David A.

Rosenberg February 22, 2011

Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 6013

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING
IN THIS ISSUE
Global equity markets are selling off quite sharply and oil prices soaring amid
the political turmoil in Libya — at one point overnight, WTI hit a two-year high of • While you were sleeping:
$98.48/bbl and was up 10%. The fact that equities are sliding amid the global equity markets are
selling off quite sharply
geopolitical tensions in the Middle East and North Africa is a classic signpost of and oil prices soaring
an overbought and overextended market that was ripe for a corrective phase. amid the political turmoil
And the fact that WTI has risen to near $100 a barrel (and trading at a historical in Libya; bond market
discount to Brent — so reliance just on light sweet crude may be misleading investors are treating this
because oil costs globally have risen to much more onerous levels) despite the latest series of events
overseas as a deflationary
fact that Libya produces just 2% of the world’s supply and is the number 8
shock; cyclical spending is
producer within OPEC (it exports 1.5 mbd) is an additional sign of just how tight about to go through the
global crude supplies are. proverbial wringer
• The U.S. consumer
The risk that the turmoil in the Arab states spreads further could very easily
hibernates? Not even the
touch off further gyrations and upward pressure on energy prices, especially with rally seems to be doing
Chinese demand showing no sign of abating … yet. After all, pricing in Libya much these days in terms
supply disruptions is one thing but what if this social unrest spreads to Saudi of sparking a sustained
Arabia, which holds 20% of the world’s oil? If Libya can spark a $10/bbl wealth effect on spending
response, imagine what a similar uprising in Saudi Arabia could unleash. Do the • Fiscal contraction is
math: we’d be talking about $200 oil (as dictatorships/ruling elites come under coming ... this is a key
assault, one can’t help but think if it is possible that the turmoil could ever theme: major budgetary
spread to China — see China Cracks Down on Web Amid Unrest on page A8 on restraint is coming our
way in the second half of
today’s WSJ and have a good look at Beijing and the Arab Revolt on page A13).
the year, and so we would
If equity risk premia do not manage to rise in this environment then we most recommend that you enjoy
certainly are in a total new era — of complacency. whatever fiscal and
monetary juice there is left
As it stands, even $100 a barrel is a dead weight drag on cycle-high profit in the blender
margins and discretionary consumer spending. Remember when oil first reached
the $100 mark in March 2008 the unemployment rate was 5%, not 9%, and
fiscal policy was about to be loosened in a dramatic fashion, not tightened. The
Fed had 300 basis points of rate cuts in its chamber, not zero. And while the
impact will be felt in the real U.S. economic aggregates as a rising price deflator
cuts into real-side activity, the effects are even harsher in emerging markets,
who’s economies are far more energy-sensitive (and less energy efficient) than
is the case in the developed world.

It is also interesting to see how government bond markets are reacting to the oil
price surge — by rallying, not selling off. In other words, bond market investors
are treating this latest series of events overseas as a deflationary shock. The
yield on the 10-year U.S. Treasury note has fallen nearly 20bps from the nearby
high (but the sell off took the 30-year fixed-rate mortgage above 5% and you can
see the damage that has incurred on housing demand, which has gone back

Please see important disclosures at the end of this document.

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February 22, 2011 – BREAKFAST WITH DAVE

into freefall — mortgage application volumes for home purchases have sagged
at a 62% annual rate in just the past month! We’ll see what that does to Home
Depot’s first quarter numbers). To add insult to injury, the National Association
of Realtors may well have dramatically overstated resale housing activity in
recent years (i.e. its 5% estimated decline contrasts with the 11% fall-off as per
CoreLogics database — see Home Sales Data Doubted on page A3 of WSJ).

The recession has apparently been over for a year and a half, and yet we have
had but two months of nonfarm payrolls north of 200k (and they happened in
early 2010) and one quarter of real consumer spending growth above a 2.5%
annual rate (which happened in Q4, courtesy of a quirk in the price deflator and
a drop in the savings rate). We certainly have seen a revival in manufacturing
activity, capital spending and an inventory rebuild of significance, and yet all this
has just been a bounce off a depressed low. Here we are, well into year two of
some sort of government-engineered recovery, and the level of industrial
production — and this has been the center point of the revival — is still almost
The worst recession in seven
6% lower now than it was at the pre-recession peak. Manufacturing shipments decades and draconian
are still more than 10% below pre-recession levels and these are measured in intervention by the government
nominal dollars too; order books are 23% smaller today. Yikes! The worst and yet we are still just digging
recession in seven decades and draconian intervention by the government and ourselves out of the hole
yet we are still just digging ourselves out of the hole. Yet we have legions of
economists, strategists, analysts, and money managers who believe we are
really into something good here — some new sustainable up-cycle, when all
along it has been a case of clawing our way out and we’re not even really out of
the hole yet even on the most bullish of economic indicators.

