David A.

Rosenberg May 29, 2009

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

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING
Investor risk appetite is back with a vengeance today: IN THIS ISSUE
• The world MSCI index is up 0.7% so far, the third advance in a row. • Risk appetite back with a
vengeance
• Asia-Pac rallied 1.2% today. Emerging market equities pulled in a net
$2.1bln in fund flows this past week (15 weeks in a row of inflows); this • Global data mixed, but
followed a $2.5bln inflow the week before. overall constructive
• Mortgage delinquencies
• Gold just hit a three-month high of $973/oz (up 1.4%) and silver is coming hit a new high
of its best month in 22 years.
• Industrial activity recedes
• Oil has broken above its 200-day moving average; energy stocks do not sharply
appear to be priced for a sustainable $65/barrel crude price (U.S. oil • Jobless claims point to
inventories have declined for three straight weeks — last week’s 5.4 million worrisome employment
barrel draw was far larger than expected, though we hear that a large picture
amount of crude is being stored in tankers ready to come to port — see • Home sales stagnating
page C6 of the WSJ). despite record stimulus

• Commodity currencies are on a tear, with the Aussie leading the pack. The
sharp rally in the CAD along with the weak U.S. consumer is a dead-weight
drag on Canadian manufacturers.

• Despite the heightened risk appetite, government bonds are rallying (off
massively oversold levels) — yields are down 7bps in the U.K. and Germany
and down 3bps in the U.S.A. This week’s Treasury auctions went fairly well;
the next crucial test will be the 10- and 30-year auctions in early June (for
some reason, supply concerns don’t seem to affect other markets — there
has been a huge $20 billion of new junk bond issuance so far in May with
hardly a peep about it in the business media). As a contrarian, I just love it
when I see headlines like this (page C10 of the WSJ) — Deflating the Bubble
in U.S. Treasuries. The Treasury market was never in a ‘bubble’, folks.
Nothing that is fully guaranteed and pays a coupon semi-annually with no
call or prepayment risk goes into a ‘bubble’ just because it was expensive
at the yield low. Sentiment never got wildly bullish; the public never
became enamoured of Treasuries; there was no widespread ownership or
‘new paradigm’ thoughts. At the lows in yield, there were legitimate
concerns over a depression-like economic backdrop and deflation. That
was the story for the bond market — it never ever met the classic
characteristics of a bubble as was the case with the dotcoms or housing.

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May 29, 2009 – BREAKFAST WITH DAVE

• One of our long-standing themes has been the deflation that has hit the
labour market in a way that we have not seen in the last six decades. For
more on this file, have a look at Still Working, but Forced to Make Do With
Less on the front page of the NYT. Also take a read of Paul Krugman’s
excellent column on page A23 (The Big Inflation Scare).
Short-covering still a major source of buying power for the equity market.
Indeed, according to Bloomberg data, short interest in the S&P 500 fell an
additional 1.7% in the first half of May.
For all the talk about how foreign central banks, led by China, would
impose a buyer’s strike against U.S. bonds, we see that in the week ending
May 27, total custodial holdings of Treasuries at the Fed rose $8bln to
$1.191trln.
Intel was the latest to post a decent bottom line — beating estimates by a
penny per share (at 24 cents) — but like so many others, missed its revenue
target. Sales dropped 23% YoY to $12.3bln versus the $12.7bln consensus
estimate.
KEEP AN EYE ON THE U.S. DOLLAR:
IT IS BASIS POINTS AWAY FROM SEEING THE 50-DAY M.A. (83.8) CROSS BELOW
THE 200-DAY M.A. (83.6). THE ‘SPOT’ INDEX IS 79.9. IN THE EVENT OF THE
‘CROSSOVER’, WHICH LAST OCCURRED THREE YEARS AGO, THE COMMODITY
COMPLEX AND PRECIOUS METALS WILL LIKELY RECEIVE AN EVEN LARGER
PUSH TO THE UPSIDE.

ON THE DATA FRONT, MIXED NEWS BUT OVERALL … CONSTRUCTIVE:

• The U.K. is pulling out of its morass. GfK consumer confidence hit a year-long
high in April and is up now three months in a row (to -27 from -30). The
Nationwide home price survey showed a 1.2% pop to home prices in May —
the best result since December 2006 (but still down 11.8% YoY).

• Real retail sales in Germany came in as expected, at +0.5% (inflation-

adjusted) in April — the third increase in a row (but still down 0.8% YoY).

• Despite all the good economic news, pricing power is tough to come by as
Eurozone inflation hit zero last month for the first time in at least 13 years.

