David A.

Rosenberg September 15, 2009

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

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING
IN THIS ISSUE
Couple of news items from overseas. First, the closely watched German ZEW
sentiment index edged up to 57.7 in September from 56.1 in August, to stand at • While you were sleeping:
a three-year high. But it fell short of the 60.0 headline that was the consensus German ZEW index came
forecast and hence the Euro actually sold off on the news. This is why it is in below market
always critical to assess what is “priced in”. expectations — Euro sold
off on the news despite
the index being at its
Second, in the U.K., RPIX inflation was pretty well as expected in August — 1.2% highest level in three
on a YoY basis. But the Bank of England did throw in a bit of a wrench to the years; U.K. RPIX inflation
outlook for Sterling as Governor King hinted that we could see the central bank as expected
reduce the deposit rate on bank reserves as a means to incentivize lenders to …
• Reviewing some secular
well, lend. themes: We are in a post-
bubble credit collapse
REVIEWING SOME SECULAR THEMES environment; the
We are in a post-bubble credit collapse environment. The transition to the next transition to the next
sustainable bull market and economic expansion is likely years away. The most sustainable bull market
and economic expansion
notable “non-confirmation” signpost for this bear market rally in equities is the is likely years away
3-month Treasury bill yield, which is just 13 basis points away from zero. This
could be Japan all over again. • San Francisco Fed
President Janet Yellen
supports our cautious
The global economy is being held afloat by rampant fiscal stimulus, which is view
accounting for all of this year's growth rate and 80 pct of next year's. This is very
much like the 1930s when the pace of economic activity was in need of major
stimulus. The sharp downdraft in the equity market and the steep recession in
1937-38 after the government had the temerity to remove the life support fully
eight years after the initial shock is case in point.

As for the U.S.A., real GDP would have contracted at a 6% annual rate in 2Q, not
1%, if not for the dramatic fiscal stimulus out of Washington. As for the current
quarter, that 2-3% annualized GDP gain penned in by the consensus would
actually be flat to negative without all of the fiscal help (ie, Cash for Clunkers)

While policy reflation is massive, there are limits and to date, the initiatives have
only helped cushion the blow. The key to the inflation process is not what the Fed
is doing to the money supply but the extent to which, if at all, the “liquidity” is being
circulated in the real economy. Velocity is still contracting. You can bake a cake
as a central banker, but that doesn’t mean anybody is going to eat it. Rents are
declining for the first time in 17 years. Consumer credit is contracting at a rate not
seen in 65 years, and this not only reflects a desire to bolster depleted savings
rates but also rising charge-off rates among lenders; and, wages/salaries are
shrinking at an unprecedented annual rate of nearly 5%. Between rents, credit
and wages, we have a deflation on our hands of epic proportions.

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
September 15, 2009 – BREAKFAST WITH DAVE

As a result, an income focus in the portfolio is necessary. Investors must not

only be aware of returns, but must also be aware of the extremely high level of An income focus in the
risk there is in the stock market today. Greed is again testing our long-term portfolio is necessary
resolve. The S&P 500 is trading north of a 26x P/E multiple on trailing operating
earnings and history shows that at these high valuation levels, the market
declines in the coming year 60% of the time.

While there is a chance we could see corporate bond spreads widen over the
near-term, we still see them as relative outperformers. As a group, investment-
grade credit is discounting 2% real growth versus 4% for (U.S.) equities. For
bonds to play catch up to equities, in terms of pricing in “growth”, spreads would
have to narrow to 200bps — about 100bps of tightening from today’s level. If
stocks played “catch down” to corporates, the S&P 500 would correct towards
the 850 area. In essence, for the risk involved, corporate bonds are more
attractive relative to equities, which offer historically low earnings AND dividend
yields (the latter at just over 2%).

While rampant fiscal largesse will keep the yield curve steeper than would have
otherwise been the case, the work published by Rogoff and Reinhardt show that
government debt always explodes after a credit collapse. But if the U.S.
experience of the 30s and Japan experience of the 90s are any indication, the
ultimate lows in long-term yields is down the road and south of 2%.

Commodities are a group that, at this stage, is also discounting a reasonable In our view, commodities
global growth trend of 3%. We see them as fair-value right now, but are clearly are still in a secular bull
in a secular bull market. While China may have already stockpiled enough raw market
materials for the year, as long as the Asian economy does not relapse, basic
materials are likely to remain on their long-term uptrend. That is principally why
we favor the Canadian equity market over the U.S. equity market and the
Canadian dollar over the U.S. dollar (note that since the secular bull market in
commodities began eight years ago, the TSX composite index has outperformed
the S&P 500 by 8,200 basis points in Canadian currency-adjusted terms).

