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David A.

Rosenberg March 1, 2010


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

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave


WHILE YOU WERE SLEEPING
IN THIS ISSUE
Fast start to the equity markets to kick off the month — no Ides or slides or
bromides of March with European bourses up nearly 1% thus far and gains are • While you were sleeping —
seen across Asia (Nikkei and Kospi both +0.5%; Hang Seng +2.2%; Shanghai positive start to global
equity markets in March;
+1.2%). Bonds are selling off with Gilts getting crushed alongside some solid risk assets get a lift from
manufacturing data releases (echoed throughout Europe today). AIG and Greece; busy
week ahead in North
Commodities are firm — copper experiencing its best session in nearly a year on America
supply concerns following the severe Chilean earthquake. Gold and oil are • U.S. bank credit still
following in tandem — even in the face of the much worse-than-expected contracting — down
showing by China’s manufacturing diffusion index; the PMI fell to 52.0 in another $33bln, the 7th
February from 55.8 and was well below the consensus estimate of 55.2. weekly contraction in a
row. The question is, how
AIG is rallying sizably and reinforcing the positive sentiment across all risk assets is the economy managing
to grow with this severity
on the news that it intends to sell off its Asian life insurance unit for $35.5
in credit contraction?
billion to Prudential. In addition, government default and contagion concerns
are also being alleviated by strong signals now that the EU will come to the • Our take on the U.S. GDP
data — real GDP was
support of Greece (by allowing state-owned to buy Greek debt. Now let’s see
revised up in Q4, to 5.9%
what sort of credible fiscal austerity plan Greece is going to come up with in at an annual rate;
response and what the investors response is going to be for its looming, and however, keep in mind
delayed, 10-year bond auction; the country has over $15 billion of debt that at this stage of the
maturities it needs to roll over by the end of May). Watch out for a possible, but business/policy cycle, the
inevitably fleeting, near-term bounce in the Euro as the record short position level of real GDP is
already back at a new
gets at least partially covered; and the net speculative longs on the dollar too.
high
This could well unleash a renewed round of risk-taking so beware – there is over
a 50% inverse correlation between the long speculative position movements in • Fiscal follies — the fiscal
challenge for the U.S.
the U.S. dollar and the performance of the S&P 500, just as an example (a
federal government is
correlation that has doubled in recent years). spending. Federal
government spending now
On days when the Japanese Yen is in retreat, as is now the case, are days represents over 24% of
typically when global carry trades and risk appetite come back to the forefront. GDP, the highest ratio
The Yen is weakening on calls from Financial Services Minister Shizuka Kamei outside of World War II
for the BoJ to quickly begin a program of monetizing the government’s debt). spending
• Chicago bulls… or bears?
Despite the better tone to the data, the Sterling is getting pounded this morning
• More bad housing news in
from not only the AIG sale but also the latest polls showing that the Tories’ lead the U.S., and the U.K.
over the Labour Party has all but evaporated. Elections in the U.K. must be held
• Sentimental journey
by June and investors are contemplating the implications of a ‘hung parliament’
(political uncertainty). Couple that with heightened RBA rate hike expectations • The once-hot ECRI leading
and the Aussie dollar just hit a 25-year high against its U.K. alternative. Finally, economic indicator has
Warren Buffet’s forecast that the U.S. housing market will not recover before now rolled over
2011 given the lingering supply-demand mismatch more than likely will have the
growth bulls crowing that there’s only more year to go!

Please see important disclosures at the end of this document.

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March 1, 2010 – BREAKFAST WITH DAVE

CHART 1: RECORD NET SPECULATIVE SHORTS ON THE EURO


United States: Noncommercial Short minus Long Positions on the Euro
(number of contracts)
80000

40000

-40000

-80000

-120000
99 00 01 02 03 04 05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff

Busy week ahead, by the way, with Canadian GDP for Q4 out today (came in at
5.0% at an annual rate), the BoC policy meeting tomorrow (shift in tone?); the
Throne Speech on Wednesday, the Federal Budget on Thursday, and then we
have the U.S. payroll data to look forward to on Friday. Another decline in
nonfarm payrolls is expected but will be blamed on the weather. Indeed, the
weather is being blamed for everything that happened in February (except
perhaps by Colts fans) — see Snow Hits February Car Sales on page B1 of
today’s WSJ; in fact, the WSJ on page B9 blames the weather for why Canada
fell short on its own the podium objectives at the Winter Olympics — this time it
was “little snow” and not an abundance of it impeded “home freestyle skiing” on
Cypress Mountain.