But we must tip our hat to Ben Bernanke for he deserves full credit for being
able to create this mirage. That takes a real skill beyond just traditional central
banking. All we know is that since the onset of his quantitative easings, the S&P
500 has tracked movements in the Fed balance sheet with an 86% correlation.
And if there is one thing we know with certainty, it is that pundits will base their
assessment of where the economy is headed purely on what the stock market is
doing in any particular day, week, or month. What is lost is that in each of the
last two asset inflation cycles engineered by the Fed, the equity market provided
precious little lead time in preparing anyone for the recessionary phases that
were about to ensue.

After getting clocked yesterday, European equities are down about another 1%
so far today but we have Hong Kong losing 2.1%, Shanghai down 2.6%, Korea
off 1.8% and Singapore slipping 1.7%. In all, the Asia-Pacific index was off 1.8%
today (while the Nikkei matched this decline, it was encouraging to see New
Respect for Japanese Stock Market on page B1 of today’s NYT — two-thirds of
the 1,700 companies that are listed on all the exchanges trade at below book
There is a new thrust in
value). The U.S. dollar is benefiting from safe-haven flows even though the U.S.
Congress and it is towards
itself is a large net oil importer. It will be interesting to see how the CAD
restoring fiscal integrity
responds — our guess would be positively.

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February 22, 2011 – BREAKFAST WITH DAVE

In other times, we would be hearing of how the folks in Washington would be

dreaming up ways — tax goodies, rebates, etc — to cushion the blow for the
beloved consumer, but as we saw time and again over the weekend, there is a
new thrust in Congress and it is towards restoring fiscal integrity. And it’s not just
about oil — it’s also about global food prices, which have jumped 15% in just the
past four months. Cyclical spending generally is about to go through the
proverbial wringer after the past few months of declining precautionary savings
balances to fuel consumption. Forewarned is forearmed. Just consider that
gasoline prices in the U.S.A. are now just days away from hitting $3.25. That is
up 50 cents from Labour Day and in turn that is a $65 billion drag (at an annual
rate) on household discretionary spending (equivalent to a 1% pay cut). But if We head into this situation
the unrest abroad was to spread to Saudi Arabia, gasoline could well hit $5 at
with institutional portfolio
managers at near record-low
the pumps (see front page story in the USA Today), which would be a $300
cash ratios and sentiment
billion drain on consumer cash flow and would undoubtedly trigger a recession
measures highlighting extreme
of huge proportions and with limited tools for the government to reverse the tide
bullishness and complacency
this time around. And remember, we head into this situation with institutional
portfolio managers at near record-low cash ratios and sentiment measures
highlighting extreme bullishness and complacency (much as we heard coming
out of the ISI conference in New York last week — a new era has dawned … an
era where governments will put a new and higher floor underneath the price of
risky assets).

If it weren’t for developments in the Arab world, what would be dominating the
papers today would be another geopolitical event — the huge defeat that
German Chancellor Angela Merkel just faced by the CDU in the first of seven
state elections — the first time the party has lost power in Hamburg in a decade.
At stake is the EU summit on March 24-25 to address the debt crisis in Greece
and Ireland and negotiations now may be thrown off kilter.

The chart of the euro displays one sick puppy. In essence, we can understand
why you have to hold your nose with dollar bills (or should we say, Federal
Reserve Notes) in hand, but who would want to touch the euro when Spain’s
central bank comes out and says that 46% of the nation’s savings banks have
exposure to “problematic” construction and real estate loans (see page B2 of
today’s NYT)? Gold, meanwhile, has rebounded smartly of late — there has been
a giveback today but we are now heading to some very critical resistance levels
(been three other times since last fall) of $1,430/oz. Silver has been the real
star, hitting new 31-year highs recently.

