David A. Rosenberg Chief Economist & Strategist drosenberg@gluskinsheff.

com + 1 416 681 8919

January 4, 2011 Economic Commentary

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING Equity markets remain firm across the board today while the relative safety of government bonds loses their allure Asia just hit a new 2 year high today. Consistent with the pro-cyclical sentiment at the current time, the U.S. dollar is slipping as it dips below the 50-day moving average and admittedly the chart of the DXY looks pretty sick at this juncture, which in turn is adding some impetus to the commodity upturn (copper just made a new high for the fourth day in a row and oil is now at a 27-month high though gold is consolidating near its record highs). The big winner has been the Asian FX complex the Korean won has firmed to a seven-week high today. The overseas data so far today have been sparse but mixed with the U.K. PMI coming in strong in December (best in 16 years!) but French consumer confidence dropping unexpectedly. German unemployment also rose 3k to 3.15 million versus consensus estimates of down 15k, though inclement weather is the culprit no matter where we look across research reports for the surprising weakness. The equity markets have indeed started off the year with a bang and there is a risk that talk of the fabled January effect lures more buyers into stocks. This is still very much a sentiment game. After all, all the Fed had to do was jawbone the market into believing that the Fed was going to not only abandon any steps to shrink its balance sheet but to actually expand it further last fall to generate a renewed uptrend in valuation. But keep in mind that we heard all this claptrap this time last year about what the market does for the year if the first week of January is a positive one. The NYSE actually rose smartly in the first six sessions to kick off 2010 and that told you nothing of the meat-grinder we were going to endure right through to the end of the summer. Not until the government handed out more steroids to Mr. Market in the late summer and fall did equities change course and head back up from the low end of what was at the time a year-long trading band. In terms of themes for 2011, we think that there are wide swaths of the fixedincome market that offer good value at current pricing levels. Although REITs look expensive, it does look as though fundamentals are showing improvement (see Signs of Life in Office Market on page A2 of todays WSJ occupancy rates and rents are rising for the first time in nearly three years). Sentiment in equities is way overdone, but the barbell between hard assets and incomegenerating securities still seems to have merit. Volatility or the cost of insuring against a market correction is about as cheap as it can be right now.

IN THIS ISSUE
While you were sleeping:

equity markets remain firm across the board, U.S. dollar slipping, overseas data has been sparse and mixed
Oh, Canada! The market

clearly favours the country with the more sound national balance sheet and more solid long-term economic prospects
Markets lining up behind

Bernanke? Look for what happened in the past four months to have been nothing more than a bad case of misplaced optimism
ISM the good and the

not-so-good: the headline numbers seem impressive but still below the peak posted last April
A December to remember:

half of the gains in the S&P 500 for 2010 can be attributed to the run-up in December
Getting a grip: the U.S.

economy has its share of structural problems that will come home to roost at some point abound

Signs of exuberance What was the real

surprise of the year? That we would close 2010 with the yield on the 10-year U.S. Treasury note anywhere near 3.3%.
Is the sun rising in Japan?

Please see important disclosures at the end of this document.

Gluskin Sheff + Associates Inc. is one of Canadas 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

January 4, 2011 BREAKFAST WITH DAVE

Commodities are in a secular bull market but have moved a tad too parabolic right now and speculative interest has picked up dramatically of late. With exploration budgets expanding sharply, the real play within the space may be in oil and mining services. The largest S&P 500 companies are sitting on 10% more cash than a year ago at over $900 billion and that means more dividend payouts, so the yield theme is intact (255 companies raised their payouts last year compared to 157 in 2009). With all this cash, M&A will be a major theme (up 12% last year to $895 billion according to Dealogic), which in turn means that financials with a high concentration in the merger space may not be bad places to be. Stock buybacks have risen now for five quarters in a row and that may also end up being a source for the cash hoard going forward, and as such could help establish a firmer floor under the equity market. (However, we remain of the view that this market is overvalued, overbought and overextended at the current time, but that we will be entertaining the notion of becoming more constructive when corrective phases set in that serve up more compelling valuation metrics. The key is to buy low and sell high; we are not convinced that buying high and trying to sell higher is going to work over the near-term in such a frothy market.) The Korean Kospi index just made a new all-time high today. See the chart below. This will likely add more fodder to cyclical sentiment, though we maintain that the stock market is hugely overbought from here. CHART 1: THIS IS PRETTY CONSTRUCTIVE SIGN FOR THE BULLS KOSPI HIT A NEW HIGH
South Korea: Korea Index
2400 2000

1600

1200 800

400

0 96 97 98 99 00 01 02 03 04 05 06 Source: Wall Street Journal/Financial Times /Haver Analytics Source: Haver Analytics, Gluskin Sheff 07 08 09 10

