David A.

Rosenberg June 15, 2009

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

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

PLEASE NOTE THAT DUE TO BUSINESS TRAVEL, BREAKFAST WITH DAVE
WILL RETURN ON WEDNESDAY, JUNE 17 IN THIS ISSUE

• Today’s reversal in
WHILE YOU WERE SLEEPING overseas markets were
Equities are selling off with the global MSCI index off nearly 1.0% and the losses more words than deeds
broadly based (Europe off 1.8%, Japan down 1.0%, Hong Kong losing 2.1%). • The bond market survived
Bonds are rallying 6 - 7 basis points here and across the pond. Commodities the supply onslaught of
are facing a heavy round of profit-taking — gold down to a three-week low, last week … not to
copper slipping more than 3.0%, oil slipping 2.0%. The U.S. dollar is mention Russia’s
comments as well
strengthening right across the board too — back below 1.40 on the Euro and the
CAD is back above the 1.13 mark. The Asian FX complex and the commodity- • The Fed, the lender of first
based currencies are taking it on the chin. and last resort … and
everything in between
THERE WERE NO DATA RELEASES TODAY, SO WHAT HAS CAUSED THIS • Some fascinating tidbits in
REVERSAL? the University of Michigan
More words, than deeds. survey
First, the G8 meeting ended with emphasis being placed on exit strategies that • The 55+ age cohort — in
involve stimulus withdrawal. Investors have no clue how the global economy or search of safe income
the financial markets can operate on their own two feet, so investors are now
voting with their pocketbooks. A future without a government subsidy doesn’t
look so promising for all these once-successful beta trades.

Second, the Russian finance minister Alexei Kudrin went on the wires claiming
that Russia sees the U.S. fundamentals as being solid and that there is no
replacement for the dollar. Spasiba.

Third, the head of New Zealand’s Manufacturer’s and Exporter’s Association,

John Wally, followed in Mark Carney’s footsteps and said overnight that “I don’t
see any green shoots in our markets in New Zealand and the rest of the world.”
That’s all this faith-based equity market rally needed to hear was that the green
shoot era was over before the selling settled in.

Hans Heinrich, the President of Germany’s Chamber of Commerce, also had the
temerity to tell the Telegraph that funding conditions for German business was
actually tougher now than it was at the peak in credit spreads. Now who wants
to hear that? We’re amazed that the comments were published.

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June 15, 2009 – BREAKFAST WITH DAVE

THESE ARE GREEN SHOOTS?

The bond market
survives the supply
These YoY numbers, as of last week, hardly paint the picture of an imminent
onslaught …
recovery:
! Raw steel production (-47.3%)
! Lumber production (-32.6%)
! Railway traffic (-20.1%)
! Electrical output (-12.9%)

DEFLATION HITTING EUROLAND?

Just as the entire region posted a zero inflation rate in April, we see one country
in May whose YoY CPI trend actually went into sub-zero mode in May — Ireland
with a -4.7% rate. This represented the sharpest deflation rate since 1933.

SOME POSITIVE SIGNS IN CHINA

While exports seemed to have suffered a bit of a setback in May (-36.4% YoY
versus -22.6% in April), it does look as though the government stimulus is
percolating through the Chinese economy much more quickly than it is the case
in the industrialized world. Retail sales are up more than 15.0% YoY; turnover in
the commercial and residential real estate market has expanded 45.3% and
investment spending has accelerated at a 33% YoY pace. No wonder
commodity prices are booming again.

GAS PAINS FOR THE U.S. CONSUMER

… So much for the
Gasoline receipts surged at a 52.0% annual rate in May and the ‘siphon off’ view that investors
effect is going to get worse because the IEA is forecasting $2.70 on retail were going to
gasoline across the U.S.A. by next month. That would imply a $150 billion drag abandon Treasuries
at an annual rate so far this year on discretionary spending or the equivalent of for good
a near 2% pay cut for the average worker.

BOND MARKET SURVIVES THE SUPPLY ONSLAUGHT ... NOT TO MENTION

RUSSIA WITHOUT LOVE
So much for the view that investors were going to abandon Treasuries for good
— of all the auctions, the one that served up the bond with the longest duration
fared the best last week. The bid-cover ratio for the 30-year bond auction was
2.68, up from an average of 2.21. The auction yield of 4.72% was right in line
with the when-issued market. Indirect bidding took up a 49% share of the
auction, up from a 33% average, and a sign that there are other central banks
(Bank of Japan, for example) that are likely more than just a tad more important
than Russia or Brazil.