CHART 2: RECORD NET SPECULATIVE LONGS ON THE DOLLAR INDEX


United States: Noncommercial Long minus Short Positions on the Euro
(number of contracts)
60000

40000

20000

-20000

-40000
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff

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March 1, 2010 – BREAKFAST WITH DAVE

BANK CREDIT STILL CONTRACTING


Let’s take it at face value that as long as bank credit is still shrinking, the jury will
As long as bank credit is
continue to be out regarding the consensus view of Fed rate hikes in the second
still shrinking, the jury will
half of the year and the ability of the economy to sustain above-potential growth.
continue to be out
The week of February 17 showed another week of contraction in banking sector
regarding the consensus
balance sheets with credit outstanding down $33 billion (-0.5%), the seventh view of Fed rate hikes in
contraction in as many weeks, during which the cumulative decline has come to the second half of the year
an astounding $150 billion. On a 13-week rate of change basis, bank lending to and the ability of the
households and businesses has collapsed at over a 12% annual rate, and the economy to sustain above-
declines have been broad based across personal loans, credit cards, mortgages, potential growth
home equity lines of credit, commercial real estate and industrial loans.

CHART 3: BANK LENDING CONTINUES TO CONTRACT


United States: Loans & Leases in Bank Credit for all Commercial Banks
(year-over-year percent change)

20

15

10

-5

-10
75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

Banks used to be in the business of making loans and yet as Chart 4 depicts,
lending as a share of assets is the lowest it has been in recorded history.

CHART 4: LENDING SHARE OF BANK CREDIT AT RECORD LOW


United States: Loans & Leases in Bank Credit as a share of Total Bank Assets
(percent)
66

64

62

60

58

56
75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

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March 1, 2010 – BREAKFAST WITH DAVE

The fact that the money multiplier and money velocity continue their descent
should be a warning sign to the Fed to go easy on its new strategy of reducing
the size of its balance sheet. The monetary expansion has only shown up in
$1.3 trillion of cash on bank balance sheets, which goes to show that the link
between money and growth has been delinked in a deleveraging cycle that is
actually gaining in intensity.

CHART 5: MONEY MULTIPLIER AT A RECORD LOW


United States: St. Louis Fed Biweekly M1 Money Multiplier
(ratio)

3.2

2.8

2.4

2.0

1.6

1.2

0.8
85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

CHART 6: VELOCITY OF MONEY AT A CYCLE LOW


United States: Velocity of Money: Ratio of Nominal GDP to M1 Money Supply
(ratio)

10.8

10.4

10.0

9.6

9.2

8.8

8.4
00 01 02 03 04 05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff

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March 1, 2010 – BREAKFAST WITH DAVE

CHART 7: A MOUNTAIN OF CASH


United States: Cash Assets For All Commercial Banks
(US$ billions)

1500

1250

1000

750

500

250

0
75 80 85 90 95 00 05
Source: Haver Analytics, Gluskin Sheff

The question is how the economy is managing to grow with this severity of credit
contraction. While consumer spending is second only to commercial contraction
in terms of lagging the nascent upturn in GDP, it is still growing. There is still no
How is the economy is
managing to grow with
job creation 26 months after the recession began and the lagged effects of a
this severity of credit
$12 trillion loss of household net worth continues to weigh on consumer
contraction?
confidence. The only component of personal income that has been growing on
any sustained basis has been government transfers. A 17% underemployment
rate is capping organic wage and salary growth.

