David A.

Rosenberg August 24, 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
It’s a tad brutal overnight, with most Asian markets in a sea of red, and Europe
seemingly following suit. The Asia-Pacific index sagged 0.8% today with the • While you were sleeping:
global equity markets sold
Nikkei off 1.3%, to 8,995, which is the lowest close since May 1, 2009 and now
off overnight; global bond
officially in bear market terrain with a 21% slide from the April peak. Watch the markets rallying hard
U.S. indices play catch-up. despite all the bubble talk;
commodity-based
Bonds are also rallying hard despite all the bubble talk — 10-year German bunds currencies taking it on the
are a snick above 2¼%, a new record low, and 30-year bunds have rallied to chin; commodity prices
slipping
2.83% (long Treasuries in the U.S. need to rally nearly 80bps to catch up). As we
have said time and again, in a deflationary backdrop, safe income is king (long • Chicago! The Chicago Fed
governments are carrying extremely well and not only that, long-dated investment- National Activity Index not
grade corporates still command a nice 200bp premium over Treasuries). out of the woods; the
consumer/housing
component still shows that
Caution is also evident in the FX market as the yen has strengthened to an eight- the U.S. economy might
year high against the euro and to a 15-year high against the U.S. dollar. At the not be out of the recession
same time, the cyclically-sensitive commodity currencies are taking it on the chin yet
this morning, so even with the slide against the ultra-defensive yen, the DXY has
• If Bank of Canada Governor
rallied this morning and broken back above its 50-day moving average (of 83.3)! Carney is not done … well
he should be. The BoC is
In the commodity complex, look no further than the oil prices, which are slipping an inflation driven bank
for the fifth day in a row; ditto for industrial metals (nickel is off 2% today; copper and there is no more
by nearly 1%). Nobel laureate Joseph Stiglitz is on the tapes saying that with all smoking gun
deference to the blowout Q2 German GDP data, the continent is facing growing • Even more job loss ahead?
recession risks amid the radical cutbacks in government spending. Bank of We could see a situation
England official Martin Weale pretty well told the London-based Times the same where another 4-5 million
thing about the U.K. economic outlook. Have a look at Eurozone Growth Loses jobs could be shed in the
U.S.
Impetus and Doubts Over Paris Outlook for Economy on page 2 of the FT. And
don’t look now but credit default swaps in poor Ireland, which has tried to do • Getting small — sushi style:
everything right to turn its fiscal ship around, have widened 100bps in March to there was a really terrific
nearly 300bps, which implies a 22% chance of default within five years. Hey, editorial piece in the
Sunday NYT that is worth a
where is its bailout?
read (Japan and the
Ancient Art of Shrugging)
Meanwhile, long-time bull, David Wyss, who is Chief Economist at S&P, said at a
Tokyo speech (how a propos) that “I think there is still a realistic possibility in the • Is Ed Leamer, head of the
U.S. that it’s slipping into this pattern like Japan has – 10, 20 years of stagnation.” forecasting center at L.A.’s
Anderson School of
Sacrilege! How can he get away with saying such a thing? And, if you want to
Management, a dreamer?
know what Japan looks like — a decade after rates went to zero and with a 200%
government debt-to-GDP ratio — have a read of the tear-jerker on page B3 of the
NYT (Japan Finds It Has Few Options in War Against Falling 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
August 24, 2010 – BREAKFAST WITH DAVE

But look at the bright spot, we are finally exiting the denial stage and heading
towards acceptance. That, my friends, is progress in its own right. When The Chicago Fed National
Washington realizes that the solutions lie in supply-side policies that will promote
Activity index came out for July
and rang in at a stagnant 0.0
growth in the capital stock and hiring/work incentives — education, infrastructure,
after hitting a recession-like
payroll taxes, a coherent energy strategy (nuclear!) — and begin to abandon failed
-0.70 print the month before
policies such as this ongoing emphasis on Keynesian short-term spending quick
fixes, the adoption of “too big to fail” strategies, initiatives aimed at bailing out
delinquent homeowners, measures that actually try to prevent market forces from
working, initiatives that pay people to stay off work for 99 weeks with no thought
behind skills improvement and training in return, and attempts at influencing the
equilibrium level of asset prices, such as real estate, then indeed, when we have
finally broken free from these failed interventionist and distorting manoeuvres,
then we will likely have much more reason to turn optimistic.

CHICAGO!
The Chicago Fed National Activity index came out for July and rang in at a
stagnant 0.0 after hitting a recession-like -0.70 print the month before. The
chart below just about says it all ... the consumer/housing segment has been
below zero now for each of the past 43 months, which is unprecedented.

