David A.

Rosenberg December 14, 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
Equities for the most part are bid, and so are government bond markets. The
U.S. dollar is a tad off this morning, and commodities, for the most part, are • While you were sleeping —
firmer. Helping on the risk front was the news that Abu Dhabi will step in to save economic data overseas
left much to be desired
Dubai World’s debt problems.
• Frugality them far from
However, the economic data from overseas left much to be desired. While the over, in fact, it has just
Japanese Tankan business sentiment index improved in Q4 (up nine points, to begun
-24), it remains deeply in negative terrain and came in well below expected. • The next wave of
Japanese businesses said they still intend on slashing capex in the next three instability … sovereign
months. (Not only that, but consumer confidence dropped in November for the debt
first time in 11 months.) Japanese businesses also said they intend to slash • The blame game — in
capital spending. This is still happening after the country’s credit bank asset President Obama’s latest
bubble burst nearly two decades ago. weekly address, he
blames the banks for
luring borrowers into the
Eurozone October industrial production fell 0.6% MoM, and in the U.K. we saw
myriad of products during
home prices decline 2.2% sequentially in December (Rightmove survey). the credit bubble

This is a busy week ahead in the U.S. — the FOMC meeting on Tuesday- • Why we see the Bank of
Canada not raising rates
Wednesday (some other central banks meet as well, including the BoJ, and BoC for a very long time
Governor speaks Wednesday afternoon at 1 pm) and tons of data — 10 in total
south of the border. • A second look at U.S.
retail sales — overall, the
FRUGALITY THEME FAR FROM OVER level of retail sales is still
on a downward path
The household sector is, in fact, telling you that. Floyd Norris ran with a
• U.S. consumer sentiment
fascinating article in the Saturday NYT titled Americans Owe Less. That’s Not All
improves, but still very low
Good. In fact, the deleveraging process is highly deflationary. The article cites a
survey conduced in November showing that households intend to boost their • No capitulation! For every
savings rate to 15% (from 5% now) before the recovery begins. From our dollar the public invests in
equities, it puts in two
estimation, such a boost in the savings rate would be equivalent to a two dollars into bonds
percentage point drain in baseline GDP growth over the past five years. So, this
notion that the Fed is going to be pulling some sort of “exit strategy” actually • Major shift in attitudes
towards housing too
seems like a bit of a joke.
• The taxman! The U.S.
The low hanging fruit in coming months, quarters, and years will be buying the government is becoming
front end of the yield curve and those Eurodollar strips or Fed futures contracts increasingly creative in its
quest to raise money to
during those periods (ie, when a piece of above-expected data comes out or
fund its fiscal
when a Fed bank president of little or no consequence comes out with hawkish interventions
remarks) when the markets price in Fed (or Bank of Canada) tightening. The
• Utility in utilities
history of post-bubble credit collapses is that when the central bank takes rates
to zero, they stay there for a very looooong period of time. • Could Q4 U.S. real GDP
growth come in at 5%?

Please see important disclosures at the end of this document.

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December 14, 2009 – BREAKFAST WITH DAVE

Also check out Shoppers Check Out Private Store Brands on page A10 of the
Investor’s Business Daily and ’Tis The Season to be Frugal on page A11. Also We are seeing the early
have a look at the very sad front page article in today’s WSJ (For America’s stages of the debt
Santas, It’s Hard to Be Jolly With the Tales They’re Hearing: In Hard Times, Kids deleveraging process in
Ask for Bare Essentials; Shoes, Eyeglasses and a Job for Dad). All signs of these the U.S.
point to deflationary times and when deflation hits the ‘golden arches’ (except in
your waistline), you know that this is a secular, and not merely a cyclical shift in
behaviour.

Indeed, McDonald’s just said that it’s going to start offering ‘breakfast for a
buck’ on its national menu starting in January. Even more on the deflation
theme can be found on page B1 of today’s NYT — As Prices Fall, Blu-Ray Players
are Invited Home.

HOW FAR INTO THE DELEVERAGING PROCESS ARE WE?

Early innings. From the peak, the level of nonfederal debt has deflated by $260
billion. Some of this has been either paid down, written off, modified, defaulted
on or some combination of the four. No matter.