JANET YELLEN SUPPORTS OUR CAUTIOUS VIEW

San Francisco Fed President Janet Yellen delivered a superb speech last night San Francisco Fed
that really resonated with us — a true reality check for a stock market which has President Janet Yellen’s
galloped ahead by 54% from the lows, purely on a record eight point expansion speech last night really
of the P/E multiple. The move in equity valuation suggests that stock market resonated with us
investors are anticipating 4% real GDP growth in the coming year. Janet Yellen
has proven to be one of the more astute economic forecasters at the Federal
Reserve and so we thought it prudent to re-print part of her sermon.

First, the good news

“I’m happy to report that the downturn has probably now run
its course. This summer likely marked the end of the
recession and the economy should expand in the second half
of this year.”

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September 15, 2009 – BREAKFAST WITH DAVE

A slow motion recovery lies ahead

“But I regret to say that I expect the recovery to be tepid. Yellen expects the
What’s more, the gradual expansion gathering steam will recovery to be tepid
remain vulnerable to shocks. The financial system has
improved but is not yet back to normal. It still holds hazards
that could derail a fragile recovery. Even if the economy grows
as I expect, things won’t feel very good for some time to come.
In particular, the unemployment rate will remain elevated for a
few more years, meaning hardship for millions of workers.
Moreover, the slack in the economy, demonstrated by high
unemployment and low utilization of industrial capacity,
threatens to push inflation lower at a time when it is already
below the level that, in the view of most members of the
Federal Open Market Committee (FOMC) best promotes the
Fed’s dual mandate for full employment and price stability.”

Sorry, but the credit crisis is not over

“Unfortunately, more credit losses are in store even as the
economy improves and overall financial conditions ease. She also believes that
Certainly, households remain stressed. In the face of high and the credit crisis is not
rising unemployment, delinquencies and foreclosures are yet over
showing no sign of turning around. The delinquency rate on
adjustable-rate mortgages is now up to about 18 percent, and,
on fixed-rate loans, it’s about 6 percent. Delinquencies on both
types of loans have increased sharply over the past year and
are still rising. This trend is consistent across other major loan
categories, and is affecting high- and low-quality borrowers
alike. Even recent-vintage loans are experiencing rising
delinquency rates …

…As I said, financial conditions are better, but not back to

normal. And the likelihood of continuing losses by financial
institutions will add new fuel to the credit crunch. In particular,
small and medium-size banks could experience damaging
losses on commercial real estate loans. Thus far, the largest
losses have been on loans for construction and land
development. Going forward, however, rising loan losses on
other commercial real estate lending is likely because property
values are falling, office vacancy rates are rising, and credit
remains tight or nonexistent for those many property owners
that will need to refinance mortgages over the next few years.
Financial contagion from this sector is one of the most
important threats to recovery.”

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September 15, 2009 – BREAKFAST WITH DAVE

Severe consumer headwinds

“The chances are slim for a robust rebound in consumer Slim chance for a robust
spending, which represents around 70 percent of economic rebound in consumer
activity. Of course, consumers are getting a boost from the fiscal spending
stimulus package. But this program is temporary. Over the long
term, consumers face daunting issues of their own. In fact, it’s
easy to draw a comparison between the financial state of
households and that of financial institutions. For years prior to
the recession, households went on a spending spree. This
occurred during a period that economists call the “Great
Moderation,” about two decades when recessions were
infrequent and mild, and inflation was low and stable. Credit
became ever easier to get and consumers took advantage of this
to borrow and buy. Stock and home prices rose year after year,
giving households additional wherewithal to keep spending. In
this culture of consumption, the personal saving rate fell from
around 10 percent in the mid-1980s to 1½ percent or lower in
recent years. At the same time, households took on larger
proportions of debt. From 1960 to the mid-1980s, debt
represented a manageable 65 percent of disposable income.
Since then, it has risen steadily, with a notable acceleration in
the last economic expansion. By 2008, it had doubled to about
130 percent of income.

It may well be that we are witnessing the start of a new era for
consumers following the traumatic financial blows they have
endured. The destruction of their nest eggs caused by falling
house and stock prices is prompting them to rebuild savings.
The personal saving rate is finally on the rise, averaging almost
4½ percent so far this year. While certainly sensible from the
standpoint of individual households, this retreat from debt-fueled
consumption could reduce the growth rate of consumer
spending for years. An increase in saving should ultimately
support the economy’s capacity to produce and grow by
channeling resources from consumption to investment. And
higher investment is the key to greater productivity and faster
growth in living standards. But the transition could be painful if
subpar growth in consumer spending holds back the pace of
economic recovery.”

