David A.

Rosenberg March 2, 2011

Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 6013

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING
IN THIS ISSUE
Equity markets overseas are down considerably as the realization of what $100
oil is likely to do to purchasing power at the consumer level and profit margins at • While you were sleeping:
the producer level. The U.S. dollar is still soft and gold is consolidating after equity markets overseas
are down; U.S. dollar is
yesterday’s surge to new record highs. Treasuries are surprisingly not benefiting still soft and gold is
from the slide in equities though there is a modestly positive tone in European consolidating
debt markets and a nice 5bps rally in Japanese government bonds back down to
• Fifteen reasons to love the
1.25% (didn’t Japan just get downgraded recently … twice??). It is still testament
loonie (we couldn’t stop at
to the greed factor that according to the just-released Investors Intelligence ten!)
survey, we still have over 50% bulls and less than 20% bears populating the poll
• Bank of Canada
universe. Yikes!
statement rather benign ...
fails to ratify hawkish view
On the data front we had decent construction data out of the U.K. supporting the on rate
pound and aggressive producer price numbers out of the eurozone underpinning
• Chain store sales look
the euro. In the U.S.A. we just got the ADP private employment figures and they
sluggish
were strong, up 217k, better than the 180k penciled in by economists. Keep in
mind that this indicator has a shoddy track record of helping predict nonfarm • Construction still in the
payrolls (NFP) recently. In January for example, it was pointing to a near-190k doldrums
increase and private nonfarm payrolls came in at just 50k. Over the past two • Optim-ISM: ISM
months, we have seen ADP overestimate NFP by over 100k and we doubt that manufacturing index
many economists will be making materials changes to NFP estimates came in better than
expected in February
(consensus estimates are sitting around 200k for private payrolls and 190k for
total). We also received the Challenger job figures for February. While hiring rose • Random market thoughts
nicely to a four-month high — though 85% of the tally was in one sector (retail) —
job cut announcements jumped 20% YoY to the highest level in 11 months.

FIFTEEN REASONS TO LOVE THE LOONIE (WE COULDN’T STOP AT TEN!)

1. Better growth than in the U.S.A. and without need for stimulus
2. Responsible central bank, limiting growth in its balance sheet
3. Better fiscal backdrop
4. More conservative political environment
5. Triple the exposure to raw material than the U.S.A.
6. Investors get 115 basis points premium over Treasuries at the front end of
the government yield curve
7. Canada in the top 15 net oil exporters globally … U.S.A. top importer
8. TSX dividend yield at 2.36%; S&P 500 dividend yield at 1.82%
9. Housing market in balance in most of the metro areas; no foreclosure
supply coming

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
March 2, 2011 – BREAKFAST WITH DAVE

10. Inflation is low and stable with minimal risk of deflation

11. Economic recovery being fuelled principally by business spending
12. Corporate tax rates on a sliding scale down
13. Immigration and capital flows running at record levels
14. Vancouver rated top city in the world to live
15. Stable banking system with consistent dividend growth
BANK OF CANADA STATEMENT RATHER BENIGN ... FAILS TO RATIFY
HAWKISH VIEW ON RATE
The Bank of Canada basically said economic activity here and in the U.S.A. is The Bank of Canada basically
improving in line with expectations; however, caveats in these statements said economic activity here
matter and the addition of “although risks remain elevated” suggests that there and in the U.S.A. is improving
is a wide error term around its macro projections. Acknowledging that the in line with expectations;
recovery here is “proceeding slightly faster” than the Bank had been projecting however, caveats in these
was simply a mark-to-market exercise and the word “slightly” tells me they are statements matter
not convinced over the veracity or longevity considering that GDP growth in Q4
did come in a full percentage point above expected.

Household spending is seen rising in line with “household incomes” (i.e. not
expecting any further decline in the savings rate), exports are seen as being
“challenged” and while bullish on Canadian capex based on the press
statement’s wording, “expand rapidly”, underlying inflation is still seen as
“subdued”. The “persistent” strength in the Canadian dollar is cited — the Bank
ostensibly feels there is enough restraint being exerted by the loonie.