• There was a slate of data out of Japan today, and what investors are fixated
on is the massive 5.2% surge in industrial production in April on top of the
1.6% pickup in March (expectations were for a 3.3% gain); and, the
government (METI) says that output should bounce 8.8% in May and 2.7%
in June too. The Japanese government raised the economic outlook last
week just in the nick of time. Or so it seems. While export-led activity is
improving after what was a data-detonation in January, domestic spending
indicators are still quite moribund. Housing starts in April were down 32.4%
YoY, the fifth month in negative terrain. Household spending also
contracted 1.3% YoY, and the labour market is imploding there as it is in
the U.S.A. — the unemployment rate hit 5.0% in April from 4.8% in March
and the key job offers-to-seekers ratio fell to 0.46 from 0.52.

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May 29, 2009 – BREAKFAST WITH DAVE

MORTGAGE DELINQUENCIES HIT NEW HIGH Chart 1: REFI BOOM IS OVER

United States
The Mortgage Banker’s Association delinquency rate data came out for
MBA: Volume Index: Mortgage Loan Applications for Refinancing
the first quarter, and they were bad: A year ago, the markets and the (March 16, 1990 = 100)

financials would have taken a big hit on data like this, but heck, when the 8000

government steps in to guarantee the longevity of the large commercial banks,

reports like this are now easily dismissed. Still, they attest to the deteriorating 6000

level of credit quality, fully 18 months into this crisis. The all-in mortgage
delinquency rate rose to a new record of 9.12% from 7.88% in the fourth 4000

quarter and 6.35% a year ago. Subprime delinquency rate jumped to 24.95% 2000

from 31.88% and prime delinquency rates rose to 6.06% from 5.06% in Q4
(3.71% a year ago). Amazingly, fully 27.58% of the subprime ARM space is 0

now past due; and 12.04% for prime (double where this was a year ago). 07 08

Source: Haver Analytics, Gluskin Sheff

What’s amazing is that the homebuilding stocks slid 4.4% on the data, because
they ostensibly are not to big to fail. The big banks are to big to fail, so on days
like this when we get the worst delinquency data in modern history, the stocks of
these companies can muster a rally (financials advanced 3.6% yesterday)
because everyone knows that the Obama economics team is going to
completely backstop the banking system.

You really have to start wondering if the Fed has lost control — or at least, it’s
probably safe to assert that monetary policy has lost much of its effectiveness.
After announcing the bond-buyback program in March, the yield on the 10-year
note has surged over 100 basis points and this has taken place with the data for
the most part still coming in on the soft side. The Fed remains focused on the
housing market and yet mortgage rates have now backed up to three-month highs
(up 40 bps from the lows to 5.44%) with only faint signs of stabilization at hand.

Meanwhile, mortgage refinancing activity has turn down after a brief bounce —
down 19% last week and now down 43% from the mid-March peak. The loss of
cash-flow support here coupled with higher gasoline prices and lingering 500k
monthly job declines puts at risk the view that we are going to see GDP swing to
positive growth terrain next quarter.

INDUSTRIAL ACTIVITY RECEDES SHARPLY

Having digested the U.S. durable goods report that came out for April, the only
conclusion that can be reached is: (i) the fiscal stimulus (infrastructure part) is
not hitting the economy yet; and, (ii) with over one-third of manufacturing
capacity sitting idle, the incentive to embark on new capital spending projects
is basically nil. All signs point to a GDP contraction at this point of between
3% and 4% at an annual rate this quarter. A turnaround for Q3, as per the
consensus, seems like pure guesswork right now, though the equity market
seems to believe in the recession-is-about-to-end view.

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May 29, 2009 – BREAKFAST WITH DAVE

Chart 2: NO GREEN SHOOTS IN

While headline new orders did rise 1.9% MoM, like existing home sales, the so- DURABLE GOODS ORDERS
called bounce occurred off a sharp downwardly revised March print, which now United States
shows a 2.1% MoM decline. What feeds into the capex portion of GDP, the non- Mfrs' New Orders: Nondefense Capital Goods ex Aircraft
(year-over-year % change)
defense capital goods orders ex-aircraft, was down 1.5% MoM and has
collapsed at a 28.6% annual rate over the three months to April. This tells us 30

that we have to be ultra selective in the industrials space. Core capital goods 20

shipments also dropped 2.1% MoM and down now in each of the last four 10

months — sliding at a 29.3% annual rate since January.

