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David A.

Rosenberg January 21, 2011

Chief Economist & Strategist Economic Commentary
+ 1 416 681 8919


Breakfast with Dave

A mixed start to the day with European bourses up almost across the board on
debt rescue package optimism plus news that the German Ifo business  While you were sleeping:
confidence index rose to a record level in January (those Germans must love European bourses up
almost across the board;
ponying up for bailouts) as well as French business confidence just hitting a new Asian down; U.K. retail
three-year high. Asia is down for the most part on Chinese policy tightening sales came in very weak;
pessimism. U.K. retail sales, however, were very weak today (-0.8% in U.S. dollar continues to
December). soften; bonds trading
The U.S. dollar continues to soften and is perilously close to breaking below key  What will turn me more
support levels but despite that, gold just now broke below the 100-day moving bullish on the U.S.A. —
average for the first time in six months — the 200-day moving average is here’s a list of ten ideas
$1,280/oz and in the past, periodic corrections like this have proven to be nice (send yours in!)
re-entry points. Bonds are trading defensively and this may be putting a crimp in  LEI: less than meets the
the U.S. stock market for now as small-cap stocks have rolled over and the S&P eye: three components
500 has begun to sputter after its asymptotic run up from the August lows. accounted for 90% of the
Equities are as overbought now as they were oversold at the March 2009 lows increase ― hardly a show
of strength
and back then sentiment was very poor and today it is extremely high.
 U.S. initial jobless claims
The news has not been bad at all, in fact, the ‘street spin’ on yesterday’s data improve but may reverse
was positive and yet the equity market could still not close higher after course
Wednesday’s sharp selloff. Of course, digging beneath the surface, the leading  Some good news on the
indicator was actually close to being flat adjusted for the stock market, yield housing front, but still a
curve and spurious jump in building permits: the coincident-to-lagging ratio fell long way to go
and peaked last June; the jobless claims data based on the seasonal factors  Philly Fed slips in January
can be expected to reverse course and head back up substantially in coming but ISM still on track for a
weeks, and the housing data were noteworthy for showing that even with the gain
sales pickup, deflation is accelerating with median resale prices slipping 0.8% in
December and down for six months running — during which they have declined
at a non-trivial 15% annual rate. That hurts.

We are also hearing that policymakers are working behind the scenes to see it
that state governments begin to receive federal bankruptcy protection. What
that means for bondholders remains to be seen since recovery rates may end up
being 100% at the end of the day but for the public sector unions and their
workers, this can’t be very good news, especially those with massive unfunded
pension liabilities because one can be sure that contribution rates — taxes by
another name — are going to go up and up by a whole lot. The gravy train is
over. And the accelerating cutbacks in this critical part of the economy are going
to prove to be very deflationary. Maybe this is why investor reception to
yesterday’s TIPS auction was so tepid (the bid-to-cover ratio of 2.37 was the
weakest since April 2009 when the economy was knee deep in recession).

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
January 21, 2011 – BREAKFAST WITH DAVE


TEN IDEAS (SEND YOURS IN!) We need delineation of the
future of Fannie and Freddie if
1. An energy policy that truly removes U.S. dependence on foreign oil (shale
case, coal, nuclear).
there is any …
2. A complete rewrite of the tax code that promotes savings, investment,
and a revamp of the capital stock. Cut tax rates, eliminate loopholes and
costly tax breaks. Tax consumption, promote savings and investment.
That is crucial. But it will take political courage (ask Brian Mulroney).
3. A credible plan that reverses the runup in the debt to GDP ratio. This
includes not just on-balance sheet items but new rules governing
entitlements too. We need delineation of the future of Fannie and
Freddie if there is any … they became wards of the government nearly
three years ago and there is still no clarification on this file (slightly more
important than these periodic consumer spending gimmicks that have
surfaced over the past few years). We need a complete rewrite of social
contracts and a reversal in sacred cows that have been created over the
years that are completely unaffordable. Plus, people are not going to
learn to live within their means if our politicians continue to set a bad
example. The act of dipping into Social Security, incentivizing companies
who are already cash-rich to spend more on new equipment and
extending a Bush tax cut that always had a 10-year expiry date at the
expense of the already severely strained public purse was political
expediency at its worst.
4. A massive mortgage write-down by the banks — a Jubilee of biblical
proportions — that provide much-needed equity to upside-down
5. A creative strategy to put people to work instead of paying them to be
idle — having nearly half of the unemployed ranks out of work for over 15
weeks and a 25% youth jobless rate is unacceptable at any level.
6. Tort reform. The only way to rationally bring down health care costs to
more manageable levels.
7. And from six — use whatever proceeds they can save to enhance their
education skills, especially in the sciences and mathematics where the … they became wards of the
U.S.A. is sliding down the global scale. government nearly three years
ago and there is still no
8. Financial sector regulatory reforms that actually have some teeth. clarification on this file
9. Change tax policy to free up the hundreds of billions of dollars of
corporate cash sitting in reserve in overseas accounts — bring this
money home!
10. Our Republican friends may not like this too much but in Canada, we
understand the importance of immigration inflows and the U.S.A. should
be doing more on this front to stimulate its long-run growth potential.
This is where Japan’s decade of lost growth became two decades but its
decision to resist immigration rule changes is more cultural in nature.
The U.S.A., like Canada, is already extremely diverse. But as economists,
what goes into economic growth is both simple and complicated. The
simple part is merely identifying the two ingredients: growth in the
population (more specifically, the part of the population that is working)
and productivity (what most of the other nine ideas listed above would
attempt to generate). But the dependency ratio is working against the
U.S.A. and a smart immigration policy would help at least stem the runup.

