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David A.

Rosenberg February 5, 2010

Chief Economist & Strategist Economic Commentary
+ 1 416 681 8919


Lunch with Dave

In the overall scheme of things, considering the intense fiscal problems in
Euroland, the prospect of sovereign debt defaults and the future of the regional • U.S. employment report —
monetary union, today’s U.S. payroll report is really a secondary event. The what ever happened to
men at work?
headline payroll result was below expected at -20k (consensus was +20k) and
there were downward revisions of 930k to the back data (April 2008 to March • A technically-driven
2009) from the much-anticipated benchmark revisions. market — yesterday’s
sharp and broadly based
decline in the equity
To put the -20k headline payroll result into perspective, history shows us that markets was the worst
what is normal is that fully 24 months after a recession begins we are printing we’ve seen since April 20
employment gains of 100k. In other words, labour market conditions can still be of last year
described as being somewhat abnormal and fundamentally soft even if the pace
• Canadian jobs report —
of deterioration has abated. upside surprise on the
headline, but details were
As we and others had been saying for so long, it was ludicrous for the Bureau of not that great
Labor Statistics to have been assuming that the economy was generating net
• Income theme is intact —
new jobs from business creation. As a result of the changes made to the ‘birth- equity mutual funds saw a
death’ model, we had downward revisions in four of the prior five months net outflow of $370mln in
(totalling 245k — for example, December was revised to show a 150k loss the final week of January,
versus the initial -85k print). Excluding the federal government hiring last while bond bonds
month, payrolls would have declined 53k. And, while the diffusion indices for received another $7.5bln
private payrolls and manufacturing did improve, they do remain squarely below
50, which suggests that the plurality of employers are still in the process of • Unbelievable productivity
shedding labour, more than two years after the recession officially began. data out of the U.S.A.
• Employment conditions in
In what good news there was, factory payrolls rose 11k, the first increase in the U.S. is still sluggish —
three years (the fact that Canada lost 15,700 manufacturing jobs may indeed take a look at the initial
attest to the view that we have some degree of overvaluation in the Canadian jobless claims data
dollar to correct and vice versa for the greenback). Temp agency employment • Mixed news on the retail
rose a further 52k on top of a 59k increase in December and this is widely front — estimates on
viewed as a leading indicator for future employment. January same-store sales
are all over the map
As for the workweek, another leading indicator, it rose to 33.3 hours in January • Not everything is bearish
from 33.2 hours — the index of aggregate hours worked rose a healthy 0.3% — yes, the outlook for
MoM. It does look like the personal sector did squeeze out some decent income business spending in the
U.S. has improved
growth as well, which may account for the better tone in the retail sales surveys
that just came out for January. Indeed, employment in this sector rebounded
42k last month and average hourly earnings eked out a 0.3% MoM gain, and
once the expanded workweek is tacked on, average weekly earnings jumped
0.6%. Not only that, but the factory workweek, along with the higher number of
manufacturing workers, rose 0.5% MoM so expect to see a pretty good industrial
production number (out on February 17) — validating the jump we saw in the
ISM manufacturing index.

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
February 5, 2010 – LUNCH WITH DAVE

The Household survey did show a nice rebound of 541k in January and almost
half the gains were in full-time positions. Not only that, but the number of folks The working-age population
working part-time for economic reasons plummeted 849k, or by nearly 10% — in the U.S. plunged 92k in
talk about an eye-popper. January; such a decline has
occurred but five times since
Be that as it may, keep in mind that the January rebound in Household 1951
employment fell short of recouping the entire 589k plunge in December and the
job count here is still 1.5 million lower today than it was in July. After four
months of decline, the labour market (officially defined) rose 111k (well short of
offsetting the 661k plunge in December) and together with the rebound in
Household employment, all the job market ratios improved:

• The jobless rate down to 9.7% from 10.0%;

• The employment ratio up, to 58.4% from 58.2%;
• And even the broad U6 measure of the unemployment rate slipped to a five-
month low of 16.5% from 18.3%.

The working-age population plunged 92k in January and such a decline has
occurred but five times since 1951 and they most happen in January, so we could
well be spending an inordinate amount of time analyzing a report that is rife with
bad sampling. For example, we also found that despite the great headline in the
Household survey, adult-male employment (aged 25 years and over) actually fell
75k and has declined now for 18 months in a row. Moreover, the adult-male
unemployment rate yet again was at 10% in January, a level it has either been at
or breached for six straight months in unprecedented string dating back to 1947.