So how is it that consumer spending is growing at all? Well, when you read
articles like When It's OK to Walk Away from Your Home in the WSJ and you see
websites being constructed that show distressed homeowners how to not pay
their mortgage and still stay in their house — strategic defaults that allow people
to switch from paying their mortgage to vacations in Disney World — then all you
know for sure is that we have reached a point where freeing up debt means
freeing up cash flow for other purposes. The reason why this was not the Great
Depression was because back in the 1930s there was still a certain shame in
not meeting your payments — there is no longer any stigma in defaulting and the
bank-bashing by the Obama team, not to mention foreclosure moratoria by edict
and recently, musings from the White House that foreclosures will be practically
outlawed entirely, has reinforced this mentality that being delinquent only
carries consequences for lenders and their shareholders. (Oh yes, there is the
argument that the banks shouldn’t complain because they were saved by Uncle
Sam — that is like a bank robber being shot in the act of the crime and then
brought to the hospital to be operated on: jail time still follows the operation and
that is the position the banks are now in).

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March 1, 2010 – BREAKFAST WITH DAVE

So at the margin, what we have are a growing number of Americans living for
free in homes they never could afford to begin with during the bubble era, and What we have are a growing
the repercussions lie with the lender in today’s populist backdrop, not the number of Americans living
borrower. As the banks and the taxpayer foot the bill, retail sales get for free in homes they never
underpinned even as credit contracts because the debt is either being written could afford to begin with
off by the banks or socialized by Uncle Sam. during the bubble era, and
the repercussions lie with
In the meantime, the debtor is enjoying the benefits of living for free with the the lender in today’s populist
complicity of a government finding it easy to point the finger at the banks for
backdrop, not the borrower
creating the mess we are still in today. This is why the banks were forced to
charge off 2.9 % of their loan book at the end of 2009 — the highest rate since
the FDIC began keeping records in 1934; not to mention the fact that 5.4% of all
bank loans were at least 90 days late at the end of last year. Meanwhile, the
FDIC ate two more banks on Friday, bringing the total number of failures so far
this year to 22 — compared to 16 this time in 2009 when everyone thought the
Battle of Megiddo was days away.

As the WSJ concluded, “whether we like it nor not, walking away from debt is as
American as apple pie.” One has to wonder what the implications of all this will
be on credit activity in the future. What financial institution will ever want to
lend again without the ability for recourse, as is the case in Canada (where for
some reason, the default experience turned out to be totally different than was
the case state-side).

OUR TAKE ON THE U.S. GDP DATA


Let’s just repeat that at this stage of the business and policy cycle, the level of
real GDP is already back at a new high. However, since this is a deleveraging
cycle in the context of a post-bubble credit collapse, comparisons to prior
recession/recovery phases don’t apply. Having said that, it is still instructive to
note that the level of real GDP is still 1.7% lower today than it was when the
recession began in the fourth quarter of 2007.

Not only that, looking at the past five decades, at no other time has NOMINAL GDP
contracted over a six-quarter period, as has been the case in the current cycle. In
the context of the most aggressive government stimulus on record, we can only
say that the efforts to cushion the blow from the intense private sector credit
collapse have fallen short of resurrecting a cycle of sustained inflation. Deflation
pressures abound with a de facto unemployment rate of nearly 17% and a
capacity utilization rate of just over 70% and a record post-WWII low in both the
employment rate and participation rate for adult males (ages 25 to 54 years old).

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CHART 8: EMPLOYMENT-TO-POPULATION RATIO FOR ADULT MALES AT


AN ALL TIME LOW…
United States: Employment-to-Population Ratio: Men (25-54 Years)
(percent)

96

92

88

84

80
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

CHART 9: … DITTO FOR THE PARTICIPATION RATE


United States: Labour Force Participation Rate: Men (25-54 Years)
(percent)

98

96

94

92

90

88
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

As an aside, Chart 10 shows that the five-year trend in nominal GDP just took
out the 1958 low, currently at 3.6% (the same level as current yield on the 10-
year Treasury note). This includes the latest Q4 bounce in real GDP and the
record amount of stimulus in the system and is consistent with a long-run S&P
500 Total Return assumption of just over 6% (not over 11%).

