Sheff entity and/or its directors, officers and employees may be plaintiffs, defendants, co-defendants or coplaintiffs with or involving companies mentioned in this report is based on public information. Facts and views presented in this material that relate to any such proceedings have not been reviewed by, discussed with, and may not reflect information known to, professionals in other business areas of Gluskin Sheff in connection with the legal proceedings or matters relevant to such proceedings. Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Investors are urged to seek tax advice based on their particular circumstances from an independent tax professional. The information herein (other than disclosure information relating to Gluskin Sheff and its affiliates) was obtained from various sources and Gluskin Sheff does not guarantee its accuracy. This report may contain links to third-party websites. Gluskin Sheff is not responsible for the content of any third-party website or any linked content contained in a third-party website. Content contained on such third-party websites is not part of this report and is not incorporated by reference into this report. The inclusion of a link in this report does not imply any endorsement by or any affiliation with Gluskin Sheff. All opinions, projections and estimates constitute the judgment of the author as of the date of the report and are subject to change without notice. Prices also are subject to change without notice. Gluskin Sheff is under no obligation to update this report and readers should therefore assume that Gluskin Sheff will not update any fact, circumstance or opinion contained in this report. Neither Gluskin Sheff nor any director, officer or employee of Gluskin Sheff accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents.

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