CHART 1: THIS IS ONLY 75% OF THE ECONOMY —

DID IT EVER GET OUT OF RECESSION?
United States: Federal Reserve Bank of Chicago National Activity Index: Personal
Consumption and Housing (positive = growth above trend)

0.4

0.2

0.0

-0.2

-0.4

-0.6
70 75 80 85 90 95 00 05 10

Shaded region represent periods of U.S. recession

Source: Haver Analytics, Gluskin Sheff

Now we’ll tell you why this is a depression, and not just some garden-variety
recession. For all the chatter about whether the recession that started in
December 2007 ended sometime last year, here is what you should know about
the historical record. The 1930s depression was not marked by declining
quarterly GDP data every single quarter. In fact, the technical recessionary
aspect to the initial period following the asset and credit shock goes from the
third quarter of 1929 to the third quarter of 1933.

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August 24, 2010 – BREAKFAST WITH DAVE

There was another deep downturn in 1937-38, but the initial recession lasted four
years and if you read the Benjamin Roth diary, you will see the euphoric response For all the chatter about
to any piece of good news — as brief as they may have been. Such is human
whether the recession that
started in December 2007
nature and nobody can be blamed for trying to be optimistic; however, in the
ended sometime last year,
money management business, we have a fiduciary responsibility to be as realistic
keep in mind that the
as possible about the outlook for the economy and the markets at all times.
depression in the 1930s was
not marked by declining
What is important to know is this. In that initial four-year economic downturn, quarterly GDP every single year
from 1929 to 1933, there were no fewer than six — six! — quarterly bounces in
the GDP data. The average gain in these up-quarters was 8% at an annual rate!
But because they proved not to be sustainable, the National Bureau of
Economic Research (NBER) refused to declare that the recession officially
ended, even though the stock market rallied 50% in the opening months of
1930 on the belief that the downturn was about to end. False premise. And
guess what? We may well be reliving history here. If you’re keeping score, we
have recorded four quarterly advances in real GDP, and the average is only 3%.

It wasn’t really until we could put together a string of very solid GDP data in
1934, 1935, and well into 1936 that the recession definitely had come to a
close and at least an intermitted period of solid growth took hold. That is, until
the policy mis-steps of 1937. All that second recession of the decade proved
was just how fragile the post-bubble recovery really was.

The 80% rally of 2009 that whipped up so much excitement at the time and
reignited all the criticism over the “bears” and how they didn’t understand the What is important to know is
power of stimulus and how their call over the 2007-08 meltdown was just dumb this. In that initial four-year
luck, will be remembered in the future about as much as the 50% rally of the economic downturn, from
1930. It’s funny how nobody seems to recall that massive dead-cat bounce off the 1929 to 1933, there were no
lows; people just remember 1930 was a period of soup lines, bread lines, and fewer than six — six! —
unemployment lines. Maybe it’s because we ended up with a classic Bob Farrell- quarterly bounces in GDP
like third wave — the fundamental downtrend to a new low over the next two years,
and the overall economic malaise with double-digit unemployment rate lasted for
another decade even with massive doses of government intervention.

We can understand how emotional the debate can get over whether or not we
have actually just stumbled along some post-recession recovery path or whether or
not this is actually a depression in the sense of a downward trend in economic
activity merely punctuated with noise that is influenced by recurring rounds of
government intervention. The reality is that the Fed cut the funds rate to zero, as
was the case in Japan, to little avail (perhaps only making a bad situation less
bad). Then the Fed tripled the size of its balance sheet — again with little
sustained impetus to a broken financial system (see the op-ed on page A15 of the
WSJ by George Melloan — The Fed Can Create Money, Not Confidence).

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August 24, 2010 – BREAKFAST WITH DAVE

Keep in mind that by now the Fed was suppose to be shrinking its pregnant
balance sheet but has refrained from doing so, though the Bernanke-led move The critical issue for the Bank
to sustain its incursion in the capital markets is not being universally supported
of Canada is whether their
policy setting is consistent
(have a look at the front page of the WSJ — Fed Split on Move to Bolster Sluggish
with a stable price
Economy). Also keep in mind that the Fed sliced its economic forecast twice in
environment
the past two months and we are coming off a Q2 GDP growth pace that was
likely little better than a 1% annual rate (as we will see post-revision this Friday).
When you cut your forecast and the economy is barely growing faster than 1%, a
renewed contraction cannot be ruled out (in fact, the monthly data showed this
erosion to be taking place as we type).

How’s that for a reality check. It’s not too late, by the way, to shift course if you
have stayed long this market.

IF CARNEY IS NOT DONE …

…then he should be. This is an inflation-driven Bank of Canada and as such,
there is no more smoking gun. We could care less about somebody’s definition
of what “emergency” interest rates are. The critical issue for the Bank is
whether their policy setting is consistent with a stable price environment.