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CHART 10: FIVE-YEAR GROWTH TREND IN NOMINAL GDP


United States: Nominal GDP
(20-quarters percent change, annualized rate)

12

10

2
55 60 65 70 75 80 85 90 95 00 05

Shaded region represent periods of U.S. recession


Source: Haver Analytics, Gluskin Sheff

U.S. real GDP was revised up in Q4, to a 5.9% annual rate from 5.7% in the
initial report, but the details were mixed to somewhat disappointing. The bulk of
the revision was in inventories and capital spending (the latter exploded at an
18.2% annual rate); inventories added 3.9 percentage points or exactly two-
thirds to the headline GDP gain. Excluding inventories, GDP growth was 1.9% at
an annual rate, downgraded from 2.2% in the first estimate a month ago. Strip
out the added boost from the foreign trade sector and GDP actually slowed to
1.6% at an annual rate in Q4 from 2.3%. This is a very similar pattern to what
we saw in 1991 and 2002 — very fragile and jobless recoveries. The only
difference is that there is a whole lot more stimulus behind today’s data.

The sectors that are in secular decline are obvious from this report:
• State & local government contracted at a 2% annual rate and is now down in
four of the past five quarters.
• Nonresidential construction sagged at a 13.9% annual rate and is down in
each of the past six quarters.
• While housing did rise at a 5% annual rate, this was a big slowdown from the big
18.9% rebound in Q3 and is nothing more than a countertrend bounce; the
latest data on housing starts and home sales suggest renewed slippage in Q1.
The three areas of support to the GDP data look suspect too:
• Exports in volume terms surged at a 22.4% annual rate, the best performance
since 1996 Q4. The problem, going forward, is that the U.S. dollar has
stopped declining and the economic outlook abroad, especially in Europe, has
been downgraded.

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March 1, 2010 – BREAKFAST WITH DAVE

• Capital spending was the real bright light in the report, but there may have
been a real skew due to Windows 7.0 because business spending on For the recovery to happen in
computers/peripherals soared at an 83% annual rate, which was the fastest the U.S., the consumer must
growth rate since 1983 Q4; this is hardly sustainable. Software spending also participate — the consumer
jumped 22% and that was the best result since 2003 Q3. Corporate spending has led 80% of all past post-
on jets and cars (transportation) skyrocketed at a 66% annual rate — again, recession revivals (capex has
hardly likely to be repeated. At the same time, ‘old economy’ capex on never led once)
machinery fell at a 6.3% annual rate (down seven quarters in a row).
• Inventories have come back in line with sales to a sufficient degree that any
further contribution to GDP from here is likely to be rather muted.
But it is the consumer that holds the key:
The consumer has led 80% of all past post-recession revivals — capex has never
led once, but maybe this time is different (I shudder as I say that).

Consumer spending was revised down to a 1.7% annual rate from the earlier
estimate of 2.0% and the stimulus-led but still rather trepid 2.7% rebound in the
third quarter of last year.

What is fascinating is the sector split. Spending on cyclical durable goods was
basically flat on the quarter and down 8% from the pre-recession peak.
Curiously, volume spending on less cyclical nondurable goods rose at a 4.1%
annual rate — the strongest in three years. Spending on groceries rose at a 5%
annual rate, as an example.

Within services, we saw that housing/utilities posted a 2.4% annualized gain and
health care advanced 1.9%, but recreation was down 0.6% (negative now for three
straight quarters), restaurants fell 0.8% (down for six consecutive quarters) and
both financial services and transportation services were basically flat.

This is a picture of a consumer that is still allocating its budget more heavily
towards essentials and away from what is non-essential. Moreover, usually the
consumer comes bouncing out of the gates after a recession ends and averages
a 5% annual rate of growth in those first two quarters of post-recession recovery;
this time around, all we are seeing is 2.25%, with the bulk on non-cyclical goods
and services and in the face of all these government policies aimed at
promoting consumption.

Another sign of just how little pent-up demand there is after a near-two-decade
run of overspending and over-borrowing — remember, from 1992 Q1 right
through to 2007 Q4, we had gone an unprecedented 64-quarters uninterrupted
string of positive consumer spending growth numbers. This process towards
mean reversion — getting back to the consumption share of GDP that prevailed
when the super-spending cycle began two decades ago — will require household
expenditure restraint of at least $300 billion. This will take some time and in
the process will unleash powerful deflationary forces for the broad retail sector.
(The S&P 500 retail sector may already be braced for this because it is still no
higher today than it was at the tail-end of 1999!)