Meanwhile adult-women employment over the age of 20 posted a 529,000 job

boom. In the battle of the sexes, Venus clearly took January. Moreover, look at
Chart 1, male employment (aged 25 to 54 years old) plunged 114k in January and
is back to levels last seen in June 1996. Almost 10% of what was once considered
the ‘breadwinner’ part of the workforce has been extinguished during this
recession. How can anyone realistically be excited about recovery prospects
knowing this?


United States: Employed: Men 25-54 Years Old (millions)






96 97 98 99 00 01 02 03 04 05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff

Page 2 of 12
February 5, 2010 – LUNCH WITH DAVE

Taking a big picture viewpoint, the U.S. labour market remains fundamentally
weak. Despite the clarion calls for recovery from the legions of Wall Street While there will be many
economists and strategists, the reality is that labour market gaps remain very economists touting today’s
wide; here we are more than two years after the recession officially started and the U.S. employment report as
ranks of the long-term unemployed continue to swell. The average duration of some inflection point, the
unemployment rose to a record 30.2 weeks from 29.1 weeks in December; and reality is that the level of
for the first time ever, we have more than 6.3 million Americans (up from 6.1 employment today, at 129.5
million in December) who have been looking for a job with no luck for at least six
million, is the exact same
level it was in 1999
months. That is an unprecedented 41.2% share of the pool of unemployment.

While there will be many economists touting today’s report as some inflection
point, and it could well be argued that we are entering some sort of healing phase
in the jobs market just by mere virtue of inertia, the reality is that the level of
employment today, at 129.5 million, is the exact same level it was in 1999. And,
during this 11-year span of Japanese-like labour market stagnation, the working-
age population has risen 29 million. Contemplate that for a moment; fully 29
million people competing for the same number of jobs that existed more than a
decade ago. That sounds like pretty deflationary stuff from our standpoint.

Not only that, but consideration must be taken that in 2009, we had a zero
policy rate, a $2.2 trillion Fed balance sheet and an epic 10% deficit-to-GDP
ratio. You could not have asked for more government stimulus. Yet
employment tumbled nearly 5 million in 2009.

Here we are in 2010, and what we have on our hands is a situation where the
outer limits of deficit finance have already been probed, and the Fed has pledged
to start shrinking its balance sheet and withdraw its critical support for the
mortgage market. Yet the deleveraging in the household sector is ongoing and it
now looks as though the economies in Asia and Europe are going be slowing down,
not speeding up, in coming quarters. And of course, heightened concerns over
sovereign credit quality suggest that risk premia globally are set to rise after a year
in which we had the calm before the storm. Heightened risk premia means
uncertainty, volatility and in turn a very clouded economic outlook that transcends
today’s data release, which has already consumed too much of my time.

Yesterday’s sharp and broadly based decline in the equity markets was the
worst session since April 20 of last year. The S&P 500 is now down 7.6% from
the mid-January peak and the Asia-Pacific market is just 40 basis points shy of
seeing a 10% correction after having its worst session in 10 weeks; emerging
market equity funds lost $1.6 billion in net redemptions in the past week, the
largest outflow in nearly six months. Financials were clobbered 4.2% and led
the decline, though basic materials weren’t too far behind. Volume swelled as
all the major averages fell off — not a good sign for the bulls.

Page 3 of 12
February 5, 2010 – LUNCH WITH DAVE

I went for a 5km run at the club I recently joined (I aim to lose 30 pounds ASAP Since this is a technically-
just to get back to being fat again, and the 30 pounds after that will finally take driven equity market, we are
me back to my college days). Fast Money came on the tube and it was almost bound to get a 50% reversal
laughable to see them all grappling for the reasons why the selloff occurred. of the bear market rally,
China here. Greece there. No, sorry. Remember Bob Farrell’s eleventh rule: which would take the S&P
“it’s the news that makes the market; not the other way around.” 500 to 912 — so keep your
seatbelts on
This is a stock market that is as overpriced as it was heading into the October
1987 crash and as the case back then, it wasn’t about the fundamentals but
about policy discord between the U.S., Japan and Germany. A market priced for
perfection requires perfection on all fronts.