As Chart 1 illustrates, and employing Bob Farrell’s first Market Rule on the time-
honored trend towards mean reversion, this develeraging process that began two Total U.S. nonfederal debt
years ago is really in its infancy stage. The current level of U.S. outstanding is down $260bln from the
nonfederal debt is $27 trillion, which is astounding both in absolute terms and peak, but, as a share of
even more so relative to nonfederal GDP — a 206% ratio. It is down fractionally GDP, it is still a
from the 208% peak, but here is the rub. If mean-reversion means that we get
phenomenal 206%, which
is nowhere near the more
back to some norm of the 1990s, then we are talking about the need to extinguish
normal level of 140% we
$8 trillion of nonfederal debt. The only question is how this happens, not if. If
saw in the 1990s
we’re talking about mean reverting to the very stable trend of the 1960s and
1970s, then the credit contraction is very likely to exceed $11 trillion.

Either way, this process of debt elimination is ongoing and will likely last for years.
Along the way we will see the federal government test the limits of its balance
sheet to smooth the transition and it will be long-term Treasury yields that will
determine when enough is enough in terms of Washington’s fiscal largesse. Just
as the Canadian bond market delivered the same message to the Chrétien/Martin
government in the mid-1990s that ushered in a multi-year forced era of budgetary
restraint and anemic domestic demand. Until the U.S. gets its balance sheet
under control, and monetization of the debt is likely one key strategy, the trend in
the gold price will remain in one direction and that is up.

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CHART 1: DEBT DELEVERAGING HAS BEGAN

United States: Total Nonfederal Debt to Nonfederal GDP Ratio
(percent)

220
Current = 206%

200

180

160

140
Level back in the early
120 1990s ≈ 142%
Level back in the late
100 '60s/Early 80s ≈ 120%

80

60
52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09

Source: Haver Analytics, Gluskin Sheff

THE NEXT WAVE OF INSTABILITY — SOVEREIGN DEBT

The reason why gold is back to a four-week low is because the bull trade
became very overcrowded and the yellow metal was ripe for correction after a
The reason why gold is
back to a four-week low is
parabolic move, but what a buying opportunity this is going to prove to be. Of
because the bull trade
course, the U.S. dollar has recovered from the abyss, but only for now. While the
became very overcrowded
greenback has re-emerged as a safety-valve, what makes gold special is that it and the yellow metal was
is not responsive to global economic shifts or is it any government’s liability. ripe for correction after a
parabolic move, but what a
The situation in Europe is troubling — fiscal concerns are mounting, not just in buying opportunity this is
Greece and Ireland (where deficit ratios are north of 9%) but also the U.K., Spain going to prove to be
and Portugal (though Ireland did come out with a very austere budget last week).
Greek two-year bond yields soared over 100bps in the wake of last week’s
downgrading to BBB+.

Banking sector risks are also higher in Europe than in the U.S.A., and this also
may explain the recovery in the U.S. dollar and selloff in the Euro. But let’s not
forget that we finished last week with three very poor U.S. Treasury auctions and
credit default swaps on Uncle Sam’s debt are also beginning to rise discernibly.
Bond yields have broken out technically and it will be interesting to see how this
combination of higher market rates and a countertrend rally in the U.S. dollar
filters though into a more jittery equity market, notwithstanding the prospects
that we will soon see consensus upgrades to Q4 GDP forecasts.

While the major averages closed higher on Friday, volume was down across the
board (sliding 10% on the Nasdaq and 4% on the NYSE). Moreover, the Nasdaq
yet again failed at the 2,200 threshold — a key technical non-confirmation over
this bear market rally.

Nobody put it better than the S&P’s Howard Silverblatt did in an interview with
the FT — see page 18 of the weekend edition:

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“The recovery is going to take years, and there is still huge downside
risk. The range of outcomes is the biggest I’ve ever seen. There are When things go awry, it is
huge risks even in the dividend business, and that’s not something very easy to point the
the business is used to.” finger at somebody else...
this is essentially what
Want to add something else to add to the worry list? How about the re- Washington has done,
emergence of inflation in China and what this means for: (i) the stimulus blaming the big bad banks
program — remember, China was the first out of the gates, and (ii) FX prospects as opposed to the
— will this speed up Yuan appreciation and U.S. dollar depreciation? Have a look
borrowers
at Inflation Complicates China Policy on page B10 of the weekend WSJ and
Chinese Stimulus Measures Spark Inflation Risk as Production Rises on page 2
of the weekend FT (the inflation rate turned positive in November — +0.6% YoY
— for the first time since the turn of the year).