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February 22, 2011 – BREAKFAST WITH DAVE

CHART 1: LEVEL OF INDUSTRIAL PRODUCTION IS STILL ALMOST 6%

LOWER NOW THAN IT WAS AT THE PRE-RECESSION PEAK
United States: Industrial Production
(index)
104

100

96

92

88

84
99 00 01 02 03 04 05 06 07 08 09 10
Source: Federal Reserve Board /Haver Analytics
Shading represents periods of U.S. recession
Source: Haver Analytics, Gluskin Sheff

CHART 2: MANUFACTURING SHIPMENTS ARE STILL MORE THAN 10%

BELOW PRE-RECESSION LEVELS
United States: Manufacturers’ Shipments — Durable Goods
($ billions)
230

220

210

200

190

180

170
99 00 01 02 03 04 05 06 07 08 09 10
Source: Census Bureau /Haver Analytics
Shading represents periods of U.S. recession
Source: Haver Analytics, Gluskin Sheff

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February 22, 2011 – BREAKFAST WITH DAVE

CHART 3: ORDER BOOKS ARE 23% SMALLER TODAY

United States: Manufacturers’ New Orders – Durable Goods
($ billions)
260

240

220

200

180

160
99 00 01 02 03 04 05 06 07 08 09 10
Source: Census Bureau /Haver Analytics
Shading represents periods of U.S. recession
Source: Haver Analytics, Gluskin Sheff

CHART 4: 30-YEAR FIXED-RATE MORTGAGE ABOVE 5%

United States: Contract Rates on Commitments: Conventional 30-Year
Mortgages, FHLMC
(average, percent)
5.25

5.00

4.75

4.50

4.25

4.00
APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB
10
Source: Federal Reserve Board /Haver Analytics
Source: Haver Analytics, Gluskin Sheff

THE U.S. CONSUMER HIBERNATES?

Maybe the biggest mistake anyone can make right now is to assume that
because the stock market is still making new highs that everything is just fine
with the U.S. economy. In fact, not even the rally seems to be doing much these
days in terms of sparking a sustained wealth effect on spending. The data from
the St. Louis Fed shows that real retail sales fell 0.1% in January, following a

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February 22, 2011 – BREAKFAST WITH DAVE

+0.1% print in December and +0.6% in November. The three-month annualized

rate slowed to 2.7% from nearly 12% in October/December. Considering that
January was month number one of the payroll tax cut, this was definitely not
what the consumer growth bulls were bracing for. Now how bullish is this?

The Fed’s liquidity inducements are clearly trying to bolster the stock market but
not even the FOMC minutes from the last policy meeting in late January could
conceal how the central bank really feels about the economic outlook. Correct
us if we are wrong, but this does not seem to convey a sense of optimism.

This is from the Fed staff outlook:

Because the incoming data on production and spending were stronger, on

balance, than the staff’s expectations at the time of the December FOMC
meeting, the near-term forecast for the increase in real GDP was revised up.
However, the staff’s outlook for the pace of economic growth over the medium
term was adjusted only slightly relative to the projection prepared for the
December meeting. Compared with the December forecast, the conditioning
assumptions underlying the forecast were little changed and roughly offsetting:
Although higher equity prices and a lower foreign exchange value of the dollar
were expected to be slightly more supportive of economic growth, the staff
anticipated that these influences would be about offset by lower house prices
and higher oil prices. In addition, the staff’s assumptions about fiscal policy
changed little — the fiscal package enacted in December was close to what the
staff had already incorporated in their previous projection. In the medium term,
the recovery in economic activity was expected to receive support from
accommodative monetary policy, further improvements in financial conditions,
and greater household and business confidence. Over the projection period, the
rise in real GDP was expected to be sufficient to slowly reduce the rate of
unemployment, but the jobless rate was anticipated to remain elevated at the
end of 2012.

This is from the FOMC itself:

Most participants continued to anticipate that the recovery in economic activity

was likely to be restrained by a variety of economic factors, including still-high
unemployment, modest income growth, lower housing wealth, high rates of
mortgage foreclosures, elevated inventories of unsold homes, and tight credit
conditions in a number of sectors. In addition, although many business contacts
expressed more optimism about the economic recovery, a number had aimed
their recent investments primarily at enhancing productivity rather than
expanding employment, and hiring for some businesses was reportedly focused
on temporary workers. Some participants noted that incoming data on
production, spending, and employment would need to be solid for a while longer
to justify a significant upward revision to their outlook for the likely pace of the
recovery.