The comments on Fast Money were that the fundamentals hadn’t changed —
this selloff is pure emotion. Really? We had a 70% rally from the March low in
advance of any serious turn in the economic data — this was purely a bear
market rally that was rooted in the technicals (and short coverings). How do we
know? Because at the January 19 high in the S&P 500 of 1150 it had
completed a 50% retracement off the slide from the October 2007 highs to the
March 2009 trough.

Now, since this is a technically-driven market, we are bound to get a 50%

reversal of the bear market rally, which would take us to 912 on the S&P 500 —
so keep your seatbelts on. We had been warning for a while that too much
complacency had set in, and what happens when the market shoots up 70%
without taking any serious break along the way? Investors tend to believe that
we are into some sustainable new parabolic bull run.

Meanwhile, its seems that Mr. Market had already started to top out back in
We are still long-term bullish
mid-September, yet so many pundits still believed we were still in the throes of a
on the commodity sector and
bull phase market even though a vivid topping formation was becoming
precious metals but the
increasingly evident. How about that slide in bond yields yesterday? In the charts do point to a further
realm of technical analysis, a break towards 3.2% on the U.S. 10-year Treasury correction in the comings
note yield cannot be ruled out over the near-term. weeks/months … keep your
power dry for now
We are still long-term fans of the commodity complex and precious metals but
again, the charts are indicative of a further correction in coming weeks and
months so keep your powder dry and be ready to add to long-term positions in
the areas of the investment arena that are in secular bull markets.

The U.S. dollar has broken out on the upside, and while this is more a reflection
of the problems overseas than anything overly encouraging state-side, the
charts again are telling a story of a flight-to-safety not unlike what we
experienced in late 2008 and early 2009. It is a countertrend rally in the
greenback but this could last a while longer — the DXY tested the 90 threshold in
the last such up-move nearly a year ago, which would imply another 10% rise
from current levels (ie, this countertrend rally may only be 40% of the way done).

Page 4 of 12
February 5, 2010 – LUNCH WITH DAVE

Again, countertrend rallies in the U.S. dollar are not generally associated with
upward movement in the commodity complex, so expect to see further near- We are currently seeing a
term declines in the resource space. Although the chart of gold against the euro countertrend rally in the U.S.
and many other currencies still looks quite constructive. dollar… all of a sudden, the
USD looks like the one-eyed
Moreover, talking about policy discord. Yesterday, New York Fed President man in the land of the blind
Dudley expressed concern over how weak the recovery is likely to be and that
the odds of a double-dip recession “are not zero”, and dissenting voter Hoenig
from Kansas City continuing to express his view that rates are not going to stay
where they are indefinitely (even though they’ve been at zero in Japan for well
over a decade).

On the global data docket, we see that German industrial production fell 2.6%
MoM in December, more than wiping out the 0.7% gain the month before and a
huge disappointment to the consensus forecasting community that had penned in
a 0.6% advance. To be sure, if President Obama gets his wish of doubling exports
in the next five years, he is going to need a little help from his friend otherwise
known as the greenback. For the time being, there are other countries in the
world, notably in Europe (the Euro is now at an eight-month low) and in Japan, that
probably need a good dose of currency depreciation even more.

The Sterling is also getting pounded in the aftermath of comments out of the
Bank of England to the effect that more quantitative easing will be forthcoming
“should the outlook warrant it”. There is even less pressure now for a Yuan
revaluation seeing as China’s current account surplus has collapsed 35% in the
past year. The Indian rupee is succumbing to huge capital outflows. And so long
as the commodity complex is in correction mode, rest assured that the likes of
the Loonie, Kiwi and Aussie will be trading defensively as well.

All of a sudden, the USD looks like the one-eyed man in the land of the blind.
With that in mind, have a look at the article on the tough choices facing
Euroland policymakers — default or bailout? — on page B1 of the NYT (Fraying At
the Edges: The Economic Weakness of Some Members May Test the Eurozone).


Canadian employment data is like a yoyo — massively outperforming
expectations in November (+72,200), then massively disappointing in December
(-28,300) and now again massively surpassing expectations today in the January
report (+43,000). Consensus estimates were at +20,000.