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September 15, 2009 – BREAKFAST WITH DAVE

Soft labour market underbelly

“Weakness in the labor market is another factor that may keep Weakness in the labor
the recovery in low gear for a while … my business contacts market will keep the
indicate that they will be very reluctant to hire again until they see recovery in low gear
clear evidence of a sustained recovery, and that suggests we
could see another so-called jobless recovery in which employment
growth lags the improvement in overall output. What’s more,
wage growth has slowed sharply … when the array of problems
facing consumers is considered, it is hard to see how we can
avoid sluggish spending growth.”

Inventories the major impetus to growth

“Putting the whole puzzle together, the main impetus to growth in
the second half of this year will be inventory investment. The boost
it provides will be a big help for a while, but we will need to look to
other sectors to sustain growth. The fact that the largest sector of
the economy — consumer spending — is likely to be lackluster
implies a less-than-robust expansion. Even the gradual recovery
we expect will be vulnerable to shocks, especially from the
financial sector.”

Deflation the principal risk, not inflation

“The slow recovery I expect means that it could still take several
years to return to full employment. The same is true for capacity
utilization in manufacturing. It will take a long time before these
human and capital resources are put to full use.

My personal belief is that the more significant threat to price

stability over the next several years stems from the disinflationary
forces unleashed by the enormous slack in the economy. The
1980s provides a useful historical comparison. During that period,
fears about burgeoning federal deficits and an unsustainable fiscal
situation were widespread, as they are today. Moreover, the Fed
was under significant political pressure, and some worried whether
it would be able to safeguard its independence. But those
circumstances didn’t ignite a renewed bout of inflation …

…Of course, that period differed from ours in one critical respect.
Then, inflation was coming down from unacceptably high levels.
Monetary policy was designed to be tight enough to bring inflation
down to price stability, a goal we accomplished and have
maintained for two-and-a-half decades. Today, we are starting with
very low inflation. Core PCE price inflation has averaged just under
1½ percent over the past twelve months, which is already below the
2 percent rate that I and most of my FOMC colleagues consider an
appropriate long-term price stability objective. With slack likely to
persist for years, it seems likely that core inflation will move even
lower, departing yet farther from our price stability objective ...

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September 15, 2009 – BREAKFAST WITH DAVE

…I can assure you that we will be ready, willing, and able to tighten
policy when it’s necessary to maintain price stability. But, until that
time comes, we need to defend our price stability goal on the low
side and promote full employment. Thank you very much.”

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September 15, 2009 – BREAKFAST WITH DAVE

Gluskin Sheff at a Glance

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms.
Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to the
prudent stewardship of our clients’ wealth through the delivery of strong, risk-adjusted
investment returns together with the highest level of personalized client service.

OVERVIEW INVESTMENT STRATEGY & TEAM

As of June 30, 2009, the Firm managed We have strong and stable portfolio
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teams. Aside from recent additions, our Our investment
Gluskin Sheff became a publicly traded
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fundamental analysis. For long equities, we
Our investment interests are directly investment portfolios.
look for companies with a history of long-
aligned with those of our clients, as
term growth and stability, a proven track
Gluskin Sheff’s management and
record, shareholder-minded management
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client of the Firm’s investment portfolios.
intrinsic value. We look for the opposite in Canadian Value Portfolio
We offer a diverse platform of investment equities that we sell short. For corporate in 1991 (its inception
strategies (Canadian and U.S. equities, bonds, we look for issuers with a margin of date) would have grown to
Alternative and Fixed Income) and safety for the payment of interest and $9.0 million2 on July 31,
investment styles (Value, Growth and principal, and yields which are attractive
1 2009 versus $5.0 million
Income). relative to the assessed credit risks involved. for the S&P/TSX Total
The minimum investment required to We assemble concentrated portfolios – Return Index over the
establish a client relationship with the our top ten holdings typically represent same period.
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and $5 million for U.S. & International this way, clients benefit from the ideas
investors. in which we have the highest conviction.
PERFORMANCE Our success has often been linked to our
$1 million invested in our Canadian Value long history of investing in under-
Portfolio in 1991 (its inception date) followed and under-appreciated small
would have grown to $9.0 million on July and mid cap companies both in Canada
2

31, 2009 versus $5.0 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 $10.7 million
usd on July 31, 2009 versus $8.1 million
2
and the U.S.
PORTFOLIO CONSTRUCTION
In terms of asset mix and portfolio For further information,
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please contact
between our bottom-up security-specific questions@gluskinsheff.com
fundamental analysis and our top-down

macroeconomic view, with the noted

usd for the S&P 500 Total Return Index
over the same period. addition of David Rosenberg as Chief
Economist & Strategist.
Notes:
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 7 of 8
September 15, 2009 – BREAKFAST WITH DAVE
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