THE BLAME GAME

Below we highlight President Obama’s weekly address, in which he blames the
big bad banks for luring borrowers into the myriad of products during the credit
bubble, a bubble that in our view was promulgated by the nation’s policymakers.

When things go awry, however, it is very easy for those in Washington to point
the fingers at somebody else. What did Congress, the SEC, the Fed, and the
White House think in that 2002-07 bubble period except that excess credit was
creating jobs; in turn, those jobs were creating prosperity and that prosperity led
to votes. Now the borrowers, who signed contracts, and as adults should also
be held accountable, are being treated as “victims” by politicians and the media.

“Over the past two years, more than seven million Americans have
lost their jobs, and factories and businesses across our country
have been shuttered. In one way or another, we’ve all been touched
by the worst economic downturn since the Great Depression.

The difficult steps we’ve taken since January have helped to break
our fall, and begin to get us back on our feet. Our economy is
growing again. The flood of job loss we saw at the beginning of this
year slowed to a relative trickle last month. These are good signs for
the future, but little comfort to all of our neighbors who remain out
of a job. And my solemn commitment is to work every day, in every
way I can, to push this recovery forward and build a new foundation
for our lasting growth and prosperity.

That’s why I announced some additional steps this week to spur

private sector hiring. We’ll give an added boost to small businesses
across our nation through additional tax cuts and access to lending
they desperately need to grow. We’ll rebuild more of our vital
infrastructure and promote advanced manufacturing in clean
energy to put Americans to work doing the work we need done.

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And I have called for the extension of unemployment insurance and

health benefits to help those who have lost their jobs weather these
storms until we reach that brighter day.

But even as we dig our way out of this deep hole, it’s important that
we address the irresponsibility and recklessness that got us into this
mess in the first place. Some of it was the result of an era of easy
credit, when millions of Americans borrowed beyond their means,
bought homes they couldn’t afford, and assumed that housing
prices would always rise and the day of reckoning would never
come.

But much of it was due to the irresponsibility of large financial

institutions on Wall Street that gambled on risky loans and
complex financial products, seeking short-term profits and big
bonuses with little regard for long-term consequences [emphasis
added]. It was, as some have put it, risk management without the
management. And their actions, in the absence of strong oversight,
intensified the cycle of bubble-and-bust and led to a financial crisis
that threatened to bring down the entire economy.

It was a disaster that could have been avoided if we’d had clearer
rules of the road for Wall Street and actually enforced them.

We can’t change that history. But we have an absolute

responsibility to learn from it, and take steps to prevent a repeat of
the crisis from which we are still recovering.

That’s why I’ve proposed a series of financial reforms that would

target the abuses [emphasis added] we have seen and leave us
less exposed to the kind of breakdown we just experienced.

They would bring new transparency and accountability to the

financial markets, so that the kind of risky dealings that sparked
the crisis [emphasis added] would be fully disclosed and properly
regulated.

They would give us the tools to ensure that the failure of one large
bank or financial institution won’t spread like a virus through the
entire financial system. Because we should never again find
ourselves in the position in which our only choices are bailing out
banks or letting our economy collapse.

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And they would consolidate the consumer protection functions

currently spread across half a dozen agencies and vest them in a
new Consumer Financial Protection Agency. This agency would
have the authority to put an end to misleading and dishonest
practices of banks and institutions that market financial products
like credit and debit cards; mortgage, auto and payday loans
[emphasis added].

These are commonsense reforms that respond to the obvious

problems exposed by the financial crisis. But, as we’ve learned so
many times before, common sense doesn’t always prevail in
Washington. Just last week, Republican leaders in the House
summoned more than 100 key lobbyists for the financial industry to
a “pep rally,” and urged them to redouble their efforts to block
meaningful financial reform. Not that they needed the
encouragement. These industry lobbyists have already spent more
than $300 million on lobbying the debate this year.

The special interests and their agents in Congress claim that

reforms like the Consumer Financial Protection Agency will stifle
consumer choice and that updated rules and oversight will frustrate
innovation in the financial markets. But Americans don’t choose to
be victimized by mysterious fees, changing terms, and pages and
pages of fine print. And while innovation should be encouraged,
risky schemes that threaten our entire economy should not
[emphasis added].

We can’t afford to let the same phony arguments and bad habits of
Washington kill financial reform and leave American consumers and
our economy vulnerable to another meltdown.