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March 1, 2010 – BREAKFAST WITH DAVE

Similar on the leverage side, consumer credit rose each and every month from
February 1998 without stop to July 2008. Over that time frame, consumers In our view, only invest in
tacked on $1.2 trillion in non-mortgage loans to the liability side of their balance companies with proven cost-
sheet; basically 30% of incremental expenditures were being conducted off the cutting skills and effective
credit card or other loan products. Since July 2008, when the music died and market share expansion
Chuck Prince stopped dancing, we have seen no fewer than 15 monthly declines strategies because top-line
in consumer credit, which is as many in the past 18 months as we saw in the prior revenues will be difficult to
18 years. Welcome to the new paradigm of consumer deleveraging and frugality.
grow and the overall
consumer spending pie is
more likely to shrink than
Buy only those companies with proven cost-cutting skills and effective market
advance
share expansion strategies because top-line revenues will be difficult to grow
and the overall consumer spending pie is more likely to shrink than advance. As
an exclamation mark to the deflation view, the GDP price deflator came in just
40 basis points north of zero in Q4 (was 60bps in the first estimate); think of
that in the context of a 5.9% ‘real growth’ and the lingering impacts of all the
monetary, fiscal and bailout stimulus.

Chart 11 is the five-year trend in real GDP and as you can see, it depicts the
business cycle to a tee … half-decade cycles that see a low of around 1.5% and
a high of 4.5-6.0%. Look what happened this past cycle. For the first time,
despite the massive credit bubble, the best the economy did on this trend basis
was peak at 3%. And, we bottomed at barely over 1%, which has never
happened before, at least within the confines of the post-WWII experience. Now
we are into a credit collapse and the starting point on the trend rate of growth in
real GDP is flirting with the 1% threshold. This may well be why, despite all the
prognostications of a bull market over and over again, equities have little to
show for the past decade except no net gain and tons of volatility and why fixed-
income has been the outperforming asset class.

CHART 11: THE FIVE-YEAR GROWTH TREND IN REAL GDP


United States: Real GDP
(20-quarter percent change, annualized rate)
7

1
55 60 65 70 75 80 85 90 95 00 05

Shaded region represent periods of U.S. recession


Source: Haver Analytics, Gluskin Sheff

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March 1, 2010 – BREAKFAST WITH DAVE

FISCAL FOLLIES
I get asked all the time why anyone should get nervous over the fiscal backdrop
since so much of the deficit is due to faltering government revenues. Well, here is
the answer. If revenues had not declined as a share of GDP, as it usually does in a
recession as lower employment, wages and sales drag down tax receipts, then the
deficit would be $1.1 trillion today, not $1.5 trillion. Hopefully that makes you feel
better, but it shouldn’t because what this means is that even if the economy
comes back to the point where revenues re-accelerate, we would still be left with a
deficit of 7-8% of GDP. We need a budget gap of half that size at most to prevent
the U.S. public debt-to-GDP ratio from maintaining its upward trajectory.

The fiscal challenge is one of dramatic overspending by the federal government


— not just spending, which is normal to combat a recession, but the degree and
the lack of effectiveness since cash-for-clunkers, Social Security bump-ups,
bailouts and housing goodies provide a short-term sugar-high but do not have
very powerful multiplier impacts and do little to encourage investment and
productivity growth. So, when we do the math a little differently and assume
that the government had held its spending-to-GDP ratio constant during this
recession, then the deficit would be $650 billion today (due to the recession
effect on the revenue base and the effects from whatever tax relief has come
our way over the last two years).