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February 22, 2011 – BREAKFAST WITH DAVE

Most participants saw the large degree of resource slack in the economy as
likely to remain a force restraining inflation, and while the risk of further
disinflation had declined, a number of participants cited concerns that inflation
was below its mandate-consistent level and was expected to remain so for some
time. While the FOMC members may
well have raised their GDP
So while the FOMC members may well have raised their GDP forecasts — forecasts they still have no
basically marking them to market for lack of a better phrase — they still have no conviction on the veracity of
conviction on the veracity of this recovery and see far more downside economic this recovery and see far more
risks than upside surprises. Fragility remains the watchword. downside economic risks than
upside surprises
FISCAL CONTRACTION IS COMING ... THIS IS A KEY THEME
Based on the assessments above, what exactly are the reasons to be bearish on
the bond market? Oh yes, fiscal deficits!

Well, if you haven’t yet heard, major budgetary restraint is coming our way in the
second half of the year, and so we would recommend that you enjoy whatever
fiscal and monetary juice there is left in the blender. There isn’t much that is for
sure. The weekend newspapers were filled with reports of how the conservative
wing of the Republican party have banded together to ensure that spending cuts
will be in the offing — see In House, Republicans Close to Approving Record Cuts
on page A13 of the Saturday NYT. The state and local governments are already
putting their restraint into gear — see Wisconsin Leads Way as Workers Fight
State Cuts on the front page of said NYT; and Wisconsin Democrats Keep On the
Move on page A3 of the weekend WSJ. First it was Christie’s New Jersey that
was a role model in terms of embarking on true fiscal structural reforms. The
baton was then passed to Mitch Daniels in Indiana. Now it is Scott Walker in
Wisconsin who is the new poster boy for fiscal reforms and necessary
restructuring.

What is happening at the lower government level definitely has a grassroots

Mike Harris ring to it, and for those that do not know who Mike Harris is go Shared sacrifice by the civil
ahead and google him and the ‘Common Sense Revolution’ that gripped Ontario servant community, not
in the 1990s. Yes, it can be done. And shared sacrifice by the civil servant widespread defaults at the
community, not widespread defaults at the state and municipal level, is going to state and municipal level, is
be the solution — either accept higher contribution rates to your pension, higher going to be the solution
payments for your health care, and wage cuts — or lose your job. Sounds like the
deals that ultimately got struck across the lean and mean private sector in
recent times from the auto sector to the airlines (wasn’t GM at one point nothing
more than a health insurance provider?). To think that the President can stick
his nose into local government budgetary affairs and accuse Wisconsin of an
“assault” on unions (then again, didn’t he once accuse a police officer of being a
racist?) at a time when he plans to actually EXPAND the federal government
deficit this year to $1.7 trillion is truly remarkable.

In any event, the process towards fiscal integrity will continue unabated and we
highly recommend added readings on the topic — see Battle Fuels Wider War
Over Labor, Spending and Public-Pension Fight Surfaces in California. The free

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February 22, 2011 – BREAKFAST WITH DAVE

lunch is over and with it the expectation that there will be sustained growth in
domestic spending. Yes, the corporate sector is cash rich but well over half of
the so-called $2 trillion of dry powder sitting on U.S. company cash balances are
locked in deposits overseas and will not be brought home due to American tax
policy (see Why Investors Can’t Get More Cash Out of U.S. Companies on page
B1 of the weekend WSJ). And yes, it is a big world out there and most of U.S.
sales growth has come from the once-hot overseas economy, but between the
massive fiscal restraint in much of Europe and the anti-inflation monetary
tightening in the emerging market universe, that gravy train of strengthening
What a market trained to focus
domestic demand abroad will be sputtering before long. on this quarter’s earnings
reports cannot see right now
What a market trained to focus on this quarter’s earnings reports cannot see are the inherently variable lags
right now are the inherently variable lags between policy shifts and the ensuing between policy shifts and the
impact on real economic activity and profits. The investors that chose to focus ensuing impact on real
on the rear and side view mirrors in 2000 and again in 2007, as opposed to economic activity and profits
looking through the front window, were the ones that emerged as the big losers.
The folks that got greedy at the peak and did not lock in that last 13% gain in the
S&P 500 in the year to the ultimate 1,565 peak in the fall of 2007, saw those
gains totally vanish in front of their eyes in barely more than three months. Easy
come, easy go.