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January 21, 2011 – BREAKFAST WITH DAVE

I refuse to be labelled a perma-bear even if I have been bearish for a long time.
Having been a bull in the 80s and 90s I do know what it feels like to wear rose- The reality is that U.S. policy
coloured glasses. But the reality is that U.S. policy has been adrift for over a has been adrift for over a
decade and it looks like all we have are measures that merely kick the can down decade and it looks like all we
the proverbial road. So it looks like 2012 will be the critical inflection point if have are measures that merely
there is one, not unlike, hopefully, what 1980 ushered in which was a complete kick the can down the
about-face from the ruinous policies dating back to the early 1970s. What we proverbial road
have on our hands right now is a recovery built of straw instead of bricks. An
economic expansion and bull market built on rampant expansion of the Fed and
Federal governments’ balance sheet is neither sustainable nor desirable. I am
desperately looking for reasons to turn more optimistic, but to do so, some
major policy shifts have to take place, like the ones above.

I am convinced that we will, before long, be replaying something along the lines
of the reversal of the tech mania and the reversal of the housing mania, which
were equally unsustainable. Those fully invested in the stock market today
thinking they have it all figured out are going to be faced with a deep quandary
and are putting their clients at huge risk.

No doubt there are some opportunities and we have identified them and they
include large-cap companies with impressive cash flow streams, trade
inexpensively, have nice dividend payouts and are non-cyclical in nature. We
also like basic materials for the longer term, and hedging out the inherent
volatility via long-short strategies makes perfect sense. And since corporate
balance sheets are still in reasonably good shape, it also is completely sensible
to be deriving income gains from the credit universe.

But now is the time, with the S&P 500 doing in 22 months what it took 60
months in the last bear market rally to accomplish (which is to double from the
recession lows), to start reassessing the beta and risk in the overall portfolio and
what your tolerance level is at the highs. Remember, we have witnessed a bear We have witnessed a bear
market rally, not the onset of a full-fledged secular bull market where you can
market rally, not the onset of a
full-fledged secular bull market
close your eyes and go to sleep for 16-18 years as opposed to nimble trading
where you can close your eyes
strategies to get you in and out. If and when we see the sort of policy shifts that
and go to sleep for 16-18 years
deliver secular growth, as we did in the 1950s and the first half of the 1960s
and again in the 1980s and 1990s, then it will be time to re-evaluate the
landscape and, dare I say …. become secular bulls!

Rest assured nobody is looking forward to that day more than yours truly. Until
then, the bond-bullion barbell and S.I.R.P. strategies (safety and income at a
reasonable price) are perfectly acceptable investment themes, and can be
captured across every asset class, even in equities!

Finally, it is worth stating that my concern over the sustainability of the current
economic expansion is not without support from some fairly impressive
individuals, even those that worked for President Obama. I strongly feel that
Peter Orszag’s column today on page 9 of the FT is a must-must read (America
Must Brace Itself For Turbulence).