OH, CANADA! First off, the loonie managed to cross above par against the greenback on December 28 for the first time in eight months. Second, the TSX closed the year with a 21% gain in USD terms, outpacing the 13% gain in the S&P 500 by 800 basis points. This marks seven of the past eight years in which the Canadian stock market outperformed the U.S. in common-currency terms.
Page 2 of 15

January 4, 2011 BREAKFAST WITH DAVE

Third, the 10-year Canada yield trades at a 21 basis points discount to the U.S. 10-year note and the long Canada bond is now around 90 basis points below U.S. comparable levels. This is unprecedented and comes despite a policy rate that is 75 basis points higher in Canada, which tells you that, when adjusted for the gap in the cost of carry, bond yields at the longest maturity are arguably 125 basis points lower in Canada than they are in the U.S.A. Think about that for a moment. What the markets are telling you is that Canada, the little brother to the north, is a much safer place to park your money from a fiscal balance sheet standpoint. Both countries are rated AAA by the major credit agencies, but the market has clearly discriminated which country has the more sound national balance sheet and more solid long-term economic prospects. (Who has the bigger army; lets not get into that). CHART 2: CANADIAN BOND YIELDS LOWER THAN U.S.
Canadian long bond yields minus U.S. long bond yields (percentage points)
3

What the markets are telling you is that Canada, the little brother to the north, is a much safer place to park your money from a fiscal balance sheet standpoint

-1 90 95 Source: Haver Analytics Source: Haver Analytics, Gluskin Sheff 00 05 10

Moreover, the fact that the Canadian dollar is appreciating is only one part due to commodities. The other part is a more responsible fiscal policy. The U.S. government continues to pursue a profligate spend-and-borrow fiscal strategy that is not going to end up doing much more than mortgage economic growth from future generations. Dipping into Social Security so that people can have more pocket money to buy more gasoline imported from the Mideast and more electronic gadgets manufactured in emerging Asia hardly represents a very impressive long-term growth plan (like the 5-year ones they have in China). Though it does at least make the quarterly data-flow appear to be more buoyant than they actually are and will be able to fool investors for as long as the stimulus doesnt wear out. But as Herb Stein famously said, anything that cant last forever, by definition, wont. And in the Year of the Rabbit, this may well end up being applied to the rabbits that reside in Ben Bernankes hat ... there may not be that many more that he will be able to pull out.

Page 3 of 15

January 4, 2011 BREAKFAST WITH DAVE

Canada is experiencing very similar modest rates of economic growth like the U.S. but not on the back of quantitative easing and not at the risk of blowing a hole through the government balance sheet. Household debt in Canada is clearly problematic, but for now, completely serviceable. At the national level, as far as we know, Canada is the only G7 country with a credible federal government plan to balance the books over the next five years and at the same time promote domestic competitiveness via a schedule of sliding top marginal corporate tax rates, which just fell to 16.5% from 18%, and is on track to slip to 15% by 2012. By way of comparison, top federal rates on profits are 35% in the U.S.A. and Japan, and 25% on average in Europe. There was a nice compliment on Canadas efforts to stimulate the private sector without resorting to beggar-thy-neighbour monetary policies in the op-ed section of yesterdays WSJ (Canada's Competitive Edge page A16). Our models say the Canadian dollar is overvalued, as they have for some time, but these are only models and what they dont include are intangibles such as a comparatively intelligent and affordable set of fiscal and monetary policies. MARKETS LINING UP BEHIND BERNANKE? They will make it through the storm. This is from Ben Bernanke. And they are Fannie and Freddie. These words were literally uttered a mere two months before Fannie Mae and Freddie Mac collapsed and were effectively nationalized. This is about on par with the troubles in the subprime sector on the broader housing market will likely be limited and of course what I think what is more likely is that house prices will slow, maybe stabilize just prior to the collapse. We of course do not want to appear disparaging, but this is the chief monetary official that the markets have lined up behind and put their faith in over the past four months. (Check out the picture of Mr. Bernanke decked out in a superman costume with cape and all on page R1 of yesterdays WSJ. Yikes!) Look for what happened in the past four months to have been nothing more than a bad case of misplaced optimism. This is how the story ends. For those of us with memories of how liquidity-induced bubbles end, this is a time for maintaining resolve, not for following the herd and joining the bandwagon. ISM THE GOOD AND THE NOT-SO-GOOD Well, the ISM did manage to rise in December to 57.0 from 56.6. This was bang-on the consensus estimate but the whispered number was far higher following last weeks regional data (especially the ripping Chicago-land data). The headline seems impressive but is still below the 60.4 peak posted last April (which is why it is absolutely incredible that todays WSJ would run with the headline on page A2 Factory Activity Surged in December. Sorry 0.4 point advance is hardly a surge).