The proof in the pudding is always in the eating – but the reality is that the
current interest rate structure is proving to be totally consistent with a
disinflation backdrop at a time when measured inflation rates are microscopic.
Look at the latest CPI data. Strip out the effects of the HST, and consumer
prices fell 0.1% in July. Not only that, but the CPI excluding indirect taxes has
been flat or down now for six months in a row, during which it has deflated at a
1.2% annual rate. You read this right — deflation, and with a much lower
unemployment rate than is the case south of the border to boot (7.3% on a
comparable U.S. basis versus the actual 9.5% in the United States).

What if we looked at “core” excluding indirect taxes? This price metric

dropped 0.2% in July and over the past six months is running at the grand
total of a 0.0% annual rate. Only one other time in recorded history was the
rate this low over a six-month span — at the troughs of the last two economic
downturns (2008 and 2001) the trend was 0.7% at an annual rate and 0.8%
respectively, and here we are into some sort of economic recovery and it is
running at zero. Imagine where this trend goes if the economy continues to
slow down or even catches some of the U.S. double-dip fever — well, this is a
prospect that we are sure a pragmatist like Mark Carney is imagining in his
mind’s eye. The Bank should be done hiking for now.

EVEN MORE JOB LOSS AHEAD?

The article in yesterday’s WSJ titled Specter of Layoffs Stalks Wall Street really
resonated with us. As we said in yesterday’s note, the size of the securitized
loan market has shrunk 60% in the past two years. Balance sheets, production,
order books and staffing requirements are all rightsizing to this new semi-
permanent landscape of reduced credit availability.

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August 24, 2010 – BREAKFAST WITH DAVE

In fact, we could see a situation where another 4 to 5 million jobs could be shed We could see a situation where
in the United States — and in the three sectors that were, and remain, the most another 4 to 5 million jobs
affected by the housing crisis and financial collapse. could be shed in the United
States — especially in the three
For example, historically, the construction industry employed three workers for sectors (construction, finance
every housing start. Today, that ratio is closer to 10. This could easily mean and state/local government)
that we see 3 to 4 million construction jobs being lost going forward, barring a that were, and remain, the
major revival in the housing market, which isn’t happening. most affected by the housing
crisis and financial collapse
The ratio of employees in the financial sector to outstanding private sector credit
is at a new and lower level that would warrant around a workforce 500,000
lower than is the case today — just to get to productivity ratios that prevailed in
the pre-bubble era. And the third sector, which is the fiscally-challenged state
and local government segment, for payrolls there to mean revert to the level
commensurate with the ever-declining level of public spending would also mean
roughly 500,000 employment cutbacks. No doubt there are other sectors that
will provide some offset in health and education and even manufacturing, but it
took 25 years for these areas combined to rise five million and something tells
us that the downsizing that is left in the housing, financial and state/local
government sectors will occur in a much shorter period (and the latter too, if
what happened recently in New Jersey is any indication, the social contract with
public sector unions will soon go the way of the dodo bird).

Note that the year-on-year trend in layoff announcements, after a brief period of
declines, is now re-accelerating in the three above-mentioned affected sectors.
For the first time since late 2007, the financial sector posted no hiring
announcements in each of the last two months and this has also been the case
in three of the past four months in the real estate sector. Government sector
hiring announcements, as an aside, have plunged 75% from year-ago levels.
The signs are already there — get ready for another downleg in employment as
the jobless claims are now suggesting — especially as it pertains to this 33
million or 25% chunk of the total workforce.

CHART 2: RATIO OF CONSTRUCTION EMPLOYMENT TO HOUSING STARTS

United States (ratio)

15.0

12.5

10.0

7.5

5.0

2.5

0.0
60 65 70 75 80 85 90 95 00 05 10

Shaded region represent periods of U.S. recession

Source: Haver Analytics, Gluskin Sheff

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August 24, 2010 – BREAKFAST WITH DAVE

GETTING SMALL — SUSHI STYLE

There was really a terrific op-ed piece in the Sunday NYT by Norihiro Kato, a
professor of Japanese literature at Waseda University, titled Japan and the
Ancient Art of Shrugging. He explains to us how the next generation in Japan
was affected by the fallout of the credit collapse and real estate deflation. It’s
all about ‘getting small’ — one of our long-lasting post-bubble themes. Deflation
at its penultimate. The article was all about how attitudes are changing among
young people in Japan, and there may well be some takeaways from this for the
rest of us:

“Three years ago, I saw a television program about a new breed of

youngster: the nonconsumer. Japanese in their late teens and early
20s, it said, did not have cars. They didn’t drink alcohol. They didn’t
spend Christmas Eve with their boyfriends or girlfriends at fancy
hotels downtown the way earlier generations did. I have taught
many students who fit this mold. They work hard at part-time jobs,
spend hours at McDonald’s sipping cheap coffee, eat fast food
lunches at Yoshinoya. They save their money for the future.