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January 21, 2011 – BREAKFAST WITH DAVE

His conclusion:

“The bottom line is that there may well be U.S. public debt tremors this year,
both during federal debate over raising the debt ceiling and with at least a Claims are about 20k below
limited number of crises in local and city governments. The bigger problem, the December nonfarm
though, lies beyond 2011, as the unsustainability of the federal government’s reference week so we should
fiscal trajectory becomes increasingly clear. I hope it does not ultimately require see this translate into a
a crisis to restore fiscal sustainability at the federal level, but I fear it will. “ somewhat better payrolls
report when the data are
LEI: LESS THAN MEETS THE EYE released on February 4

The U.S. leading economic indicator (LEI) rose by an eye-popping 1.0% MoM in
December (nearly double the median expectation), following on the heels of a
1.1% increase in November. There was a strong contribution from the ‘financial’
variables ― the S&P 500 and yield curve together accounted for 50% of the
gain. Not only that but building permits, which surged by 17% MoM in
December but was likely a one-month wonder ahead of building code changes,
added four-tenths of a percentage point. So these three components accounted
for 90% of the increase ― hardly a show of strength.

Moreover, the coincident-to-lagging index, which tends to lead the LEI, fell 0.1%
MoM and continues to roll-over on a year-over-year basis; now at 1.3%,
significantly off from the 6.2% peak in April.


Initial jobless claims saw an unexpected improvement for the week of January
15 (which is the nonfarm payrolls reference week), dipping to 404k from the
downwardly revised 441k the week prior (and the first time we have seen the
prior week’s number revised down in over two months). Claims are about 20k
below the December nonfarm reference week so we should see this translate
into a somewhat better payrolls report when the data are released on February

Nonetheless, we continue to caution against drawing definitive conclusions from

these data. As we mentioned last week, this is a very difficult period to
seasonally adjust (and in fact, the not-seasonally adjusted claims still remain
elevated). We could see more volatility next week as the seasonal factor
becomes much less aggressive and this could lead claims to tick up again.

After the disappointing U.S. housing starts data a few days ago, we did see some housing starts data a few days
better numbers out of the existing home sales report, which rose 12.3% MoM in ago, we did see some better
December. This was better than the 4% penciled in by economists, but was numbers out of the existing
partially telegraphed by pending home sales (which tend to lead existing home home sales report
sales). We wouldn’t classify this as a ‘clean’ number in the sense that there may
have been one-off factors boosting the December figure. For one there was an
increase in distressed sales (+35%) after a recent moratorium and mortgage
rates jumped by 50bps, which may have pushed some buyers off the fence.

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January 21, 2011 – BREAKFAST WITH DAVE

Months supply ticked down to 8.1 months from 9.5 ― but by no means is this a
balanced market (i.e. it still favours buyers). This may explain why home prices What wasn’t as convincingly
continued to dip (down six months in a row) and negative on a year-over-year strong was the six-month
basis. outlook, which slipped by
nearly six points
The Philly Fed survey pulled back slightly in January, slipping to 19.3 from 20.8.
This is one of those surveys where the details don’t add up to the headline ...
and the details for the most part were on the strong side. New orders jumped
13-points to 23.6 (highest in over six years), while current shipments rose by
eight points. The number of employees index also rose sharply, to the best level
in over four years. Overall, along with the Empire Index that was released earlier
this week, so far these two surveys suggest that the ISM will rise when released
on February 1.

What wasn’t as convincingly strong was the six-month outlook, which slipped by
nearly six points. Within the details, we noted a decline in expectations of the
number of employees. The Special Question this month dealt with factors
influencing hiring plans over the next six-to-12 months. Amongst those firms
planning on increasing hiring over the medium term, the number one factor (by a
very large margin) was the expected growth rate of sales. Similarly, for those
firms not increasing hiring, the number one factor cited was sales growth (labour
costs came in third). So the message is that sales growth (and not much else)
will be critical for these firms hiring plans for 2011.

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January 21, 2011 – 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.


As of December 31, 2010, the Firm We have strong and stable portfolio
managed assets of $6.0 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 49% 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 Equity 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 $9.1 million2 on
investment styles (Value, Growth and For corporate bonds, we look for issuers
1 September 30, 2010
Income). with a margin of safety for the payment
versus $5.9 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. period.
We assemble concentrated portfolios -
our top ten holdings typically represent
PERFORMANCE between 25% to 45% of a portfolio. In this
$1 million invested in our Canadian way, clients benefit from the ideas in
Equity Portfolio in 1991 (its inception which we have the highest conviction.
date) would have grown to $9.1 million
Our success has often been linked to our
on September 30, 2010 versus $5.9 million long history of investing in under-
for the S&P/TSX Total Return Index followed and under-appreciated small
over the same period. and mid cap companies both in Canada
$1 million usd invested in our U.S. and the U.S.
Equity Portfolio in 1986 (its inception PORTFOLIO CONSTRUCTION
date) would have grown to $11.8 million
usd on September 30, 2010 versus $9.6
2 In terms of asset mix and portfolio For further information,
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
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January 21, 2011 – BREAKFAST WITH DAVE

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