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David A.

Rosenberg September 15, 2010

Chief Economist & Strategist Economic Commentary
+ 1 416 681 8919


Breakfast with Dave

It’s mixed overall in the equity market. European markets are down, (uh oh —
the bloom is off the rose — see Europe’s Economic Recovery Weakens” on page • While you were sleeping:
bonds are consolidating
A16 of today’s WSJ) and U.S. indices hitting resistance levels while the Nikkei
after yesterday’s rally;
gained 2.3%, to 9,516, on the back of the currency intervention to reverse the Japan’s FX intervention
unbelievable strength in the yen (prior to the yen intervention, the Nikkei was has helped the U.S. dollar
down 1.3%). Gains in Asia were broad based, though China was a notable reclaim its 200-day moving
dissent with a 1.3% slide in the Shanghai index (down 19% year to date). average; gold continues to
edge higher; our S.I.R.P.
strategy continues to work
Bonds are consolidating after yesterday’s rally. Japan’s buying of the U.S. dollar
(first FX market intervention in six years) has helped the DXY reclaim the 200-day • Goldilocks: We can use
moving average line but even so, gold continues to edge even higher after yesterday’s action as a
breaking out to new highs yesterday (thank you very much!). The case for bonds microcosm to what is
actually driving the gold
continues to build, and not just government securities, but also corporates, and
price higher … and it is not
while analysts have been reducing their earnings estimates of late, and inflation
economists cutting their growth views, it was fascinating to see rating upgrades of
speculative-grade U.S. companies outpace downgrades so far this year, by a 171- • U.S. retail sales, in a word,
uninspiring: headline retail
111 margin (and 21 to 12 in August). Safety and Income at a Reasonable Price
sales came in at 0.4%
(S.I.R.P.) has been a focus of ours, and when combined with gold, appears to be a MoM in August; however,
very rewarding barbell — and not just for this year, but for the past 10 years ( see outside of the bare
Chart 1)! We have been, and remain, big fans of the Canadian dollar; however, the necessities, sales was
loonie, now at a six-week high, has substantially leapt above our estimate of its actually flat on the month
equilibrium level and as such, we would advise near-term caution. Plus, outside of • Harsh words from small
gold, the Japanese intervention today has knocked the commodity complex down businesses regarding the
a peg or two (since stuff, like copper, is priced in U.S. dollars). state of the U.S. economy


United States: 10-year Returns by Asset Class
(August 2000 to August 2010: percent change)

99 107



S&P 500 3-month T-bills Real Estate High Grade Commodities Long-term Gold
Corp. Treasuries

Source: Haver Analytics, Bloomberg, Gluskin Sheff

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
September 15, 2010 – BREAKFAST WITH DAVE

S.I.R.P., by the way, does not preclude a core position in dividend-paying equities
There are always things to
(or preferreds for that matter). While we are “underweight” equities as an asset
buy and S.I.R.P. does involve
class, we aren’t exactly zero-weight. There are always things to buy and S.I.R.P.
a dividend theme, and as
does involve a dividend theme, and as such it is encouraging to see company
such it is encouraging to see
after company, even in the once-growthy tech space, catch on to the insatiable company after company
baby boomer appetite for income. Hence, we now see Cisco join the likes of catch on to the insatiable
Microsoft and Oracle in generating cash payments to their investors. According baby boomer appetite for
to S&P, so far this year, there have been 179 dividend increases and just three income
cuts — in 2009, there were 110 increases and 72 cuts! The S&P 500 dividend
yield is now 2.0% and if you look at the historical data, 45% of the stock market
return is derived from reinvested dividends. So, do the math and “expected
returns” should really be no higher than 5%. This is exactly what a sub 3% yield
on the 10-year T-note is telling you, as well as, a 5% yield on a generic BBB-rated
corporate bond. Five percent today is what 10% was two-decades ago and 15%
three-decades ago, and if you can achieve that or even do better than that
consistently, consider yourself a hero.

The S&P 500 continues to trade in a very narrow range as 1,040 acts as support
on the downside and 1,130 resistance on the upside. The 4.5% surge in short
interest in August has been squeezed out as the relief rally in September took
hold on the view that the economy was not about to double-dip. Be that as it
may, fragility is still in place and far too many market watchers gaze at shipping
rates, which are supply related, or transport volumes, which are coincident
indicators, and at this point, are telling us that the inventory cycle is continuing
even as sales are lagging behind. This could well set up a disappointing fourth
quarter of little better than 1% growth in real GDP after what now looks to be
1.5% for Q3. So yes, the economy is not yet contracting, but it’s not exactly
expanding that much either, certainly not enough to absorb the excess
deflationary slack in the labour, product and housing markets.

