David A.

Rosenberg December 15, 2009

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

MARKET MUSINGS & DATA DECIPHERING

Latkes with Dave

WHILE YOU WERE SLEEPING
IN THIS ISSUE
Data overnight were certainly not of the bond-friendly variety with France’s
inflation rate joining China and swinging into positive territory for the first time in • While you were sleeping —
seven months (+0.5% YoY and an expected 0.2% MoM rise). Of course, much of economic data across the
globe were certainly not of
this reflects depressed year-ago bases, which are exaggerating the swing. Core the bond-friendly variety
CPI in France actually FELL 0.1% MoM and is running at a tepid 1.7% YoY rate.
• U.S. money velocity and
U.K. headline inflation also ticked up 0.3% MoM (consensus was at +0.2%) and the S&P 500 — there is a
very tight relationship
this took the YoY rate to 1.9% in November from 1.5%. European auto sales between the two
continue to respond to government incentives and popped 27% YoY in
November — again flattered by depressed November 2008 levels. This is a • Can the U.S. yield curve
steepen even more?
rapid acceleration from the +11.2% pace in October and +6.3% in September.
So if momentum is your game, then the automotive sector across the pond has • We don’t have a big
its motor running. inflation view, but in case
inflation were to stage a
comeback, we have
The German ZEW investor sentiment did dip to 50.4 in December from 51.1 in
highlighted some ways to
November but this is being treated as a green shoot as it did not drop to 50 as play that scenario
was widely expected (though it is down now for three months in a now … now in
• Post-Christmas sales may
this era of “good news only”, that was a tidbit that was really tough to find).
disappoint — according to
a consumer survey, only
In terms of market action, the U.S. dollar is firm and the commodity currencies are 35% of consumers plan to
selling off in the aftermath of comments from the Reserve Bank of Australia (from shop after the holiday
the policy meeting minutes) which have investors believing that the rate hike in the season
Land of Oz may be over and done with (or that at least a pause is in order). The • GDP is not everything —
greenback is also now trading at over a two-month high against the Euro even the data is revised
though it is the ECB that has been more vociferous over an exit strategy. Then massively in the future
again, while the U.S.A. does have Illinois and California, it does not have Spain, and is not the best
Portugal, Ireland and Greece to worry about in terms of default risks. barometer of economic
health
Bonds are trading quite jittery as inflation expectations are creeping in just as the • Why inflation expectations
supply schedule is looking more ominous. Equities are lower too with the U.S. may be creeping higher
stock market opening on a down note (U.S. futures were in the red and the S&P • Speculation runs amok —
500 is coming off a four-day winning streak that took it to a new 14-month high just take a look at the
yesterday). Asian equities were off 0.8% overnight with declines right across the latest Commitment of
board (talk about a region that is more than fully priced at the current time — Traders report
trading at 22x forward earnings). Commodities are trading lower today along with • The Empire strikes out —
the firmer dollar — the DXY index just poked its nose above the 100-day moving New York Empire State
average on the upside; gold is testing the 50-day moving average to the downside; manufacturing index
plunged in December
oil has already sliced through its 50 and 100-day moving averages and a test of
the 200-day moving average would imply $65/bbl. • Light trucks exert heavy
impact on U.S. producer
prices

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
December 15, 2009 – LATKES WITH DAVE

U.S. MONEY VELOCITY AND THE S&P 500

Chart 1 maps out the S&P 500 with money velocity (GDP/M1 ratio). There is a
If U.S. banks don’t begin to
90% correlation between the two. It is one thing to have the Fed pump liquidity
extend credit in 2010, it is
into the system but it is quite another for the liquidity to be re-leveraged into credit
hard to see the 2009
and recycled into the economy.
equity market bounce from
oversold lows as being
The Fed’s easing program is over two years old and the rampant Fed balance sustained in the coming
sheet expansion 15 months old, and still to this day, what the commercial banks year
have done (to Obama’s wrath) with all that liquidity is to keep it as cash on their
balance sheet to the tune of $1.2 trillion. We’re not sure why Obama is as rankled
as he is because the banks are in fact lending out a good chunk of that Fed-
induced liquidity — right back to Uncle Sam (the banks now own a record $1.3
trillion of government securities).