Page 4 of 15

January 4, 2011 BREAKFAST WITH DAVE

Only 61% of industries reported growth, which is okay but not great, and that actually compares to 78% in October and 94% in April. Both production and orders moved back above the 60 level, which is impressive, but what wasnt was the move down in employment to a 9-month low of 55.7 from 57.5 in November (only half of the respondents reported higher payrolls last month). Export orders also receded for the second month in a row to 54.5 from 57.0. There wasnt much there for the inflation-ists. Order backlogs stayed below 50 (at 47) for the fourth month in a row. Supplier delivery delays eased to 55.9 from 57.2, and despite the surge in copper (to record highs), crude and cotton, the ISM prices-paid index barely rose at all to 72.5 from 69.5 and well off the 78.4 nearby peak last April when the commodity complex was far lower than it is today. That spells profit margin squeeze ... unless, of course, companies maintain a tight control over their payroll cost, which was highly evident in the sagging employment component. A DECEMBER TO REMEMBER We get asked all the time what our target is for the major averages for the coming year. As if that is meaningful. What actually are the assumptions that drive the forecasts for the end of December in any given year? Its like asking what team I think is going to win the World Series next October. Wouldnt it be nice to know what trades are going to be made? What about injuries? Or unexpected Jeter-like slumps by future Hall of Famers? But what is fascinating in the markets is that so many people can be right despite all their assumptions and lines of reasoning being totally off base. That was the case in 2010 go back to the consensus in Barrons a year ago and you will see that the bullish prognosticators at the time were optimistic because of visions of a sustainable V-shaped recovery taking hold. We were rather cautious in our market view, which was based on the premise that once all the stimulus started to fade, and once the government ran out of steroids, double-dip risks would intensify and the market would roll over. This is exactly what happened from April right through to the end of August. We underappreciated the prospect of Ben Bernanke reversing course and not only forgoing the expected exit policy but embarking on another round of central bank balance sheet expansion with the specific aim of driving asset prices higher. Nor did we think that the government would enact another budget-busting stimulus program just weeks after a mid-term election seemingly fought on fiscal probity. By the time Bernanke gave his hand-holding speech on August 26, the S&P 500 was down 6.1% for the year (and 14% from the nearby highs). Since that day, the market rocketed ahead by 20%. Indeed, the entire year came down to an 18-week 20% rebound. To think that through November, which included all the good monetary and election news, the market was up 5.87% not bad, but this goes to show how dramatic this back-end loaded performance was to close off the year. Fully half of the gains came in December the stock market bounced 6.53% in the month; the entire advance for 2010 was 12.78%.

What is fascinating in the markets is that so many people can be right despite all their assumptions and lines of reasoning being totally off base

Page 5 of 15

January 4, 2011 BREAKFAST WITH DAVE

However, we would like to remind investors that silver was up nearly 90% last year, gold was up 30%, and the high-yield bond market was up a good 15%, so there were other ways to generate profits than merely through equities, although that is still the asset class that seems to dominate everyones attention. While we were not bullish enough on the stock market, as far as 2010 is concerned, our long-standing bond-bullion barbell worked out very well, once again. Even so, the stock market resurgence to close out the year was remarkable. This was certainly a December to remember. The last time we enjoyed such a Santa rally (or in Bernankes case, a rally of Maccabeus proportions) was in 1991. Despite what the stock market was telling us back then, the real sustainable recovery was more than a year away, and the next Fed tightening cycle was more than two years away. GETTING A GRIP The stock market is clearly being fuelled by ongoing dramatic government actions. While the U.S. economy has surpassed our expectations and Q4 growth looks set to cross above a 3% annual rate, there is still nothing organic about the macro economic backdrop. Investors are focused on not fighting the tape, but the U.S. economy has its share of structural problems that will come home to roost at some point: 1. Stubbornly high unemployment rate (at 9.8%, not far off the recession high of 10.1%). Oh yes, as for that ballyhooed slide in initial jobless claims, the high seasonal factor divisor contributed to a 388k headline despite an increase of 25k in raw unadjusted terms. Also note that first time claimants on States rolls increased by 118k. So, while initial claims are the lowest since July 2008, this masks just how soft the overall jobless situation really is. Continuing claims today, at 4.1 million, compares with 3.1 million back in 2008; extended benefits today are at 819,000 versus zero back then; and emergency claims at 3.7 million today versus 127,400 back then (thanks to Rich Yamarone for that little ditty). Then lets compare initial claims on a non-seasonally adjusted of 522k for this past week ... and this compares with:

The last time we enjoyed such a Santa rally (or in Bernankes case, a rally of Maccabeus proportions) was in 1991