Federal government spending now represents over 24% of GDP. Let’s put that
into some context. Scouring eight decades of data, outside of World War II,
government spending has never been so high in relation to the size of the
economy. During the roll-out of the LBJ ‘Great Society’ experiment, this share
approached but never exceeded 20%. During the peak of military spending
during the Vietnam and Korean wars, this ratio rarely touched the 20% mark. In
fact, go back to the Great Depression and the seven years of massive New Deal
stimulus and incursion by FDR, and the spending to GDP ratio peaked at just
over 10% — less than half of where it is today. (Ditto for the deficit-to-GDP ratio,
which never exceeded 6% as a share of GDP back in the 1930s; FDR was a
downright conservative next to what we have on our hands today)!

CHART 12: FEDERAL SPENDING TO GDP IS NOW APPROACHING 25%


United States: Federal Outlays as a percent of GDP (percent)

45.0

37.5

30.0

22.5

15.0

7.5

0.0
30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

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March 1, 2010 – BREAKFAST WITH DAVE

CHICAGO BULLS … OR BEARS?


The Chicago PMI was released last Friday and it came in better than expected,
at 62.6 in February from 61.5 in January (consensus was at 59.7). This was the
fifth increase in a row and the best headline result since April 2005 when the
economic recovery was three-years old.

The components were very mixed — only backlogs and vendor delivery
performance were up. Employment fell back in February, to 53 from 59.8;
inventories sagged, to 42.4 from 48.7; orders slipped, to 62.2 from 66.4; and
production eased a bit, to 65.2 from 66.6. We don’t know why there is so much
fuss over this regional indicator anyway, which does little better than a 60%
accuracy record in terms of tracking the national ISM index.

MORE BAD HOUSING NEWS


Existing home sales followed what happened in the new market for homes and
cratered in January. No doubt the weather will be blamed, although this doesn’t
hold much water because the big snowfalls happened in February, not January,
and every region, including the ones that had no snow, posted hefty declines
(the South was down 7.4% MoM, for example).

In total, sales plunged 7.2% MoM after a December detonation of 16.2% in what
was the worst two-month decline on record. At 5.05 million units (annualized),
turnover was well below the 5.50 million units that the consensus was expecting
and down to a seven-month low.

CHART 13: FROM ‘V’ TO ‘Л’


United States: Total Existing Home Sales
(million units at an annual rate)

6.8

6.4

6.0

5.6

5.2

4.8

4.4
07 08 09
Source: Haver Analytics, Gluskin Sheff

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The median price of an existing single-family home fell 3.5% MoM, to $163,600
— breaking below the January 2009 low (when everyone thought the Grim
Reaper was around the corner) to a new eight-year low. Look for the Case-
Shiller home price index, which is calculated on a three-month average, to start
deflating very soon.

CHART 14: HOME PRICES BREAK DOWN TO A FRESH EIGHT YEAR LOW
United States: Median Sales Price for Existing Single-Family Homes
(US$)

240000

220000

200000

180000

160000

140000

120000
97 98 99 00 01 02 03 04 05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff

All of a sudden, what looked to be a return to a balanced market in November


when the inventory backlog got as low as 6.5 months’ supply has since
ratcheted back up to a four-month high of 7.8 months. And, this is in advance of
all the shadow inventory from the foreclosure pipeline that still has yet to hit the
market.

The U.S. is not the only housing market to be rolling over … the U.K.’s housing
market appears to be doing the same where the Nationwide Building Society has
published the February home price data, which showed a 1% decline — the first
setback in 10 months. If this is an Anglo-Saxon trend, then there is no reason to
expect it not to come to Canada where housing values are overvalued from
anywhere between 15% to 35%.

SENTIMENTAL JOURNEY
Consumer sentiment, as per the University of Michigan survey, came in at 73.6
for the final read in February (preliminary was 73.7), which was below the 74.4
reading in January but nowhere near the disaster we saw in the Conference
Board’s report. So, what it suggests is that weather was a poor excuse for the
Conference Board reading. What separates these two surveys is that the
Conference Board is more sensitive to employment and income, while the UofM
is more linked to the stock market, which of course had a nice rebound from the
January drubbing.

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March 1, 2010 – BREAKFAST WITH DAVE

Similar to the Conference Board’s results, the weakness in the UofM survey was
in the current conditions component, which slipped to 81.8 from 84.1 in
January. The ‘outlook’ improved from the first half of the month, to 68.4 from
66.9, but was still off from the 70.1 reading in January.