Headlines that read On A Roll: Equity Bulls Have Taken Over on page 15 of the
FT are sure to lure the last vestiges of investors who have waited, frustratingly,
on the sidelines into the market at exactly the wrong time. When strategists
concoct reasons why investors should ignore cyclically-adjusted P/E ratios, it
conjures up the memory of why it made perfect sense to avoid classic valuation
metrics back in 1999 and 2000 and focus on EBITDA and eyeballs per
millisecond. Ahhhh ... the pain of “missing out” on a speculative 100% rally has
replaced the pain of being involved in a 60% downslide just a short two years
ago. Memories are short. That is what we have learned in this gigantic roller-
coaster ride. The Fed’s policies, the ones that Bernanke defends, nurtured the
post-LTCM rally that took the S&P 500 from 959 on October 8, 1998 (after the
Fed cut rates intra-day to save the day) to 1,520 by September 1, 2000. It was a
virtual non-stop 60% rally. But liquidity induced rallies only have a certain shelf
life. The stimulus did end. The lags kicked in, and by July 2, 2002, the S&P 500 The fear that was rampant on
was down to 948 so all the speculative rally was undone and then by October 9th October 9, 2002 had morphed
of that year, the S&P 500 had slid all the way down to 776. into greed on that same day in
2007
The Fed then dug deeper into its bag of tricks and massively re-stimulated until
the stock market carved out a bottom and embarked on a 100% rally from that
low of 776 to 1,565 on October 9, 2007. The writing had been on the wall for so
long but like today, bonds were the enemy and the good times were destined to
last forever, didn’t you know. The fear that was rampant on October 9, 2002 had
morphed into greed on that same day in 2007. Instead, we had another
recession nobody saw coming, and all sorts of reasons to dismiss the
overvalued and overextended nature of the market. Those who refused to drink
from the Fed’s spiked punchbowl were viewed with the same derision they faced
when they were considered old-economy dinosaurs back in 1999-2000. In

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February 22, 2011 – BREAKFAST WITH DAVE

contrast to rallies based on sound economic fundamentals as we had during the

secular bull markets in the past, liquidity-infused rallies are truly dangerous
animals and need to be handled with great care and a dose of trepidation
because the thing about liquidity is that it is your best friend one day, and a
coward the next. So it was with the downdraft from the 1,565 highs in October
2007 to the 676 lows in March of 2009.

Now, after an unprecedented experience of fiscal and monetary ease, ranging

from bailouts, to TARP assistance, to guarantees, to government buying of
If jumping in after a “double”
shares, to accounting rule changes, to verbal market manipulation, to massive
in the last liquidity cycle
expansions of the central bank balance sheet, and record levels of deficits and
proved to be the wrong thing to
debts, and not just in the U.S.A. but globally, the S&P 500 has soared from 676 do, what makes anyone think it
to 1,343. It took five years to double in the last cycle; two years this time around. won’t be the same this time
What to do, what to do, what to do? If jumping in after a “double” in the last around?
liquidity cycle proved to be the wrong thing to do, what makes anyone think it
won’t be the same this time around?

The S&P 500 actually followed the Fed balance sheet more closely last year
than anything else ― including the flow of corporate earnings reports. And if the
Fed does not embark on QE3 in June, there could be a problem lurking ―
especially since the other spigot, fiscal policy, moves from stimulus to restraint
in the second half of the year. It would have been nice to have been 100% in
equities since the March lows, especially the lowest quality, most expensive and
deepest cyclical stocks. Ah, the benefit of hindsight, but one could have said the
same in the fall of 2007 ― the ignominy of sitting out a double!! But to throw in
the towel at this stage could prove fatal to your wealth and we don’t recommend
an overweight position right now. Remain patient. Understand that once things
turn, and eventually they do, there will not be anyone to really support the
market since practically all fund managers are fully invested and have as much
cash on hand as they did at the October 2007 highs.

Our advice is to sit tight, get paid an economic rent, and then opportunistically
capitalize on the eventual corrections that are a normal part of any market cycle,
and tend to be more pernicious after rallies that were built on sticks and straws
of government liquidity than the bricks that are generally laid by organic
economic growth and an expanding private sector capital stock.