Dec 26, 2009: NSA: 557k (SA: 454k) Dec 27, 2008: NSA: 717k (SA: 514k) Dec 29, 2007: NSA: 508k (SA: 352k) Dec 30, 2006: NSA: 500k (SA: 339k)

2. Deflating home prices in fact, not only did Case-Shiller home prices decline 1.3% MoM in October, but all 20 cities showed a sequential decline, and this last happened in February 2009 (when investors were actually paying attention to what was happening in the housing market). Eight cities are now down or perilously close to new cycle lows, including some big markets like Miami, Cleveland, and L.A. As an aside, there was a nifty op-ed piece by Peter Schiff on page A19 of the December 30 WSJ that laid out the reason why (hint: Bob Farrells first rule) U.S. home prices may have another 28% downside from here (and to think we thought the Dallas Fed research team was bearish at down 23%). In wealth effect terms, would be equivalent to a 75% slide in the stock market!

Page 6 of 15

January 4, 2011 BREAKFAST WITH DAVE

3. Huge state/local government budget gaps ($65 billion this year) will be closed with tax hikes, user fees and service cutbacks. The biggest myth being promulgated today is that the economy must be doing better because state/local government revenues are on the rise. Dude! Thats not the economy! Its called tax increases. In fact, 23 states have boosted taxes in the past year. Eight have raised income taxes you may want to see the December 26 NYT editorial titled The Looming Crisis in the State. It was edifying. Ditto for the December 27 front page WSJ article titled Strapped Cities Hit Nonprofits with Fees. And yesterdays NYT ran with a front page article titled Cuomo Plans 1-Year Freeze On State Pay. This is a major macro theme for 2011 the fiscal squeeze at the lower level of government. And, its not a given that we are going to see all the stimulus at the federal level come to the fore either the new Congress will see to that (the front page of the NYT also went with GOP Newcomers Set Out to Undo Obama Victories as well as Congress Targets Spending on the front page of yesterdays WSJ). May we also suggest a read of page A3 of yesterdays WSJ Forget Pep Talks; Governors Warn of Tough Times. To wit: With sagging economies, soaring budget deficits and the loss of federal stimulus money, incoming governors face the deepest fiscal crisis in decades and expectations that they will remain true to campaign pledges to slash spending and taxes. It remains to be seen how this 12% share of GDP and 15% share of employment end up wreaking havoc on newly minted near-4% economic growth forecasts for 2011. 4. Surging energy prices oil prices have broken above $90/bbl and we seem to recall that when this happened in 2007, an unexpected recession followed four months later. Yesterdays USA Today ran with an article quoting some energy experts predicting that gasoline prices, already north of $3 a gallon, may yet test $4 a gallon before long. Now that would pretty well take care of that payroll tax cut ... and then some. Looking at the near record net speculative long positions on the New York Mercantile Exchange, as far as light sweet crude is concerned, it is abundantly clear that this runup in oil prices is not merely related to physical demand. Remember that it was this investment-related action in 2008 that ultimately caused the price to head into reverse as the physical demand growth went into reverse (as an aside, speculative longs in copper have also reached five year highs). 5. Slowing global growth, as flagged by the decline in the Chinese stock market. The dramatic fiscal squeeze in Europe is also going to affect 25% of U.S. exports and the policy tightening in inflation-bound emerging Asia will negatively influence another 25% of the pie. So forget about any 2011 improvement from the foreign trade front. 6. The looming showdown in Congress over the stopgap bill that keeps the government running until March. And stimulus freaks may have to contend with a GOP-led House that is pushing for spending to return to 2008 levels. Have a look at GOP Sets Up a Huge Target for Budget Ax on the front page of todays NYT the new Congress is not the old Congress and is seeking $100 billion of cuts in government spending this year. We wonder how many economists, giddy over the recent tax stimulus, have entertained the notion how dramatic spending restraint in their forecast as far as the widespread consensus 2011 macro forecast is concerned. We also recommend a read of the article on page 2 of todays FT Republicans Ready for Battle on Debt Ceiling. Make no mistake, steep expenditure cuts will very likely be part and parcel to any deal resolving the looming debt ceiling issue, which promises to come to a head by April.