In fact, a just published report by Moody’s showed that there is so much excess Indeed, according to S&P, so
housing inventory that it will take another three years for U.S. home prices to far this year, there have been
find a true bottom. That will be problematic for banks, as well as for consumer 179 dividend increases and
discretionary spending. Yesterday’s retail sales data were telling as consumer just three cuts — in 2009,
spending were concentrated on the bare necessities — food, gas, drugs and there were 110 increases
clothes collectively up 2% for the second month in a row. But electronics, and 72 reductions
building materials, autos, restaurants, appliances and furniture, combined, fell
0.4% and are now down three of the past four months, which would lend
credence to the view that consumer staple stocks should be outperforming
consumer discretionary. However, over the past month, consumer discretionary
stocks are up over 6% and staples by only 3%, so if there is a pint of contrary
blood in you and you are looking for a possible anomaly to take advantage of in
the equity market … there you go.

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September 15, 2010 – BREAKFAST WITH DAVE

If there was a hint of good news, the IBD/TIPP economic optimism index ticked
The yield on 10-year TIPS, at
up in September, but this came off a two-year low, and at 45.3, is still at a
0.9%, is back to where it was
recessionary level. In fact, 42% of respondents don’t think the recession has
at the depths of the
ended yet. The 3.9% gain in the index (first increase in four months) was led by
the “personal finances” component (maybe these folks were all short in August
and hence felt good coming into the fall). However, the six-month economic
outlook component slipped 2%, to 44.2. This may seem at odds with what the
stock market is saying these days — look at what a three-week rally has done to
investor sentiment (all of a sudden the economic data seem boom-like when the
S&P 500 has rallied 7% from a nearby low!).

But the bond market usually gets it right and the 0.9% yield on the 10-year TIPS
security is back to where it was at the depths of the recession. Something is
going to have to give. If we recall correctly, bonds led both the stock market and
the economy in 1990, 2000 and again in 2007. The mixed message that the
bond market is giving us, vis-à-vis the recent technical bounce in equities,
comes down more to lags than anything else. The 0.9% “real yield” and the
2.7% “nominal yield” are sending off a non-ratification signal for the equity
market bull. But they are ignoring it at their peril; as they likely did in those three
other periods just mentioned — bonds are very good at inflection points and in
the next few months we may well look back at the 130 basis point rally this
spring in the 10-year T-note as important an event as the similar rally we saw in
the summer and fall of 2007.


United States: 10-year Treasury Inflation Indexed Note Yield







07 08 09 10

Source: Haver Analytics, Gluskin Sheff

As we said before, there has been about $1 trillion of debt deleveraging that has
occurred in the U.S. household sector over the past two years and to normalize
debt/asset and debt/income ratios, there is another $6 trillion to go, and likely
to last another five years if the historical record is any indication.

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September 15, 2010 – BREAKFAST WITH DAVE

For the time being, the government will continue to try to cushion the blow; The era of shared sacrifice in
however, the best of the fiscal stimulus is behind us, and for the demographic dealing with this crisis is
reasons why that is the case, look no further than the front page of today’s WSJ now upon us, and with this
(Obstacle to Deficit Cutting: A Nation on Entitlements”). But there is hope as far comes an acknowledgment
as the political landscape is concerned — go to the op-ed section on page A19 — that, sorry, there are no
Union Power and the Christie Effect. The era of shared sacrifice in dealing with quick fixes or magic bullets
this crisis is now upon us, and with this comes an acknowledgment that there to deal with the aftermath of
are no quick fixes or magic bullets to deal with the aftermath of a deflated asset a deflated asset and credit
and credit bubble. It will mean sacrifice and return to living within our means, it bubble
can be done, and it will brighten the future as opposed to complicate it as the
plethora of current polices have already done; establishing artificial floors under
home prices, distorting the spending picture through demand-side gimmicks,
clouding financial transparency via kick-the-can-down-the-road accounting
measures for the bank assets, not to mention paying people to stay out of work
for nearly two years, which risks turning a sizeable potion of the labour market
into a welfare state.

Let’s take a feather out of emerging Asia’s cap — who would have guessed that
it would have emerged the way it did as it rose from the ashes 12 years
ago. But the region did go though a real depression, a real transformation and
radical restructuring of the economic, banking and political landscape. Kicking
the can may ease the pain, as it did in Japan, but at a cost in terms of the length
of time it takes to transition to the next sustainable growth cycle. Emerging Asia
took its medicine up front and look where it is today. It’s emerged.