Yesterday, the House passed comprehensive reform legislation that

incorporates some of the essential changes we need, and the
Senate Banking Committee is working on its own package of
reforms. I urge both houses to act as quickly as possible to pass
real reform that restores free and fair markets in which
recklessness and greed are thwarted [emphasis added]; and hard
work, responsibility, and competition are rewarded — reform that
works for businesses, investors, and consumers alike. That’s how
we’ll keep our economy and our institutions strong. That’s how
we’ll restore a sense of responsibility and accountability to both
Wall Street and Washington [emphasis added]. And that’s how
we’ll safeguard everything the American people are working so hard
to build – a broad-based recovery; lasting prosperity; and a renewed
American Dream. Thank you.”

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As a long-time reader of our research and valued friend told us over the We now have U.S.
weekend, “he [Obama] finally threw the banks under the bus”. While not borrowers as victims
suggesting the adjectives are undeserved, I am afraid that the U.S. President
has invited all consumer borrowers, creditworthy or not, to abdicate their
financial responsibility. We now have borrowers as victims.” Ain’t it the truth.
And the consequences will be profound. Our friend reminded us that in regard
to our theme of “frugality”, the current reality is that “frugal” represents just the
first wave in a fundamental change in behaviour towards complete self-interest
and risks morphing into something a little more troubling, such as abdication of
individual responsibility.

Meanwhile, the adjective used to describe the banks and their actions, were, in
a word, scary (and if you want more on ‘scary’, read the WSJ assessment on
Obama’s appearance on the television show 60 Minutes yesterday — talk about
being completely out of control and inciting divisiveness — see Obama’s Slams
‘Fat Cat’ Bankers). This backlash against the banks, whose behaviour was
condoned by the government when the credit and housing bubble was in full
swing, is surreal.

As we said, the media has no problem in running articles that complain about
the lack of credit being extended by the evil banks, even though it was excess The media has no problem
debt taken on by a profligate consumer that got us into this mess to begin with. in running articles that
The front page of the Sunday NYT runs with Rates Are Low, But Banks Balk at complain about the lack of
Refinancing. Basically, 60% of mortgage borrowers carry interest rates that are credit being extended by
above the current market cost, but refinancings are still down 57% from year-
the evil banks
ago levels because the banks have battened down the hatches on their lending
guidelines; “The plight of homeowners has become a volatile political issue”,
according to the NYT. Well, that’s probably not the case for the 30 million
Americans who own a home with no debt or the countless others who have a
mortgage but also know how to live within their means. The article says “the
banks that once handed out home loans freely are imposing such restrictions
that many homeowners who might want to refinance are effectively locked out.”
So, because the banks lent freely in the recent past, and this excess was at the
root of today’s problems, then the banks should go back to those days of
reckless lending behaviour.

Come again? Nowhere in the article is there any reason provided as to why the
banks are “stricter” — maybe it has something to do with the amount of equity
the borrower has in his/her house, or what his/her credit-rating has been cut to,
among others. The way the media and politicians are portraying the situation is
that it is every citizen’s god-given right to have credit. This is amazing. We
aren’t exactly recommending a return to Calvin or Kant puritanical behaviour,
but what we are seeing unfold right now is very disturbing.

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We continue to stress that everyone read that front page article from Thursday’s
WSJ, which was absolutely disgusting — titled American Dream 2: Default on In its latest Financial
Mortgage, Then Rent. The word “and Spend” should have been in the title too — Review, it does seem like
consumers are no longer paying their mortgage and using the funds for other the Bank of Canada sees
things like trips to amusement parks. This is now seen as being a totally cool risks dissipating, but still
and appropriate thing to do — stop paying your mortgage and go have fun. remains asymmetric

It’s the lender who will end up being screwed, but nobody cares about that
faceless bank, right? The tone of the article, and this is the Wall Street Journal
we’re talking about, sent chills down my spine — no concern at all about the
growing ability and willingness of consumers to walk away from their financial
obligations. And certainly no remorse by those quoted in the article who have
defaulted and left somebody else holding the bag. It may very well be this “tacit
approval” of such irresponsible behaviour that will end up crippling banks’ ability
and willingness to extend credit in the future, because we have news for the
President: being public companies, the lenders’ fiduciary responsibility first and
foremost is to their shareholders, not deadbeat debtors.