The Fed has now successfully convinced investors that it will defend the S&P 500 vigorously at the low end of the range

Page 7 of 15

January 4, 2011 BREAKFAST WITH DAVE

From our lens, at current valuation levels, the good news appears to be fully priced in and then some. The prospect of intense spending restraint under the new and more hawkish Congress, the limited chance of a QE3 monetary program, the realization that much of the growth we will see in 2011 will have been borrowed from 2012 and President Obamas sudden move to the center (evidenced by his choice of William Daley as his new Chief of Staff) which has greatly enhanced his re-election prospects will all make the market action beyond this quarter very interesting indeed. The current complacency is palpable. We actually saw an economist interviewed on CNBC last week who said he was dismissing the adverse consumer confidence report because it didnt line up with the other pieces of December data. The Conference Board reported that consumer confidence fell to 52.5 in December from 54.3 in November and below the consensus forecast of 55.8. The expectations component sagged to 71.9 from 73.6; one would have thought that given the fiscal goodies announced that it would have been this component that would have shot up ... hmmmm. In the past, a healthy organically-driven economy was associated with minimum levels of 90 on this barometer, a level we have not seen since the economy approached the Great Recession in the latter months of 2007. This then begs the question, what exactly is a healthy organicallydriven economy? As Doug Cliggott has recently pointed out, it is not one that requires the federal government spending $1.60 for every tax dollar it is taking in from the revenue base. The pitfalls have been ignored, in part because the Fed has now successfully convinced investors that it will defend the S&P 500 vigorously at the low end of the range; but that there is no limit for asset prices on the upside that would cause the central bank to take the punch bowl away. In fact, you know that there is nothing but air underneath this economy when you have people like Paul Krugman clamouring for even more stimulus (see his op-ed Deep Hole Economics on page A19 of yesterdays NYT). After all, lingering consumer strains were underscored by the fact that U.S. personal bankruptcy filing jumped 9% in 2010. As for the markets, you know that there is not much being fundamentally driven when you see this article on page R1 of yesterdays WSJ Meet the Supporting Cast: Markets Continued to Benefit From Intervention in 2010; Now, the Question Is, Can the Fed and Others Exit Neatly? Well, is this intervention or is this manipulation? We can see why the bears have become extinct and the shorts are running scared the government has somehow managed to convince investors that bear markets or even corrections are now unconstitutional. This question in the title could have been asked a year ago and it is so evident that once the exit strategy was about to be implemented, the markets puked. So we know what happened. QE2 happened.

In the past, a healthy organically-driven U.S. economy was associated with minimum levels of 90 on the expectations component of the Conference Board Consumer Confidence report

A level we have not seen since the economy approached the Great Recession in the latter months of 2007

Page 8 of 15

January 4, 2011 BREAKFAST WITH DAVE

This is not the onset of the secular bull market that began in 1982 when the Fed was still conducting monetary policy in a traditional way and when the government was getting out of the way instead of permeating practically every facet of the economy and capital market in order to influence asset values. For any supporter of free markets, what we are seeing unfold should be highly troublesome. This is what bubbles are made of. Decisions made on the actions or inactions of central banks as opposed to economic fundamentals. The market has become euphoric in a junior way to what we saw unfold in late 1999 and early 2000. Irrational may even be a more appropriate term because there really seems to have been very little in the month of December to have warranted a run-up in the market that on average takes over a year to achieve even in secular bull phases. At least if there is any honest reporting out there, it is from Mark Gongloff at the WSJ, although the headline of his article on the front cover of yesterdays paper (Investors Forecast: Sunny With Chance of Overheating) didnt quite talk to us as much as this little ditty did: The big concern at the dawn of 2010 was the economys budding comeback would take a nosedive concerns that were borne out over the summer but were put to rest as the economy rebounded in the final months of the year with the help of the Federal Reserve. Indeed, we were one of the few that recognized just how fragile this recovery was, but we did not think that Bernanke was going to do such an about-face regarding his exit strategy. Nor did we believe the market would have responded so aggressively, though admittedly along the way we had more bailout action in Europe and then the last-minute fiscal giveaways as the year drew to a close. We should add that Tom Lauricella of the WSJ also called it for what it was in his article on page R1 of Mondays WSJ Meet the Supporting Cast. In a mere 12 words ... The story of 2010 shows how government support continued to prop up financial markets. At this point, we remind ourselves of Bob Farrells Rule Four: Exponential rapidly rising or falling markets usually go further than you think This market has already gone much further than we had thought possible but then again, we never thought that the Fed would allow its balance sheet to get so bloated and for the government to run up such a debt tab all in the name of trying to reignite a bull market in risk assets. The title on page R2 of yesterdays WSJ does pose the question: Can Markets Star Without Help?