0

There still seems to be a view that we are going to embark on an inventory -10

building process in the second half of the year and this will lead to an end of -20

the recession and sustainable growth. We are not so sure. Even if inventories -30
95 00 05
have been pared back for four months in a row — sales are dropping at an Source: Haver Analytics, Gluskin Sheff

equivalent rate. Indeed — the inventory-shipments ratio for the durable goods
sector remains near its highest level in 16 years, at 1.88x. Go back to the last
recession in November 2001, and it was sitting at 1.56x (the ‘core’ durables
inventory-shipments ratio actually rose to 2.0x from 1.97x).

Chart 3: MANUFACTURING I/S RATIO REMAINS NEAR A 16-YEAR HIGH

United States
Durable Good Inventories as a share of Shipments
(ratio)

1.9

1.8

1.7

1.6

1.5

1.4

1.3
97 98 99 00 01 02 03 04 05 06 07 08

Source: Haver Analytics, Gluskin Sheff

The details of the durable goods orders report were quite weak and to repeat,
it looks like real GDP for Q2 is going be between -3% to -4% at an annual rate.
But there were some sectors that stood out as bright spots:

Communications equipment orders jumped 7% MoM in April, stemming a

five-month stretch of declines and the strongest month since December 2007.
By way of comparison, orders for computers/accessories plunged 6.4% MoM
(-55% at an annual rate!) and down in four of the last five months to a new
record low level (data back to 1992).

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May 29, 2009 – BREAKFAST WITH DAVE

Electrical equipment also posted a 0.3% MoM advance in new orders for two
months in a row — we haven’t seen back-to-back increases since last summer.

The U.S. defense sector, by and large, is the sector with the strongest order
book, according to the Commerce Department at least — orders soared 12%
MoM and while orders in this sector can be volatile, the YoY run-rate is 23%
versus -24% for the entire durable goods sector

JOBLESS CLAIMS POINT TO WORRISOME EMPLOYMENT PICTURE

Jobless claims fell 13k in the May 23rd week, to 623k, but they came off a
downwardly revised 636k figure the week before — this is now the 17th week
in a row in which claims have been above the 600k mark. Moreover,
continuing claims rose to a new record high of 6.788 million — up 110k and
the 19th week in a row of increases. Over the last month, the continuing
claims figures have surged 495k. The two numbers combined — initial claims
and continuing claims — points to -450k on nonfarm payrolls for May, data
comes out on June 5th; and there is upside risk to that number — remember
that there were 76k census workers added to the April figure and the Birth-
Death model added roughly 50k that month as well. The insured
unemployment rate rose yet again to a new high of 5.1% from 5.0% the week
before and 4.8% a month earlier. This is entirely consistent with the view that
the unemployment rate will head above 10.0% before this cycle is out.

Chart 4: TOUGHER AND TOUGHER TO FIND A JOB

United States
Continuing Claims: 4-Week Moving Average
(year-over-year % change)

160

120

80

40

-40
70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

Page 5 of 8
May 29, 2009 – BREAKFAST WITH DAVE

HOME SALES STAGNATING DESPITE RECORD STIMULUS

New home sales in the U.S.A. were practically unchanged in April, edging to
352,000 units at an annual rate from 351,000 in March — bouncing along the
bottom despite record affordability and the $8,000 tax credit. It is amazing
that despite all the fiscal and monetary stimulus we would have new home
sales down 34% from year-ago levels. While the inventory-to-sales ratio has
come off its high of 12.4 months’ supply back in January, and 10.6 months in
March, to 10.1 months in April, the reality is that home prices will not stop
declining until that ratio dips below 8 months’ supply. All the information we
ever need to know is in the ‘price’ — the fact that average new home prices fell
1.2% MoM April, down now in four of the last five months, and a record -19%
on a YoY basis, is a signpost that there are still more sellers than buyers.

Page A4 of today’s WSJ runs with California Housing Shows Signs of Nearing
Bottom because median home prices rose in back-to-back months (still down
37% YoY, mind you) for the first time in two years; and sales are up 49% from
a year ago as well. Problem is that there is so much activity in the forced-
foreclosure sales market that it is difficult to make book on the actual
underlying trend. But no doubt the inventory backdrop has improved from 9.8
months’ supply a year ago to 4.6 today.

Chart 5: RECORD DECLINE IN NEW HOME PRICES

United States
New 1-Family Houses: Average Sales Price
(year-over-year % change)

30

20

10

-10

-20
75 80 85 90 95 00 05
Source: Haver Analytics, Gluskin Sheff

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May 29, 2009 – BREAKFAST WITH DAVE
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May 29, 2009 – BREAKFAST WITH DAVE
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