You can go crazy analyzing each and every tick up and down in these surveys
but the big picture is that the current levels are still closer to where they average
in recessions than in economic expansions. At least there was good news for
the Treasury market in that the five-year ahead inflation expectations dipped
further to 2.7% from 2.8% earlier in the month and 2.9% in January (the nearby
peak was 3.0% last November).

ROLL OVER!
The once-hot ECRI leading economic indicator that at one point accurately
foreshadowed the near 6% GDP print for Q4 is now heading in the opposite
direction. The index dipped fractionally in the February 19th week — the fifth
decline in a row and at its lowest level since November 6, 2009.

More critically, the smoothed leading index is faltering badly — it is now down for
10 weeks running and while still positive, at 14.93, is half the nearby peak and
down to levels last seen in early August. Look for a significant cooling off in the
pace of economic activity in the months and quarters ahead. (The index has a
66% correlation to GDP growth but not with much of a lead time, actually — in
other words, the big slowdown may just be a quarter away.)

CHART 15: THE GROWTH RATE IN THE ECRI IS FALTERING BADLY


United States: ECRI Weekly Leading Index Growth Rate
(percent)

30

20

10

-10

-20

-30
06 07 08 09

Source: Haver Analytics, Gluskin Sheff

Page 14 of 16
March 1, 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 December 31, 2009, the Firm We have strong and stable portfolio
managed assets of $5.3 billion. management, research and client service
teams. Aside from recent additions, our Our investment
Gluskin Sheff became a publicly traded
Portfolio Managers have been with the interests are directly
corporation on the Toronto Stock
Firm for a minimum of ten years and we
Exchange (symbol: GS) in May 2006 and aligned with those of
have attracted “best in class” talent at all
remains 54% owned by its senior our clients, as Gluskin
levels. Our performance results are those
management and employees. We have Sheff’s management and
of the team in place.
public company accountability and employees are
governance with a private company We have a strong history of insightful collectively the largest
commitment to innovation and service. bottom-up security selection based on client of the Firm’s
fundamental analysis.
Our investment interests are directly investment portfolios.
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,
$1 million invested in our
client of the Firm’s investment portfolios. shareholder-minded management and a
Canadian Value Portfolio
share price below our estimate of intrinsic
We offer a diverse platform of investment in 1991 (its inception
value. We look for the opposite in
strategies (Canadian and U.S. equities, date) would have grown to
equities that we sell short.
Alternative and Fixed Income) and $10.7 million2 on
investment styles (Value, Growth and For corporate bonds, we look for issuers
1 December 31, 2009
Income). with a margin of safety for the payment
versus $5.5 million for the
of interest and principal, and yields which
The minimum investment required to S&P/TSX Total Return
are attractive relative to the assessed
establish a client relationship with the Index over the same
credit risks involved.
Firm is $3 million for Canadian investors period.
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)
Our success has often been linked to our
would have grown to $10.7 million on
2

long history of investing in under-


December 31, 2009 versus $5.5 million for
followed and under-appreciated small
the S&P/TSX Total Return Index over
and mid cap companies both in Canada
the 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 $11.7 million In terms of asset mix and portfolio For further information,
usd on December 31, 2009 versus $9.2
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
macroeconomic view.
Notes:
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 15 of 16
March 1, 2010 – BREAKFAST WITH DAVE

IMPORTANT DISCLOSURES
Copyright 2010 Gluskin Sheff + Associates Inc. (“Gluskin Sheff”). All rights and, in some cases, investors may lose their entire principal investment.
reserved. This report is prepared for the use of Gluskin Sheff clients and Past performance is not necessarily a guide to future performance. Levels
subscribers to this report and may not be redistributed, retransmitted or and basis for taxation may change.
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 Foreign currency rates of exchange may adversely affect the value, price or
simultaneously to internal and client websites and other portals by Gluskin income of any security or financial instrument mentioned in this report.
Sheff and are not publicly available materials. Any unauthorized use or Investors in such securities and instruments effectively assume currency
disclosure is prohibited. risk.

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

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