This is what bubbles are made of decisions made on the actions or inactions of central banks as opposed to economic fundamentals

While we are still not drinking the Kool Aid that the Fed has spiked in its punch bowl, only a fool would say that that this overextended market cant become even more extended in coming months

Page 9 of 15

January 4, 2011 BREAKFAST WITH DAVE

Well, while we are still not drinking the Kool Aid that the Fed has spiked in its punch bowl, only a fool would say that this overextended market cant become even more extended in coming months. But this is a highly speculative market and it is amazing now how analysts, economists and strategists have been so quick to raise their earnings, GDP and S&P 500 price targets for 2011. This is the exact reverse image to what we were seeing in the summer (when we were told to ignore the ECRI leading economic indicator, though now that it is back in positive terrain it has re-emerged as a source of jubilation). Looking back at the past, the time to buy the market is when the VIX is at 40x, not 17x. We now have Wall Street houses laying claim to fair-value multiples being as high as 16x (going back seven decades to the time the tech bubble began in the 1990s, the share of the time that the P/E multiple was higher than 16x was less than 30%) yet somehow this is now considered to be a normal level despite all the future uncertainties surrounding how the Fed and the Federal government can ever extricate themselves from this unbelievable volume of monetary and fiscal largesse. All we can say is that there will be a day when the piper gets paid. There is no such thing as a free lunch and yet it has been a meal of government-fed steroids that Mr. Market has been feasting on since late summer. Given the new congressional oversight and new FOMC voting membership, it is unlikely that Ben Bernanke will receive the backing he got in order to implement QE2 remember, he announced this at a Jackson Hole speech in late August before a meeting of his central bank brethren ever took hold. This will be something the market will be mulling over in the second quarter the Fed is at the end of its rope. In the meantime, we can look forward to an acrimonious relationship between the House Republicans and the Administration, and a showdown over the debt ceiling is a clear risk in coming months again, in the second quarter. At stake could be a good dose of spending restraint as pay-go rules make a sudden reappearance after being neglected by the lame duckers late last year. There is always the reality of the payroll tax cut coming to an end in December and how that will crimp personal income in 2011. Then again, we know that in the United States, giving a tax cut is like giving someone a free parking pass just try to take it away! Of course, there is always the prospect of a Q4 corporate spending binge as the bonus depreciation allowance expires. But again, that will only steal growth away from 2012. So something tells us that beyond Q1, the last three quarters of 2011 are going to be very interesting. SIGNS OF EXUBERANCE ABOUND

Equity mutual funds and ETFs took in $24 billion in December when bonds were attracting inflows like this last year, the vast majority believed the fixed-income market was in some sort of bubble

The VIX index, at 17.5x, is back to where it was last April. Remember what happened next. Investors Intelligence bullish sentiment is back to where it was at the all-time market highs of October 2007.

Page 10 of 15

January 4, 2011 BREAKFAST WITH DAVE

The non-commercial accounts on the CME have recently opened up a considerable net speculative long position in equities, particularly the QQQs (Nasdaq stocks). Market leadership is narrowing, as Bob Farrell has been busy pointing out. The number of short-selling positions slid 2.2% in the first half of December on the NYSE; and by 2.8% on the Nasdaq. The bears are running scared. As Kelly Evans asserted last week, the AAII investor sentiment poll has been above its historical norm now for 17 weeks running the longest stretch in six years. Since July, margin debt has exploded by 16% to $274 billion, the most since September 2008 when people still thought we were in a soft landing. Equity mutual funds and ETFs took in $24 billion in December (TrimTabs data) when bonds were attracting inflows like this last year, the vast majority believed the fixed-income market was in some sort of bubble, which was to be avoided (have a look at Stock Funds Draw Investor Cash on page C11 of the December 30 WSJ). But since we are now talking about the stock market garnering this much attention, it can only mean one thing; another leg up in price!! As an aside, the last time we saw retail inflows like this into equities was last March ... just ahead of a 17% correction. The front page of the December 30 WSJ ran with this as the lead article Banks Open Loan Spigot. The trigger for the article banking sector Commercial and Industrial (C&I) loans eked out a 0.2% increase in the fourth quarter, according to Moodys. This is what passes for exuberant news these days; a quarter in which business credit does not contract (it doesnt have to expand just dont go down and you reserve the right to have a front page story written about it. Then again, it may just have been a slow news day.) Lets just add here that there is no sign at all that lending is rising to the household sector. Indeed, consumer loans and residential mortgage credit from the banks have declined now in each of the past two weeks. And despite the Feds latest QE move to entice banks to lend, cash on their balance sheets continues to exceed $1 trillion, total net new credit creation is still non-existent and the money multiplier is actually contracting. Rest assured that this is the only place you will find this information (save, perhaps, for John Williams). But that does not mean the stock market cant go up instead of extending credit to the Cleaver family, the banks are seemingly using the newly minted reserves from the Fed to engage in a little bit of old fashioned speculation in the market place as the chart below on trading assets at the commercial banks would suggest. Its not a case of dont fight the Fed as much as dont fight the Wall Street prop desks!