The money market will undoubtedly continue to price in Bank of Canada

tightening in the summer and beyond until the Bank begins to provide more
clarity in its press statements.

Page 5 of 12
February 5, 2010 – LUNCH WITH DAVE

The jobless rate did dip in December, to 8.3% from 8.4%, but we have already
ascertained that it would take a move down to 7.5% to prompt the BoC into Canadian employment data
action. At the pace the unemployment rate has been declining in the past six is like a yoyo — massively
months we won’t see that critical point (7.5%) until we are into the winter-spring outperforming expectations
of 2011. in November, then massively
disappointing in December
Moreover, this is a case where the headline was a lot stronger than the details: and now again massively
surpassing expectations in
• December was revised to -28,000 from -2,600 initially, so taking the revision the January
into account, the headline was actually fractionally below expected.
• Manufacturing payrolls were down 15,700 (that would be akin to a 160,000
plunge in the U.S.A.).
• The once-hot construction industry lost 400 jobs and this was the second
decline in the past three months. This is the sector the BoC is relying on to
offset losses in export-oriented sectors.
• All the gains were in part-time. Full-time employment edged up 1,400 but that
offset less than 5% of the 29,400 slump in December.
• Those working part-time because of business conditions and actually want a
full-time jobs surged 34,600, which was the largest increase in seven months.
• While the official unemployment rate did edge down, the more inclusive R8
measure (similar to the U6 statistic in the U.S.) rose to 12.3% from 11.1%.
Now, this statistic is not seasonally adjusted; however, keep in mind that in
January 2009, when most folks thought the world was coming to an end, this
broad measure of labour market slack was sitting at 11.0%.
• You look at the industry breakdown and what you also see is a ‘low quality’
jobs performance — public administration +11,000, accommodation/food
services +14,100 and business, building and support services +34,400. The
other 85% of the Canadian employment pie shed 16,500 jobs last month. In
other words, this was one lopsided report.
• Hours worked did edge up 0.2% MoM, but that was due to a spike in services,
which is very difficult to measure — hours worked fell 0.2% in the goods-
producing sector, the second decline in the past three months.
• While average hourly earnings did rise 0.7% MoM this is a notoriously volatile
metric and the YoY trend, as BoC Governor Carney went out of his way to point
out in his speech yesterday, is slowing down markedly — from 4.8% a year ago,
to 2.4% at the end of 2009, to 1.8% now. This is the weakest trend in 6½ years.

Page 6 of 12
February 5, 2010 – LUNCH WITH DAVE


Canada: Average Hourly Wage Rate
(year-over-year percent change)

99 00 01 02 03 04 05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff


Some pundits view the large-scale inflows into bond and income funds as some
sort of bubble, but actually it is a deliberate move on the part of the general
investing public to reallocate their asset mix towards fixed-income securities,
which only command a 7% share of the asset pie. Once again, Ma and Pa Kettle
were net sellers of U.S. equity mutual funds to the tune of $370 million, while
contributing a further $7.5 billion into bond funds (after an $8 billion net inflow
the week before) in the final week of January. To reiterate, this is a secular shift
in behaviour.


U.S. productivity growth came in at a startling 6.2% annual rate in Q4, and this
followed a 7.2% spurt in Q3 and a 6.9% runup in Q2. At no point in the past five
decades has productivity risen so sharply over a three-quarter period — up at a
6.7% annual rate. And, look at the pattern since the third quarter of 2008:
-0.1%; +0.8%; +0.3%; and then all of a sudden +6.9%; +7.2%; and +6.2%.
Somehow, with no capital deepening during the 2002-07 expansion and no
innovation to speak of (sorry, but iPhones don’t cut it), we are seeing a
productivity burst that is almost without precedent.

Page 7 of 12
February 5, 2010 – LUNCH WITH DAVE

Despite the loss of 452,000 jobs in the final quarter of the year, output in the
nonfarm business sector exploded at a 7.2% annual rate. This is indeed the
Houdini recovery. And with the downward revisions to employment, these
productivity numbers are likely to show double-digit gains and make a mockery
of the advances we saw during the tech revolution of the 1990s. Catch my drift
— GDP growth is dramatically overstated and by perhaps as much as three
percentage points.