WHY THE BANK OF CANADA IS NOT RAISING RATES FOR A VERY LONG TIME
This is an excerpt from the BoC’s financial review that was published late last
week. Risks have dissipated but remain asymmetric, nonetheless:

Financial institutions need to carefully consider the aggregate risk to

their entire portfolio of household exposures when evaluating even an
insured mortgage, since a household defaulting on an insured
mortgage would likely be unable to meet its other debt obligations.
This implies that the overall quality of a bank’s loan portfolio would
deteriorate, even if no loss is incurred on the insured mortgage itself. In
addition, claims to recover losses on insured mortgages are not
themselves without cost.

The potential for system-wide stress arising from substantial credit

losses on Canadian household loan portfolios remains a relatively low-
probability risk at the moment, particularly given the near-term
prospects for growth. However, the likelihood of this risk materializing
in the medium term is judged to have risen as a result of increased
indebtedness.

While this suggests that positive momentum in the global economy is

stronger than envisioned at the time of the last FSR, economic growth
is nonetheless likely to remain subdued for some time as necessary
structural adjustments take place.

Deleveraging of the balance sheets of both financial institutions and

households, for example, remains incomplete.

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Although the uncertainty surrounding the global economic outlook has The 12-month trend on the
diminished somewhat, it nevertheless remains elevated. As well, there level of U.S. retail sales
is a risk that self-sustaining growth in private demand, a prerequisite remains on a downward
for a solid recovery, may take longer than expected to materialize, path — continue to focus
given that the recovery currently relies on an unprecedented level of on the forest, not the trees
policy stimulus. Reflecting the high level of uncertainty worldwide, there
is a wide divergence in forecasts for global economic growth.

With the slow pace of the recovery, the global economy is vulnerable to
additional negative shocks. While the probability of a renewed,
synchronous decline in world output is fairly low, even a slower-than-
expected recovery may have important implications for the
international financial system. If the global recovery does not live up to
market expectations, a market correction could ensue. A modest
market correction can normally be considered a useful purging of
excess risk taking and a re-evaluation of fundamental factors. In the
current environment, however, an economic downturn or a significant
market correction arising from renewed pessimism could, in a worst-
case scenario, reactivate the adverse feedback loop between the real
economy and financial markets (by which declines in overall economic
growth and in markets reinforce each other).”

SECOND LOOK AT THE U.S. RETAIL SALES

We looked at the non-seasonally adjusted (NSA) retail sales data and we are
scratching our heads. The data were flat sequentially — stagnant in November —
a month that is up 80% of the time, and normally by between 1% and 2%. And
so a flat NSA number this year yields a 1.3% MoM increase? Hard to fathom,
but it shows how the seasonal factor can play a role in these data releases.
Don’t be surprised if we see a downward revision in the retail sales data and a
disappointing December (where the seasonal adjustment factor looks a tad
more challenging).

Chart 2 below shows the monthly “noise” in the retail sales data and the
smoothed trend line. This is called volatility around a downward path. Focus on
the forest, not the trees.

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CHART 2: VOLATILITY AROUND A DOWNWARD PATH

United States: Retail Sales
($ billion)

390

(level)
370

350

330
(12-month
moving average)
310

290

270
01 02 03 04 05 06 07 08 09

Source: Haver Analytics, Gluskin Sheff

SENTIMENT BETTER BUT STILL LOW

The University of Michigan consumer sentiment report for December came in
better than expected, at 73.4 from 67.4 in November but it is basically no higher
than it was in September. This is far below the 90 level that is typical of economic
expansion. In fact, it is still below the average of 76 for recessions in the past.
Every region (except for the West), age and income category posted an increase in
consumer sentiment.

Interestingly, homebuying plans didn’t budge, despite all the stimulus. As a

further exclamation mark on this point, the data point dealing with confidence
over government policy dropped in December, to a 10-month low! Meanwhile,
the 5-10 year median inflation expectation number fell to 2.6% from 3.0% in
November, a nine-month low but this did little to help the bond market out … at
least for now. The Fed must be comforted with that figure, though it hasn’t been
lower than that since September 2002 — and the Fed didn’t start to tighten for
nearly two years after that. Keep in mind that back then, oil prices were
$30/bbl, not $70/bbl; and wheat was $5 per bushel, not $7 — so this inflation
expectation number is a really big deal as it probably means that people have
deflation expectations for the core CPI!