Page 11 of 15

January 4, 2011 BREAKFAST WITH DAVE

CHART 3: BANKS TRADING ASSETS HAS SURGED BY $64 BILLION IN THE LAST MONTH
United States: Trading Assets for all commercial banks (billions)
500

450

400

350

300

250 09 Source: Federal Reserve Board /Haver Analytics Source: Haver Analytics, Gluskin Sheff 10

CHART 4: MARGIN DEBT UP 24% IN PAST YEAR

United States: Debit balances in margin accounts at Broker/Dealers (% change year to year, millions)
100 75

50

25

-25

-50 99 00 01 02 03 04 05 06 Source: New York Stock Exchange /Haver Analytics Shaded region represent periods of U.S. recession Source: Haver Analytics, Gluskin Sheff 07 08 09 10

WHAT WAS THE REAL SURPRISE OF THE YEAR? That we would close 2010 with the yield on the U.S. 10-year Treasury note anywhere near 3.3%. To be sure, it is up 100 basis points from the SeptemberOctober lows, but the consensus for the 10-year note a year ago was that it would be in a 4-5% range. Nobody, except for us, was remotely constructive on the fixed-income market (Van Hoisington and Gary Shilling aside). Moreover, we have the Treasury market delivering a decent 5.3% total return last year, despite the rough going in the last few weeks of the year in particular.

Page 12 of 15

January 4, 2011 BREAKFAST WITH DAVE

Once again, the consensus sees little prospect for lower bond yields in 2011 and even former bulls have turned bearish. The December 29 WSJ ran with Fixed-Income Pro Favors Stocks. Sentiment towards bonds is so depressed that even fixed-income strategists want to switch coverage. And inflation is back on everyones radar screen just as it was a year ago when the core rate of inflation was nearly triple what it is today. So it comes as little surprise, at least to us, to see this title show up in the Current Yield column in Barrons: Fear Inflation? TIPS for 2011. In our view, the surprise will be the same in 2011 as it was in 2010 deflation is the primary risk. In stark contrast to equities, the latest Commitment of Traders report show that the speculators have established a huge net short position both in the long bond (8,852 contracts) and in the 10-year note (138,968 contracts). Back on the week of November 16, there was a net speculative long position of 57,134 contracts talk about a massive swing. Wild stuff. In any event, it may not hurt to know that the last time the net speculative short position was this high was back on June 15 of last year, we had a pretty nice short squeeze that allowed the 10-year yield to decline a nice 35 basis points within a months time. IS THE SUN RISING IN JAPAN? The yen is no longer acting as a pervasive vice on profits and the Japanese corporate sector is about to enjoy a five percentage point cut in the top marginal rate to 35%. Meanwhile, the Japanese equity market has a lot of catching up to do in relation to its G7 counterparts. As Leslie Norton points out in Barrons (page M7 In Love With Japan Yet Again), valuations look pretty compelling too, which means that whatever bad news there is, it is already priced in. Japan trades at book, whereas the U.S.A. trades at 2.2x book and nearly 2x for Europe as well as non-Japan Asia.

Sentiment towards bonds is so depressed that even fixedincome strategists want to switch coverage

Page 13 of 15

January 4, 2011 BREAKFAST WITH DAVE

Gluskin She at a Glance

Gluskin She + Associates Inc. is one of Canadas 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
As of September 30, 2010, the Firm managed assets of $5.8 billion.

INVESTMENT STRATEGY & T EAM

date) would have grown to $9.1 million on September 30, 2010 versus $5.9 million for the S&P/TSX Total Return Index over the same period.
2

We have strong and stable portfolio management, research and client service teams. Aside from recent additions, our Gluskin Sheff became a publicly traded Portfolio Managers have been with the corporation on the Toronto Stock Firm for a minimum of ten years and we Exchange (symbol: GS) in May 2006 and have attracted best in class talent at all remains 49% owned by its senior levels. Our performance results are those management and employees. We have of the team in place. public company accountability and governance with a private company We have a strong history of insightful commitment to innovation and service. bottom-up security selection based on fundamental analysis. Our investment interests are directly aligned with those of our clients, as For long equities, we look for companies Gluskin Sheffs management and with a history of long-term growth and employees are collectively the largest stability, a proven track record, client of the Firms investment portfolios. shareholder-minded management and a share price below our estimate of intrinsic We offer a diverse platform of investment value. We look for the opposite in strategies (Canadian and U.S. equities, equities that we sell short. Alternative and Fixed Income) and investment styles (Value, Growth and For corporate bonds, we look for issuers 1 with a margin of safety for the payment Income). of interest and principal, and yields which The minimum investment required to are attractive relative to the assessed establish a client relationship with the credit risks involved. Firm is $3 million. We assemble concentrated portfolios 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 which we have the highest conviction. Equity Portfolio in 1991 (its inception Our success has often been linked to our long history of investing in underfollowed and under-appreciated small and mid cap companies both in Canada and the U.S.