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THE NEW FRUGALITY

The market may well have bottomed, and maybe the economy will soon too What was a lingering
(though we are not necessarily convinced). Even so, remember that both theme during the
bottomed in the summer of 1932 and the depression did not end for another 1930s, as is the case
eight years. Moreover, despite more than a half-decade of New Deal stimulus today, was frugality
and government incursion in the capital market and the economy, we finished
off the 1930s with a 15% unemployment rate, consumer prices deflating at a
2% annual rate, the equity market extremely volatile and the long bond yield
heading below 2%. The equity market was volatile and pattern-less following the
immediate aftermath of the post-lows surge in the summer and fall of 1932, and
the enduring story was one of deflation, not inflation, and of income growth, not
capital gains. It was not until 1954 that a new bull market began, and the
economy never did manage to sustain above-trend growth until World War II.

What was a lingering theme during the 1930s, as is the case today, was
frugality; living below one’s means after more than a decade of living above
one’s means (the 1990s and early 2000’s were the new 1920s as the savings
rate dipped into negative terrain during both go-go periods). Have a look at A
New Spirit of Sobriety Takes Hold in the special insert section of the weekend
Financial Times and the story behind why it is that consumer discretionary items
like Swiss watches are down 24% on a YoY basis — the first time this has ever
happened.

THE LENDER OF FIRST AND LAST RESORT … AND EVERYTHING IN BETWEEN

Any country whose central bank takes over as the primary provider of credit to
the private sector is a country whose currency is very likely on as secular slippery
slope. This is supposed to be a capitalist economy, and yet the Fed is acting as Believe it or not, the
Fed is now backing
the credit czar and allocating loans by fiat — see Lender’s Role For Fed Makes
loans of every shape
Some Uneasy on the front page of the Saturday New York Times. Believe it or
and form
not, the Fed is now backing loans for motor homes, rental cars, snowmobiles
and recreation equipment. The article says that the Fed recently held a
conference call with RV manufacturers for crying out loud; and why shouldn’t it,
when the President applies his own pressure — Obama is quoted in the article
saying “When we talk about layoffs at companies, like Monaco Coach and
Keystone RV and Pilgrim International, we’re not just talking numbers. We’re
talking about people who’ve lost their livelihoods and don’t know what will take
its place.” Imagine lobbying the Federal Reserve to add loans for recreational
vehicles to its already extensive collateral base in the TALF — and on May 16,
the Fed indeed said it would start allowing loans backed by motor homes,
campers, boats, snowmobiles and motor vehicles. Where is the independence
of the central bank? At what point is a line drawn between necessity and luxury?

The other policy proposal being pursued by President Obama is this $4,500
‘cash for clunker’ strategy working its way through Congress to support the auto
industry at the taxpayer’s expense — yet again, the government refuses to
accept the new reality of consumer frugality and savings, which is really quite
regretful.

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The question is how Mr. Obama can preach fiscal rectitude and at the same One of the dirty little
time continue following tax policies that fuel conspicuous consumption at great secrets in the U of M
expense to the pubic purse. survey was
respondent’s opinions
As an aside, one of the dirty little secrets in the University of Michigan (U of M) about government
consumer sentiment survey was that “opinions about government policy” fell policy … down sharply
sharply in June, to 93 from 108 in May — tied for the sharpest decline on record. in June

OTHER FASCINATING TIDBITS IN THE UNIVERSITY OF MICHIGAN SURVEY

We are always on the look out for extremes, and in a sign of how extreme the
bearish sentiment is on the bond market. The share of respondents from the
U of M survey that saw interest rates backing up further rose in June to 53%
from 36%; and the share that are bullish sank to 10% from 19%.

The gap between the bond bears and bulls widened out to 43 percentage points
— the last time we had a number like this was back in August 2007, and
unbeknownst to many back then as the stock market was heading to new all-
time highs, the yield on the 10-year note was 4.8% and rallied 100 bps to 3.8%.