Sadly, the past recession did not resolve the glaring imbalances permeating the
U.S. economy. By expanding their balance sheets, the Federal government and
Federal Reserve have really only managed to create an illusion of prosperity. By expanding their balance
Maybe this is what they have to do ― buy as much time as possible. Kick the can sheets, the Federal
down the road just far enough in the hope that something ignites the economy government and Federal
Reserve have really only
to the point that growth can be sustained without reliance on government-
managed to create an illusion
administered steroids. Printing money does not create wealth. It actually risks
of prosperity
eroding real purchasing power. And governments may be able to redistribute
income but in no way can create it ― government’s tax, spend and borrow. The
national debt is now $14.1 trillion.

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February 22, 2011 – BREAKFAST WITH DAVE

The United States is a 236-year old country, and almost 40% of the entire public
sector debt has been built up by the current Administration in barely more than
two years. The United States has a monetary base of $2.06 trillion, and nearly
60% of that has been created since Helicopter Ben took over the cockpit in early
2006. A 236 year-old country, and well over half of the stock of money has been
created in just the past half-decade. Remarkable. Maybe the real question we
should be asking is why the stock market has only managed to double from the
lows with all this massive intervention?

Well, as Dandy Don used to bellow out on Monday evening blowouts back in the
70s and 80s, “turn out the lights, the party’s over. They say that all good things
must end ...”

Indeed, while every economist has raised the 2011 GDP forecast because of the While every economist has
fiscal stimulus initiated late last year, nobody has adjusted their projections for raised the 2011 GDP forecast
the looming fiscal drag. Not only that, but it is becoming crystal clear that the because of the fiscal stimulus
Treasury debt ceiling is going to emerge as a potentially destabilizing issue very initiated late last year, nobody
soon ― see U.S. Faces Deadlock Over Budget on page 3 of the weekend FT as has adjusted their projections
well as Deficit War May Lead to Gov’t Shutdown on the front page of Monday’s for the looming fiscal drag
Investor’s Business Daily.

As for monetary policy, inflation is simply going to be too high for the Fed to be
able to embark on QE3 as early as June, which is when QE2 expires and this is
too bad for the bulls because it is very evident that the liquidity rush had a much
bigger impact on equity valuation since the end of last summer than either the
economy or earnings did ― see Betting on Ben: Central Banks Have Been
Supporting Share Prices in the always excellent Buttonwood column in the
Economist (page 83). Caveat emptor. At the same time, QE2 has only been a
success in terms of generating a speculative and liquidity-induced rally in
equities, it has not helped redress the dismal job market backdrop ― the decline
in the labour force participation rate did a far better job in pulling the
unemployment rate down than Fed policy ever did.

The Fed’s policies, by triggering a pro-risk investment landscape, led to money

being pulled out of the bond market to such an extent that mortgage rates have
skyrocketed back above 5% and thereby further impaired the housing market. At
the same time, the Fed’s policies have at least played a partial role in
stimulating this most recent up-leg in commodity markets, and this in turn has
an impact on real consumer spending since the surge in food and fuel prices in There is no question that the
particular will exert a negative impact on discretionary expenditures. All the more global food crisis is a real
so after the fourth quarter drop in the savings rate, which looked to be one part game-changer as far as the
wealth effect and one part pent-up demand (the recovery is six quarters old and macro and market forecast is
Q4 was the only one that could remotely be called decent as far as consumer concerned
expenditure growth is concerned).

But from the spreading political turmoil in the Middle East to real spending
power here at home, there is no question that the global food crisis is a real
game-changer as far as the macro and market forecast is concerned. Current

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February 22, 2011 – BREAKFAST WITH DAVE