Our investment interests are directly aligned with those of our clients, as Gluskin Shes management and employees are collectively the largest client of the Firms investment portfolios.

$1 million invested in our Canadian Equity Portfolio in 1991 (its inception date) would have grown to $9.1 million2 on September 30, 2010 versus $5.9 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 date) would have grown to $11.8 million 2 usd on September 30, 2010 versus $9.6 million usd for the S&P 500 Total Return Index over the same period.
Notes:

PORTFOLIO CONSTRUCTION
In terms of asset mix and portfolio construction, we offer a unique marriage between our bottom-up security-specific fundamental analysis and our top-down macroeconomic view.
For further information, please contact questions@gluskinshe.com

Unless otherwise noted, all values are in Canadian dollars. 1. Not all investment strategies are available to non-Canadian investors. Please contact Gluskin Sheff for information specific to your situation. 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 14 of 15

January 4, 2011 BREAKFAST WITH DAVE

IMPORTANT DISCLOSURES
Copyright 2010 Gluskin Sheff + Associates Inc. (Gluskin Sheff). All rights reserved. This report is prepared for the use of Gluskin Sheff clients and subscribers to this report and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Gluskin Sheff. Gluskin Sheff reports are distributed simultaneously to internal and client websites and other portals by Gluskin Sheff and are not publicly available materials. Any unauthorized use or disclosure is prohibited. Gluskin Sheff may own, buy, or sell, on behalf of its clients, securities of issuers that may be discussed in or impacted by this report. As a result, readers should be aware that Gluskin Sheff may have a conflict of interest that could affect the objectivity of this report. This report should not be regarded by recipients as a substitute for the exercise of their own judgment and readers are encouraged to seek independent, third-party research on any companies covered in or impacted by this report. Individuals identified as economists do not function as research analysts under U.S. law and reports prepared by them are not research reports under applicable U.S. rules and regulations. Macroeconomic analysis is considered investment research for purposes of distribution in the U.K. under the rules of the Financial Services Authority. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. Securities and other financial instruments discussed in this report, or recommended by Gluskin Sheff, are not insured by the Federal Deposit Insurance Corporation and are not deposits or other obligations of any insured depository institution. Investments in general and, derivatives, in particular, involve numerous risks, including, among others, market risk, counterparty default risk and liquidity risk. No security, financial instrument or derivative is suitable for all investors. In some cases, securities and other financial instruments may be difficult to value or sell and reliable information about the value or risks related to the security or financial instrument may be difficult to obtain. Investors should note that income from such securities and other financial instruments, if any, may fluctuate and that price or value of such securities and instruments may rise or fall and, in some cases, investors may lose their entire principal investment. Past performance is not necessarily a guide to future performance. Levels and basis for taxation may change. Foreign currency rates of exchange may adversely affect the value, price or income of any security or financial instrument mentioned in this report. Investors in such securities and instruments effectively assume currency risk. Materials prepared by Gluskin Sheff research personnel are based on public information. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of Gluskin Sheff. To the extent this report discusses any legal proceeding or issues, it has not been prepared as nor is it intended to express any legal conclusion, opinion or advice. Investors should consult their own legal advisers as to issues of law relating to the subject matter of this report. Gluskin Sheff research personnels knowledge of legal proceedings in which any Gluskin Sheff entity and/or its directors, officers and employees may be plaintiffs, defendants, codefendants or coplaintiffs with or involving companies mentioned in this report is based on public information. Facts and views presented in this material that relate to any such proceedings have not been reviewed by, discussed with, and may not reflect information known to, professionals in other business areas of Gluskin Sheff in connection with the legal proceedings or matters relevant to such proceedings. Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Investors are urged to seek tax advice based on their particular circumstances from an independent tax professional. The information herein (other than disclosure information relating to Gluskin Sheff and its affiliates) was obtained from various sources and Gluskin Sheff does not guarantee its accuracy. This report may contain links to thirdparty websites. Gluskin Sheff is not responsible for the content of any thirdparty website or any linked content contained in a thirdparty website. Content contained on such thirdparty websites is not part of this report and is not incorporated by reference into this report. The inclusion of a link in this report does not imply any endorsement by or any affiliation with Gluskin Sheff. All opinions, projections and estimates constitute the judgment of the author as of the date of the report and are subject to change without notice. Prices also are subject to change without notice. Gluskin Sheff is under no obligation to update this report and readers should therefore assume that Gluskin Sheff will not update any fact, circumstance or opinion contained in this report. Neither Gluskin Sheff nor any director, officer or employee of Gluskin Sheff accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents.

Page 15 of 15