The bottom line is that not until the Bank gets rid of the statement “considerable
slack in the economy” will it be appropriate to start factoring in Bank of Canada
rate hikes (and if you look at the statement it was there). In my view, the
consensus and market views that the Bank would start to tinker with rates
sometime in the second quarter are still off base. Despite the recent GDP
pickup, the Bank does not expect the output gap to close until the end of 2012
based on this statement and that is key. The 2-year Government of Canada yield
is trading 84 basis points north of the policy rate and the 5-year is trading at a
+164bps spread. Historically, the average spread is about 60bps (over 20 years
of data) and 120bps respectively, so there would seem to be a bullish rates
opportunity at the front-to-mid part of the Canada curve if the Bank opts to stay
on the sidelines for longer.
Of course we now know that in
CHAIN STORE SALES LOOK SLUGGISH real terms total consumer
The weekly data came out for the end of February from the International Council spending actually contracted
of Shopping Centers (ICSC) and YoY sales growth slowed to 2.2% for the month fractionally in January and
from the 4.7% pace posted in January. Of course we now know that in real terms while this metric feeds into
total consumer spending actually contracted fractionally in January and while
GDP, it receives scant
attention next to the same-
this metric feeds into GDP, it receives scant attention next to the same-store
store chain store sales data
chain store sales data, especially on a YoY basis. But what we do know is that
the retailers were planning for a 2.5-3.0% range for February, so 2.2% was a tad
below. No doubt that the U.S. economy is performing better than last summer

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March 2, 2011 – BREAKFAST WITH DAVE

when double-dip fears reached their apex, but is it really outperforming

expectations currently?

CONSTRUCTION STILL IN THE DOLDRUMS

Even with a (spurious) rebound in residential outlays that was largely skewed by
a surge in multi-family housing starts, total U.S. construction spending sagged
0.7% MoM in January on top of a 1.6% slide the month before. Non-residential
expenditures tumbled 3.3% sequentially and are down now in each of the past
four months.

Between that, real consumer spending and capex shipments, we may well begin
to see all those 4% GDP growth forecasts for Q1 end up being cut in half!

OPTIM-ISM
Too bad the ISM index doesn’t
Too bad the ISM index doesn’t feed right into GDP. The economy would be feed right into GDP. The
booming. economy would be booming

The ISM manufacturing index did come in better than expected in February but
rarely has such a strong number in the past been so well advertised. The
diffusion index ticked up to 61.4, which is the highest print since May 2004 (the
peak for the cycle, but …. the bulls would tell you that still meant another 3-plus
years of economic growth and a bull market mania), not to mention up seven
months in a row. That is a streak and nothing in the components suggested any
near-term giveback.

New orders edged up to 68.0 from 67.8 while inventories were run down to 48.8
from 52.4 in January. So what this in turn did was kick the orders-to-inventories
ratio higher for the third month in a row, to 1.39x from 1.29x — the best print
since January 2010, and if you recall, that led the headline index to a new
interim high three months hence.

Most components posted gains, including the jobs sub-index, which was in
contrast to most of the regional manufacturing indicators. It jumped to 64.5
from 61.7 in what was the fastest advance since January 1973— when factory
payrolls rose a hefty 0.65% (which would translate into +75,000 today!). The
other 10 times that the employment index was this strong or stronger was in the
1950s, and factory payroll rose an average of 1.2% (which would equate to
+130,000!).

RANDOM MARKET THOUGHTS

Only time will tell if yesterday’s market action was a true watershed.
It was the first time since the
It was the first time since last July that the stock market was down on the first last leg of the bear market
day of the month. Till yesterday, the opening days in January and February had rally began six months ago
already accounted for over half the year-to-date gains in the S&P 500 (over 90% that “good” news failed to
last year). ignite equity prices

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It was also the first time since the last leg of the bear market rally began six
months ago that “good” news failed to ignite equity prices. Yesterday we saw
auto sales shoot up 6.7% to 13.4 million units (at an annual rate) which was the
best level since August 2009, and we also saw the ISM inch higher to 61.4 from
60.8 with the “internals” of the report just as solid as the headline. This is likely
a sign that Mr. Market had already paid up for these nice tidings. Recall that last
September the data were still looking iffy, and it was not clear that double-dip
risks had totally faded, but the stock market ripped in any event. That was a
mirror image sign that at the time, all the “bad” news was priced in.