But there were deflation thumbprints all over yesterday’s quarterly productivity
report. Real compensation per hour sagged a 1.9% annual rate. Unit labour costs
as a result, and this is a key fundamental driver of the inflation process, fell 4.4%
at an annual rate and are flat or down now in each of the past four quarters.

Even if we believe that productivity gains are being overstated by mis-measured

GDP data, unit labor costs are still contracting. On a year-over-year basis, unit
labour costs are -2.8% and only five times since 1948 has the trend been this
weak. This is about deflation, not inflation.


United States: Nonfarm Business Sector Unit Labour Cost
(year-over-year percent change)



50 55 60 65 70 75 80 85 90 95 00 05

Shaded region represent periods of U.S. recession

Source: Haver Analytics, Gluskin Sheff

If demand growth is really being seen as organic or sustainable by the business

sector, then someone has to explain why it is that in the allegedly best quarter
for the economy in six years, the corporate price deflator failed to rise in Q4. It
was a goose-egg – 0.0% — and the year-over-year trend is a mere 0.7%, which is
less than half the pace of a year ago (+1.6%) when practically everyone thought
the world was coming to an end. At least the last time we saw a GDP print like
5.7% we had some modicum of pricing power — the business deflator was up at
nearly a 2% annual rate. Not zero.

Page 8 of 12
February 5, 2010 – LUNCH WITH DAVE


United States: Nonfarm Business Sector Implicit Price Deflator
(year-over-year percent change)



50 55 60 65 70 75 80 85 90 95 00 05

Shaded region represent periods of U.S. recession

Source: Haver Analytics, Gluskin Sheff

We went into the databank, and back to 1947 we have seen plenty of times
when output growth rose at over a 7% annual rate in any given quarter — over
60 times in fact. But never before has happened in the context of declining
employment — normally such growth in output is met by a 650,000 quarterly
increase in employment, not a decline in excess of 400,000 As we said, it’s the
Houdini rabbit-out-of-the-hat recovery.


Initial jobless claims in the U.S. bucked the consensus and rose for the fourth
time in five weeks — to 480k for the January 30th week, from 472k the prior
week. The smoothed four-week moving average also rose for the third straight
week, which is not a good sign at all — to 469k, which is still consistent with net
job loss even with the addition of the census workers (who, by the way, will only
be working two days a week and as such will only show up in part-time
employment). The backlog of existing claims, which includes all the folks on
emergency and extended benefits, rose 53k during the week of January 16, and
attests to the view that even as the pace of firings has subsided, hiring trends
remain extremely soft.

To put 480k in jobless claims into proper perspective, it is 80k higher than the
level prevailing in the aftermath of 9/11; and just about in line with the peak
posted in the 2001 recession. And this is with zero policy rates, a $2.2 trillion
Fed balance sheet and a 10.5% fiscal deficit-to-GDP ratio. The vagaries of a
post-bubble credit collapse.

Page 9 of 12
February 5, 2010 – LUNCH WITH DAVE


Estimates on January chain store sales are all over the map. The ShopperTrak
survey that covered the last week of January showed a 4.5% YoY slide, while at
the same time, RetailMetrics says that sales for the entire month were up 3.3%
from a year ago. The International Council of Shopping Centers (ICSC) poll
shows a 3.0% increase but again, this is off an ultra-depressed base of a year
ago when the trend was close to -5.0%.


For example, the outlook for business spending has improved. No disputing that
one and in fact, we saw U.S. factory orders come in at +1.0% MoM in December,
which was double the consensus estimates. There is more to the manufacturing
data than just the orders and inventories — we also get shipments, which is real
demand (orders can always be cancelled although they can be a good leading
indicator for future production). We did a screen on all three variables — the
near-term and intermediate trend in shipments and orders as well as the
inventory-to-sales ratio (the lower the better), and saw some interesting
divergences. Below is a list of the sectors that screened the best and the worst:

• Primary metals
• Turbines/engines/power transmission
• Computers/electronic products
• Automotive
• Paper products
• Basic chemicals

• Commercial aircraft
• Farm machinery
• Construction machinery
• Industrial machinery
• Appliances

Page 10 of 12
February 5, 2010 – LUNCH WITH DAVE

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As of December 31, 2009, the Firm We have strong and stable portfolio
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