Well, at least we know we can use yesterday’s action as a microcosm to what is
actually driving the gold price higher (up $22.55/oz, +1.8%, yesterday to $1,268
an ounce) — and it isn’t inflation. How do we know that? Because 10-year TIPS
breakeven levels — the market proxy for inflation expectations — fell seven basis
points. The correlation would seem to be more with the U.S. dollar as the DXY
sank 1.0% to 81.080 yesterday. And, what ailed the U.S. dollar were hints out of
Goldman Sachs that the Fed was indeed planning another round of Quantitative
Easing. So once again, gold has asserted itself as a monetary metal — a
currency that is no government’s liability and a hedge against these recurring
concerns over the integrity of the global monetary system.

You don’t even need to look at the TIPS market to see the disinflation
momentum is at play. All you really have to do is read these two Wall Street
Journal articles to see how the frugality theme is wreaking havoc on pricing
power, even at the high end of the U.S. consumer space: Luxury-Goods Firms
Turn Up Volume on Value on page B5, and Ritz Carlton Bows to Recession, Adds
Rewards on page B4 (price per room is down 19% over the past three years!).

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September 15, 2010 – BREAKFAST WITH DAVE


Considering the tailwinds in August for the U.S. household — record sales tax The August U.S. retail sales
holidays and $1 billion in retroactive jobless benefits — I found the retail sales report was about
data, in terms of the “mix”, to be rather sluggish. “necessities” and not about
big-ticket items, which
The headline retail sales number came in at +0.4% MoM; however, outside of would be a sign of the
gasoline (prices) and groceries (where most of the jobless benefit cheques were
consumer making a
commitment to the economy
spent), sales were barely up (by less than 0.1% MoM).

Clothing did well too (+1.2%) but outside of these three “soft” non-durable
items, retail sales were actually flat. Drugstores gained 0.6% as well, so this
was about “necessities” and not about big-ticket items, which would be a sign of
the consumer making a commitment to the economy.

Meanwhile, virtually all of the cyclical segments were weak. Autos, electronics,
furniture were all down and building materials were flat after two horrendous
months. Restaurants were also little changed.

In a word, uninspiring and with fewer tailwinds, I’d be expecting a pullback this


The latest Small Business Economic Trends released by the National Federation
of Independent Business (NFIB) had terse comments about the state of the U.S.
economy. Here are some examples:

Labour Market: “There is no life in the jobs market.” The percentage of firms
reporting one or more job openings rose a point, to 11 in August; however, when The U.S. labour market
looking at the chart, this level is still hovering near historical lows. And, the landscape through the eyes
percentage of firms planning to increase employment in the next three months
of the small business owner:
“There is no life in the jobs
fell back to 1% — in other words, no one is planning to hire.
Capex: “The environment for capital spending is not good.” Only 16% in August
of respondents said that they plan on capex in the next 3 to 6 months, down
from 18% in July and is at the same level during the depths of the recession in
March 2009.

Inventories and sales: “Small business owners continued to liquidate

inventories and weak sales trends gave little reason to order new stock.” …
Inventories at the “big” firms may start to accumulate as orders from small firms
(many of who are the final interface with the consumer) weaken.” Small firms
don’t think their current inventories are too low, and hence are not looking to
increase inventories at the current time (actually a majority — 15% in August —
are still reducing inventories) or in the future (respondents planning to add to
inventories over the next six months fell to -7% from -4% in July).

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September 15, 2010 – BREAKFAST WITH DAVE

Inflation: “The weak economy continues to put downward pressure on prices.” What small businesses in
… Widespread price cutting contributes to the high percentage reporting the U.S. need are sales, not
declining sales revenues.” just low rates

Profits and wages: “Labor costs are still under control, good news for those
worried about inflation but bad news for workers.”

Credit markets: “Those looking for loans predominately are looking for cash
flow support, not funds to expand or hire.” … What businesses need are
customers, giving them a reason to hire and make capital expenditures and
borrow to support those activities. … Sales are needed, not just low rates.”

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September 15, 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.


As of June 30, 2010, the Firm managed We have strong and stable portfolio
assets of $5.5 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 $11.7 million2 on March
investment styles (Value, Growth and For corporate bonds, we look for issuers
2 31, 2010 versus $5.7
Income). with a margin of safety for the payment
million for the S&P/TSX
of interest and principal, and yields which
The minimum investment required to Total Return Index over
are attractive relative to the assessed
establish a client relationship with the the same period.
credit risks involved.
Firm is $3 million for Canadian investors
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 $11.7 million on

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
between our bottom-up security-specific
million usd for the S&P 500 Total fundamental analysis and our top-down
Return Index over the same period.
macroeconomic view.
Unless otherwise noted, all values are in Canadian dollars.
1. Preliminary unaudited estimate.
2. Not all investment strategies are available to non-Canadian investors. Please contact Gluskin Sheff for information specific to your situation.
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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September 15, 2010 – BREAKFAST WITH DAVE

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