These are the Japanese who came of age after the bubble, never
having known Japan as a flourishing economy. They are
accustomed to being frugal. Today’s youths, living in a society older
than any in the world, are the first since the late 19th century to feel
so uneasy about the future.

I saw young Japanese in Paris, of course, vacationing or studying,

but statistics show that they don’t travel the way we used to.
Perhaps it’s a reaction against their globalizing elders who are still
zealously pushing English-language education and overseas
employment. Young people have grown less interested in studying
foreign languages. They seem not to feel the urge to grow outward.
Look, they say, Japan is a small country. And we’re O.K. with small.

It is, perhaps, a sort of maturity.”

Getting small, how novel. Make sure your portfolio dovetails with this theme.

IS LEAMER A DREAMER?
We mentioned yesterday that the Ceridian-UCLA Pulse of Commerce Index ticked
up in July, prompting its architect, Ed Leamer, to tell that Globe and Mail that “I
don’t think that a double-dip is in the cards.” Never mind that this index
appears to have peaked in early 2008, after the recession actually began. But
no sooner did the ink dry on our report that we received this from a faithful
reader, regarding Mr. Leamer:

“My favorite WSJ quote (12/14/2006) to this day is: “This time will be different,”
Ed Leamer, who heads the forecasting center at the University of California at
Los Angeles’ Anderson School of Management, predicts in a report: “This time
the problems in housing will stay in housing.”

Come to think it, this sounds like something Bernanke would have said.

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August 24, 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 June 30, 2010, the Firm managed
assets of $5.5 billion.
1
Gluskin Sheff became a publicly traded
corporation on the Toronto Stock
Exchange (symbol: GS) in May 2006 and
remains 54% owned by its senior
management and employees. We have
public company accountability and
governance with a private company
commitment to innovation and service.
Our investment interests are directly
aligned with those of our clients, as
Gluskin Sheff’s management and
employees are collectively the largest
client of the Firm’s investment portfolios. shareholder-minded management and a
We offer a diverse platform of investment
strategies (Canadian and U.S. equities,
Alternative and Fixed Income) and
investment styles (Value, Growth and
2 31, 2010 versus $5.7
Income).
The minimum investment required to
establish a client relationship with the
Firm is $3 million for Canadian investors
and $5 million for U.S. & International
investors.
PERFORMANCE
$1 million invested in our Canadian Value which we have the highest conviction.
Portfolio in 1991 (its inception date)
would have grown to $11.7 million on
2
We have strong and stable portfolio
management, research and client service
teams. Aside from recent additions, our Our investment
Portfolio Managers have been with the interests are directly
Firm for a minimum of ten years and we
aligned with those of
have attracted “best in class” talent at all
our clients, as Gluskin
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
bottom-up security selection based on client of the Firm’s
fundamental analysis.
investment portfolios.
For long equities, we look for companies
with a history of long-term growth and
stability, a proven track record,
$1 million invested in our
Canadian Value Portfolio
share price below our estimate of intrinsic
in 1991 (its inception
value. We look for the opposite in
date) would have grown to
equities that we sell short.
$11.7 million2 on March
For corporate bonds, we look for issuers
with a margin of safety for the payment
million for the S&P/TSX
of interest and principal, and yields which
Total Return Index over
are attractive relative to the assessed
the same period.
credit risks involved.
We assemble concentrated portfolios —
our top ten holdings typically represent
between 25% to 45% of a portfolio. In this
way, clients benefit from the ideas in
Our success has often been linked to our

long history of investing in under-followed

March 31, 2010 versus $5.7 million for the
and under-appreciated small and mid cap
S&P/TSX Total Return Index over the
companies both in Canada and the U.S.
same period.
$1 million usd invested in our U.S. PORTFOLIO CONSTRUCTION
Equity Portfolio in 1986 (its inception In terms of asset mix and portfolio For further information,
date) would have grown to $8.7 million construction, we offer a unique marriage please contact
usd on March 31, 2010 versus $6.9
3
between our bottom-up security-specific questions@gluskinsheff.com
million usd for the S&P 500 Total fundamental analysis and our top-down
Return Index over the same period.
macroeconomic view.
Notes:
Unless otherwise noted, all values are in Canadian dollars.
1. Preliminary unaudited estimate.
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3. Returns are based on the composite of segregated Value and U.S. Equity portfolios, as applicable, and are presented net of fees and expenses.
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August 24, 2010 – BREAKFAST WITH DAVE
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