Back to the chart — there is obviously a close connection between money turnover
and the stock market. But we can get periodic divergences as we did in the first
leg of the rally in 2003. But the carry-through from 2004 to 2007 hinged critically
on that multi-year acceleration in money velocity. If we don’t see the banks begin
to extend credit in 2010, it is hard to see the 2009 bounce from oversold lows as
being sustained in the coming year.

CHART 1: VELOCITY OF MONEY AND THE STOCK MARKET

ARE HIGHLY CORRELATED
United States: Total Nonfederal Debt to Nonfederal GDP Ratio
(percent)
10.5 1600
r = 0.90
Money Velocity
10.0 (Nominal GDP to M1:
ratio: left hand scale) 1400
9.5

9.0 1200

8.5
S&P 500 1000
8.0 (level: right hand scale)

7.5 800

7.0
600
6.5

6.0 400
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff

Page 2 of 9
December 15, 2009 – LATKES WITH DAVE

CAN THE YIELD CURVE STEEPEN EVEN MORE?

We do have the steepest U.S. yield curve in three decades on our hands, but that We do have the steepest
is not to say that it cannot get even steeper. For one, the Fed is going to come out U.S. yield curve in three
again this week, in all likelihood, and state for the record that it will be keeping decades on our hands, but
rates near zero for an “extended period” of time. This should help anchor the front that is not to say that it
end of the yield curve.
cannot get even steeper

As for the back end of the curve, if last week’s bad case of indigestion was any
sign in terms of the poor showings at the Treasury auctions, there is a risk that
we end the year with more of the same. There apparently is going to be a
whopping $118 billion of new Treasury supply to hit the market in the last week
of December, this at a time when liquidity conditions are not exactly going to be
that robust.

HOW TO PLAY INFLATION?

There is no sense in being dogmatic. But just in case inflation were to stage a
comeback, this is how one would prepare for it: We don’t have a big
inflation view, but you
• Precious metals (while gold grabs the spotlight, silver has surged 52% this never score brownie points
year and has far outpaced the 27% runup in gold; and the gold/silver ratio, by being dogmatic
while down from a peak of 84 to 66, is still above the average of 54 over the
past three decades).
• An even steeper U.S. yield curve!
• TIPS (or real return bonds) — the 5-year TIPS breakevens right now point to an
inflation expectation of just over 1.7%, whereas consumer expectations are
closer to 2.6%.
• Short-term duration corporate bonds (and go out the credit curve).
• Commodity currencies — Canadian Loonie, New Zealand Kiwi, Aussie dollar,
Brazilian Real, and Norwegian Kroner.
• Basic material stocks (including energy) as well as consumer staples (tobacco,
food/beverage).

We don’t have a big inflation view, but you never score brownie points by being
dogmatic. If (when?) the massive amounts of fiscal and monetary stimulus ever
do show through in final inflation (this will hinge on a renewed expansion in
household balance sheets and a fresh credit-creation cycle), these are the areas
that would likely garner the most investor interest.

Page 3 of 9
December 15, 2009 – LATKES WITH DAVE

UTILITIES VERSUS FINANCIALS

As Chart 2 illustrates, why buy U.S. financial stocks when you can pick up a
record yield spread in the utilities sector.

CHART 2: A BIGGER PAYOUT IN THE UTILITY SECTOR

THAN IN THE FINANCIAL SECTOR
United States: Dividend Yield: S&P Utilities relative to Financials*
(ratio)
As of Q4 2009, Dividend Yields:
2.9
Utilities = 4.10 and Financials = 1.51
2.7

2.5

2.3

2.1

1.9

1.7

1.5

1.3

1.1

0.9

0.7
59 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07

*Prior to 1974, using Financial Money Centers as a proxy for financials. After 2001, using GICS classification for
utilities and financials
Source: Haver Analytics, Gluskin Sheff

POST-CHRISTMAS SALES MAY DISAPPOINT

A survey by America’s Research Group over the weekend showed that only 35%
of consumers intend to do any shopping the week after Christmas. This is down
from 38% a year ago and below the typical range of 48-55% over the past
decade. Moreover, and this is bound to depress January sales data, the share
of shoppers buying gift cards dropped to 49% this year from 53% at this time in
2008. A mere 24% said they shopped this year with a credit card — the new era
of cash-and-carry has arrived. Apparel spending seems to have been the biggest
casualty in this new holiday frugality — people would rather play Rock Band it
seems than wear a new outfit.