The backup in mortgage rates has bitten into homebuying intentions, which
slipped to 152 in June from 162 in May. Home price declines may help out
affordability ratios, but they also scare away buyers seeking future capital gains
— the share of prospective buyers in the market because real estate is seen as a
good investment was all the way down to historic lows of 1% in June. For autos,
it was a different story; car buying intentions rose for the third month in a row, to
140 in June from 132 in May (best level since December 2006). One would
think that auto plans would be getting a lift from the looming ‘cash for clunkers’
rebates but the subindex monitoring demand for ‘new fuel efficient models’
actually was zero last month. The share saying that interest rates were
attractive also fell to 13% from 19%. So what was the kicker? Price deflation —
the share saying lower prices rose to 65% from 60% in May and 57% in April.

VALUATION — AIN’T WHAT IT USED TO BE

Good read by Paul Lim in the Sunday NYT on this topic — This Rally May Need a
New Source of Fuel. The bottom line is that in the first three months after a
market low, the multiple typically expands 10%, but this time around, it has risen
42%. Hope springs eternal that all the Obama and Bernanke stimulus will turn
the economic ship around in a V-shaped fashion. Based on operating earnings,
the multiple is now 22x, which is a full three multiple points above the long-run
average.

RECALL BOB FARRELL’S RULE #9

Hopefully we don’t need to remind anyone who the dean of Merrill Lynch
research was for the better part of four decades, and his famous Market Rules
to Remember. These are investment commandments to live by, and Rule #9
stipulates that “When all the experts and forecasts agree, something else is
going to happen.”

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June 15, 2009 – BREAKFAST WITH DAVE

We thought of that when we came across this headline in the weekend Wall
Street Journal — Building a Portfolio That Will Stay Afloat When Inflation Returns The only segment of
(page B6). In fact, ‘reflation trades’ have become the flavor du jour in virtually the population that is
every business column and economic and strategy publication we come across gaining jobs is the 55-
these days. Has there ever been a more crowded trade? Something else is plus age category
indeed going to happen. It’s called, welcome back, 2002.

IN SEARCH OF SAFE INCOME

What really struck us in the employment report of a few weeks ago was the fact
that the only segment of the population that is gaining jobs is the 55+ age
category. This group gained 224,000 net new jobs in May while the rest of the
population lost 661,000. In fact, over the last year, those folks 55 and up
garnered 630,000 jobs whereas the other age categories collectively lost over
six million positions. This is epic.

Chart 1: TALE OF TWO POPULATIONS

United States (thousands)

27,500 147,000

146,000
27,000

145,000
26,500

144,000
26,000
143,000
Total Civilian
25,500 Employment of 55+ Employment
Age Group (rhs) 142,000
(lhs)
25,000
141,000

24,500 140,000
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09

Source: Haver Analytics, Gluskin Sheff

Moreover, the number of 55 year olds and up who have two jobs or more has
risen 1.1% in the last year, the only age cohort to have managed to gain any
multiple jobs at all. Remarkable. These folks have seen their wealth get
destroyed by two bubble-busts less than seven years apart — the Nasdaq nest
egg back in 2001 and the 5,000 square foot McMansion in 2007. Both bubbles
ended in tears … and so close together.

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The boomer population saw the beloved S&P 500 from 1,520 on September 1,
2000, to 776 on October 9, 2002; and then from 1,565 on October 9, 2007, to Boomers have seen
666 on March 9, 2009. While the S&P 500 has managed to climb back to 950, their wealth get
who cares? It’s still no higher today than it was in July 1997. July 1997! The destroyed by two
median age of the boomer back then was 40; today’s it is 52, with no increase bubble-busts less than
at all in their aggregate equity wealth in 12 years. Hopefully the boomers had a seven-years apart
portfolio with relative dividend-payers because that was the only source of total
return for everyone. Outside of that, cash was a much better attractive class.
Over a 12-year span; and a span that included two historic price peaks!

But what this new demographic data from the employment data is telling us is
that there is a new drive for income ... both in the labour market, and in the
market for securities. In fact, this drive for income is also showing up in many
other places too — like reverse mortgages, for instance. In April alone, the
government insured some 11,600 reverse mortgages — the most since the
government-backed program began in 1990 — as seniors move to secure
income from whatever home equity they have left in their real estate assets.

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June 15, 2009 – BREAKFAST WITH DAVE
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