corn stockpiles now represent 4% of annual consumption, according to the WSJ,

perilously below the 15-year average of 13.5%. This is a shortfall equivalent to
around 10 million acres. Look at the ingredients of any packaged food and you
will see something related to either corn, or soybean, where there is an
estimated four million acre shortfall. In turn, this is one reason ― inflation ― as
to why the emerging equity markets have so woefully underperformed so far this
year ― down 3.5% versus the 5% advance in developed markets. Inflation in
China is around 5% (and likely under-reported) and 8% in India. And when you go
back to August 2010, when QE2 was announced, U.S. core inflation was 1.1%
and headline was 0.1%; by June of this year, we will probably be looking at 1.5%
on the core and as high as 3% on headline inflation. That combined with the
reality that the S&P 500 is 300 points higher now than it was then would The reality that the S&P 500 is
certainly suggest that the case for extension of the Fed’s QE program will not be
300 points higher now than it
was then would certainly
there, at least not by the time QE2 runs its course. So this is what we would be
suggest that the case for
looking for in terms of chronology (it may be too late to sell in May this year).
extension of the Fed’s QE
program will not be there, at
• March: Irish elections. Default back on the table. Euro weakens. Flows into
least not by the time QE2 runs
front end of the Treasury curve. its course
• April: Debt ceiling is hit. Political gridlock in vogue. Market volatility ensues.
Gold and silver firm.
• June: End of QE2. Stock market wobbles like it did last year under similar
conditions. Bonds and the U.S. dollar rally. High-beta stocks slip.
• July: Start of fiscal year for state and local governments. Big retrenchment
begins and takes a bite out of economic activity.
• October: End of fiscal year for the federal government. Fiscal restraint
replaces three years of radical fiscal expansion. Big rally in bonds. U.S. dollar
should firm up too.
• December: The payroll tax cut and the bonus depreciation allowance both
expire, creating a huge air pocket for first quarter growth in 2012. Talk of
recession accelerates. Bull flattener in Treasuries likely to ensue. Equities will
still be in corrective mode as double-dip risks re-enter the market mindset.
And keep in mind, recessions and near-recessions do occur in election years:
1960, 1964, 1972, 1976, 1980, 1992, 2000, and 2008 are examples.

Besides the sluggish labour market environment, rising food and energy prices,
which is one-quarter of the spending bucket, renewed deflation in residential
real estate values and the sudden loss of fiscal and monetary policy support that
is around the corner, another impediment to a sustained spending cycle in the
U.S.A. is the very poor financial shape that the boomer population finds itself in
after years of spending far above its means (which is one reason why it seems
so incredulous to read Bernanke Defends U.S. Policies on page A6 of the
weekend WSJ seeing as Fed policies over the years have increasingly been
geared to fuelling excessive consumption via asset inflation).

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February 22, 2011 – BREAKFAST WITH DAVE

Have a read of the sad but true article on the front page of the WSJ (weekend
edition) titled Retiring Boomers Find 401(k) Plans Fall Short. The statistic in
there was pretty scary but it does tell us that the savings rate will resume the
upward trend that was temporarily broken last year. The median household
headed by a person between the ages of 60 and 62 with a 401(k) account has
put away less than one-quarter of what is needed to meet their standard-of-living
needs in retirement. Yikes. Remember, there are 78 million boomers that are
going to turn from being net borrowers and spenders towards net creditors and
savers. This is definitely bullish for long-duration bonds, by the way, which is the
most detested asset class on the planet right now, confirmed by the latest
Merrill Lynch survey of global portfolio managers.

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February 22, 2011 – BREAKFAST WITH DAVE

Gluskin Sheff at a Glance

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms.
0

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 December 31, 2010, the Firm
managed assets of $6.0 billion.
Gluskin Sheff became a publicly traded
corporation on the Toronto Stock
Exchange (symbol: GS) in May 2006 and
remains 49% 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 December 31, 2010
Income).
The minimum investment required to
establish a client relationship with the
Firm is $3 million.
PERFORMANCE
$1 million invested in our Canadian
Equity Portfolio in 1991 (its inception
date) would have grown to $10.2 million
on December 31, 2010 versus $6.5 million
for the S&P/TSX Total Return Index
over the same period.
$1 million usd invested in our U.S.
Equity Portfolio in 1986 (its inception
date) would have grown to $12.9 million
usd on December 31, 2010 versus $10.6
2 In terms of asset mix and portfolio
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 Equity 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.
$10.2 million2 on
For corporate bonds, we look for issuers
with a margin of safety for the payment
versus $6.5 million for the
of interest and principal, and yields which
S&P/TSX Total Return
are attractive relative to the assessed
Index over the same
credit risks involved.
period.
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
which we have the highest conviction.
2
Our success has often been linked to our
long history of investing in under-
followed and under-appreciated small
and mid cap companies both in Canada
and the U.S.
PORTFOLIO CONSTRUCTION
For further information,
H

million usd for the S&P 500 Total construction, we offer a unique marriage please contact
Return Index over the same period. between our bottom-up security-specific questions@gluskinsheff.com
fundamental analysis and our top-down
Notes: macroeconomic view.
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 13 of 14
February 22, 2011 – BREAKFAST WITH DAVE
IMPORTANT DISCLOSURES
Copyright 2011 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
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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
co—plaintiffs 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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