GDP ISN’T EVERYTHING

We mentioned yesterday that there is an outside chance that we could see Q4 real
GDP approach a 4-5% range at an annual rate, well above current consensus
expectations. A good chunk of that is in inventories, not final demand, but so be it.
The point we are trying to make is that GDP is not only revised massively in the
future but it is not the best barometer of economic health, notwithstanding all the
attention it receives. Let’s not forget that Japan has had nearly 60-positive GDP
quarters since its bubble burst in the early 1990s.

You want to know what is really happening beneath the veneer of the data? Go
have a look at the front page of today’s NYT (Poll Reveals Depth and Trauma of
Joblessness in U.S.). More than half the ranks of the unemployed have been
forced to borrow money from friends or relatives since losing their jobs.

Page 4 of 9
December 15, 2009 – LATKES WITH DAVE

WHY INFLATION EXPECTATIONS MAY BE CREEPING HIGHER

It could have more to do with government mandated cost-push inflation than
Just as the Nasdaq finally
anything related to consumer demand-pull inflation. But we did see in today’s
manages to pierce the
Investor’s Business Daily an article, which stated that governments have enacted
2,200 mark, we get this
297 protectionist trade measures in the past year. (Amazingly, it was just over a
piece of downbeat tech-
year ago when the G-20 meeting was held in Washington when it was agreed that related news in the form of
no such anti-trade measures would be taken.) The number of ‘planned measures’ the New York Fed’s Empire
has risen by 50 (!) in just the past three months — the pipeline keeps growing. This State Manufacturing
is why gold is a buy on pullbacks … like the one we have on our hands right now. survey
SPECULATION RUNS AMOK
We just sifted through the latest Commitment of Traders report from the
Commodity Futures Trading Commission (looking at both futures and options) for
the week of December 8th:

• S&P 500: net speculative longs of 151,006 contracts.

• VIX: net speculative shorts of 18,872 contracts.
• Gold: net speculative longs of 264,775 contracts (still near a record high).
• Silver: net speculative longs of 43,069 contracts.
• Copper: net speculative longs of 12,626 contracts (new high for the cycle).
• Oil: net speculative longs of 141,550 contracts.

All this has occurred even with the U.S. dollar bouncing back and the net
speculative short positions on the dollar reverting to net longs in late November
and now standing at 13,854 contracts. And, the commodity complex is hanging in
even with the Baltic Dry Index rolling over again.

THE EMPIRE STRIKES OUT!

Just as the Nasdaq finally manages to pierce the 2,200 mark, we get this piece of
downbeat tech-related news in the form of the New York Fed’s Empire State
Manufacturing survey — this index (one proxy for the ISM index) plunged to +2.55
in December from +23.5 in November and the second decline in a row. This takes
the index down to its lowest level since last July. And the details were as soft as
the headline:

• Orders fell to 2.20 in December from 16.66 in November and down from the
30.82 peak level we saw back in October. At 2.20, this is the lowest level in
orders since June.
• Shipments also slowed in December, actually halting, to 6.30 from 12.97 in
November and 35.08 in October. Like orders, shipments are at their lowest
level in six months.
• The manufacturing sector in the NY region continues to reduce their
inventories, at -18.42 in December versus -17.11 in November. We have not
seen a positive inventory reading since August 2008.
• There is some margin compression going on in the manufacturing sector in
the NY region. Prices paid rose 9.2 points to 19.74 in December — highest
level since September. Prices received dipped to a 4 month low of -9.21 in
December from 2.63 in November.

Page 5 of 9
December 15, 2009 – LATKES WITH DAVE

• The employment indicators also swung back to negative terrain. The number
of employees fell to -5.23 from 1.32 in November and way off the 10.39 level
we saw back in September. And the workweek also swung from +5.26 in
November to -5.26 in December.
Chart 3 below shows what this data could mean for the Nasdaq near-term.