We also have a situation where economists are now taking down their GDP
numbers after four months of raising them. Analysts have stopped raising their
EPS forecasts. Corporate guidance has been spotty at best, and we have
corporate insiders selling their stock at 10x the rate they are buying it. Not an
encouraging signpost at all. The short interest is flirting with three-year lows so
the absence of any short-covering as the market retreats could end up making A big market decline has been
price declines more intense than normal. So far, a big market decline has been
averted because the “buy the
dip” mentality is so well
averted because the “buy the dip” mentality is so well ingrained, but dangerous
ingrained, but dangerous at
at the same time. The widespread view that $100 oil will only cause a ripple in
the same time
the global economic outlook is equally dangerous.

The complexion of the FX market has also changed materially. The U.S. dollar,
always a safe-haven in troubling times as it was in the aftermath of the global
credit collapse and periodically last year amid the European debt fiasco, is no
longer playing that traditional role during this latest round of turmoil overseas.
Gold, silver, the yen and the Swiss franc have emerged as the safe-havens this
time around. Could be a sign of the U.S. dollar losing its allure as the place to go
when the going gets tough and no doubt spur talk as to whether the reserve
currency status will ultimately be relinquished.

The weak performance of the U.S. dollar would certainly seem to reflect, at a
certain level, a lack of confidence over U.S. policy making. Nothing in Ben
Bernanke’s sermon yesterday should alter that view, especially his dismissive
response to the Fed’s role in fuelling the surge in the commodity complex since
last summer. He claims that since commodity prices have risen in all currency
terms, hence this is not a weak-dollar story. To us, this misses the point. The
Fed’s stated intent was to encourage risk-taking behaviour with QE2. He even
mentioned the Russell 2000 on CNBC recently. Well, emerging equities have a
Emerging equities have a tight
tight correlation with small cap stocks, and by igniting a huge rally in those correlation with small cap
markets, their economies boomed from the hot money investment flows. And stocks, and by igniting a huge
since it is this part of the world that is the marginal buyer of raw material, it is rally in those markets, their
little wonder why the supply-demand balance for commodities was thrown economies boomed from the
further off kilter by the Fed’s quantitative easing. hot money investment flows

Ben Bernanke said his concern was that inflation had fallen last summer to
uncomfortable levels. So the main aim was to reflate and the stated goal was a
wealth effect on spending. But only 20% of Americans own equities directly. And
the inflation that the Fed has helped generate are in necessities, which is why in

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March 2, 2011 – BREAKFAST WITH DAVE

real terms, wages are either stagnating or contracting outright. If we hadn’t had
a strong price deflator in January, consumer spending would have also been up
in real terms, not down.

No doubt we will get a nice cushion for February spending out of auto sales — an
antidote to what seems to be a lacklustre chain store sales. But even with
incentives running wild, auto sales are still nowhere near the 16-18 million unit
pre-credit-bubble norm. This is about as good as it will get, even with the
subprime market for auto loans staging a revival.

Two more items from Ben Bernanke’s testimony that investors may want to pay
attention to:

“... downside risks to the recovery have receded, and the risk of deflation has
become negligible.”

These are not the words of someone about to embark on QE3. This could be
important for a market that has had an 86% correlation with movements in the
Fed’s balance sheet over the past two years.

“Until we see a sustained period of stronger job creation, we cannot consider

the recovery to be truly established.”

Something else for investors to consider. How sustainable is a two-year 100%

rally in equity prices if the economic recovery itself isn’t sustainable? This is
what we have said all along — the U.S. economy is much more fragile than is
commonly believed, and liquidity-induced rallies are never sustained if the
macro fundamentals don’t follow suit.

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March 2, 2011 – BREAKFAST WITH DAVE

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March 2, 2011 – BREAKFAST WITH DAVE
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