CHART 3: WHAT THE EMPIRE MANUFACTURING INDEX

COULD MEAN FOR THE NASDAQ NEAR TERM
United States
(percent)
40 Empire State Manufacturing Diffusion 3,000
r = 0.71
Index (net percent: left hand scale)

30 2,800

2,600
20

2,400
10

2,200
0
Nasdaq Composite 2,000
(right hand scale)
-10
1,800

-20
1,600

-30 1,400

-40 1,200
05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff

LIGHT TRUCKS EXERT HEAVY PPI IMPACT

The U.S. producer price index (PPI) offered up a huge upside surprise today —
the headline came in at +1.8% (market was at +0.9% MoM) and the core
(excluding the effects of food and energy) was +0.6% (market was at +0.2%
MoM). The story was almost exclusively in light trucks where prices soared 4.2%
— outside of that, the core PPI was a tame +0.2%. Remember that light truck
prices sank 5.2% in October and that was the only reason why the core PPI was
down 0.6% that month.

Best to look at the broad trends — total PPI negative 0.7% at an annual rate on a
three-month basis, +0.7% on a six-month basis, and +1.2% on a YoY basis. Not
much of an inflation story here, to tell you the truth.

The pipeline measures were well behaved too — the core intermediate PPI was
+0.3%, but that followed a 0.2% decline in October and the YoY trend is
ensconced in negative terrain, at -1.2%. And the core crude PPI — the very back
end of the production process — posted a 0.8% decline, the first falloff in eight
months. So in a nutshell, less inflation here than really meets the eye.

Page 6 of 9
December 15, 2009 – LATKES WITH DAVE

STRONG PRODUCTION NUMBER OUT OF THE U.S.A.

The one thing we can take away from the November industrial production (IP)
The one thing we can take
data is the limitations of the ISM index. The diffusion index jumped to 55.7 in
away from the November
October from 52.6 and IP was flat; then we see ISM roll over in November, to
U.S. industrial production
53.6, and IP spikes 0.8% MoM.
report is the limitations of
the ISM index
The gains were broadly based too — mining +2.1%, automotive +1.8%,
machinery +0.6%, computers/electronics +0.4%, materials +1.3%, even
construction supplies were +1.6% (government infrastructure kicking in?).

With October and November results in, industrial production is running at a 5.4%
annual rate for Q4. As I’ve been saying since last week, watch consensus GDP
expectations continue to ratchet up. Problem for equities is that this was priced in
before the economists figured it out (ahem) and bond yields are ratcheting up.

Page 7 of 9
December 15, 2009 – LATKES 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
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OVERVIEW INVESTMENT STRATEGY & TEAM

As of September 30, 2009, the Firm
managed assets of $5.0 billion.
Gluskin Sheff became a publicly traded
corporation on the Toronto Stock
Exchange (symbol: GS) in May 2006 and
remains 65% owned by its senior
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public company accountability and
governance with a private company
commitment to innovation and service.
Our investment interests are directly
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We offer a diverse platform of investment equities that we sell short. For corporate
strategies (Canadian and U.S. equities,
Alternative and Fixed Income) and
investment styles (Value, Growth and
1 September 30, 2009
Income).
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Firm is $3 million for Canadian investors
and $5 million for U.S. & International
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PERFORMANCE
$1 million invested in our Canadian Value
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would have grown to $15.5 million on
2 followed and under-appreciated small
September 30, 2009 versus $9.7 million
for the S&P/TSX Total Return Index
over the same period.
$1 million usd invested in our U.S.
Equity Portfolio in 1986 (its inception
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usd on September 30, 2009 versus $8.7
2
We have strong and stable portfolio
management, research and client service
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Firm for a minimum of ten years and we
aligned with those of
have attracted “best in class” talent at all
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levels. Our performance results are those
Sheff’s management and
of the team in place.
employees are
We have a strong history of insightful collectively the largest
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fundamental analysis. For long equities, we
investment portfolios.
look for companies with a history of long-
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We assemble concentrated portfolios S&P/TSX Total Return
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fundamental analysis and our top-down

million usd for the S&P 500 Total
macroeconomic view, with the noted
Return Index over the same period.
addition of David Rosenberg as Chief
Economist & Strategist.
Notes:
Unless otherwise noted, all values are in Canadian dollars.
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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 8 of 9
December 15, 2009 – LATKES WITH DAVE
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