NO CAPITULATION!
From the comprehensive Q3 Fed Flow-of-Funds report, we were able to see that
inflows into mutual funds, closed-end funds and ETFs in terms of equity
investments came to $62 billion during the quarter, compared with $130 billion
for fixed-income inflows. So for every dollar that the general public put into
equities, they invested two dollars into bonds. Considering that households still
have 30% of their assets in real estate, 25% in equities and 7% in fixed-income
strategies, we would have to believe that there is an asset allocation shift going on.

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Basically, the household sector can’t believe how fortunate it is to have had the A secular shift in attitudes
opportunity so soon to rebalance the portfolio with the equity component at a 60% towards the equity market
premium to the March lows. is underway — for every
dollar that the general
Of course, the challenge for 2010 is the earnings landscape — will the near-$80 in public put into equities,
operating EPS priced in be achieved? To get that sort of growth, call it 60% over they invested two dollars
2009, would imply at least a 10-15% growth rate in nominal GDP, which would be into bonds
unprecedented.

The other challenge is who the marginal buyer of equities is going to be driving the
next leg of the rally. After all:

• The hedge funds, having had their margin lines re-established, have already
made up for the 2008 disaster.
• Mutual fund PMs have already taken their cash ratios down from 6% to below
4% — where they were in late 2007.
• The buying power related to dramatic short-covering now seems to have
subsided. Remember, this has really been a do-nothing S&P 500 for the past
two months.
The mutual fund data actually show that retail investors have been net sellers of
equities (at least in mutual funds) over the past two months. There is no doubt
that there is always the risk of the general public saying “enough is enough” and
jump in with both feet into the equity market, but then again, after a record bear
market rally that has taken the S&P 500 up 65% over an eight month span, it is
legitimate to ask why this capitulation has not already occurred.

Our contention is that a secular shift in attitudes towards the equity market is
underway. First, the household sector realizes that it got burned badly by two
bubbles being promulgated by Wall Street seven-years apart — dotcoms turned
into a tech wreck and then a housing bubble morphed into a credit crunch.

Second, we have to take the demographics into account because most of the
wealth is concentrated on baby boomer balance sheets and the median age of this
cohort, for the first time coming out of recession, is 52 going on 53. They are
heading into a part of their life where income strategies and capital preservation
themes dominate — coming out of the early 1990s recession, this 78 million pig in
a python that has driven everything in the past six decades from the Space Age to
Woodstock to Disco to Gordon Grekko Greed to the Internet Age and now to
Consumer Frugality, was 35 going on 36, and in the early 1980s, 25 going on 26.
Back then, this critical mass had time to wait to play the “Stocks For the Long Run”
game. No longer.

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MAJOR SHIFT IN ATTITUDES TOWARDS HOUSING TOO

As Chart 3 illustrates, homeowners’ equity as a percent of household real estate
was revised in Q1 to a new record and shocking low of 33.5%. It has since
rebounded in the subsequent two quarters to a merely hideously pathetic 38%. As
a societal matter, this calls into question the appeal of homeownership —
notwithstanding the various (mostly tax) advantages of owning (e.g. having
mortgage interest deductions) over renting — not to mention all of the efforts by
the White House and Congress to incentivize people to buy more homes!

As last week’s front-page WSJ article posited, are we destined to become a nation
of renters, particularly in light of the pain that’s been inflicted by the bursting of the
housing bubble? What are the longer-term implications of such a shift is, in fact,
taking place? Our demographics — aging boomer population selling to a smaller
group of “move up buyers” — are going to further slow the housing market’s
recovery, but that’s a story for another day. But was we saw in Friday’s University
of Michigan consumer sentiment data, a mere 2% of the population see a house
as a good investment today — and that is after an epic 35% slide in prices.

CHART 3: HOMEOWNERS’ EQUITY AS A SHARE

OF HOUSEHOLD REAL ESTATE
United States: Fed Flow of Funds: Households
(percent)

90

80

70

60

50

40

30
55 60 65 70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

TAXMAN!
If you drive a car, I’ll tax the street,
If you try to sit, I’ll tax your seat,
If you get too cold, I’ll tax the heat,
If you take a walk, I’ll tax your feet.

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The U.S. government is becoming increasingly creative in its quest to raise money
to fund all of its fiscal interventions — a new ‘Botax’ is coming (taxing elective
surgeries). There is also a move afoot in Congress to tax financial transactions
(under the guise of “speculation” — that evil activity). A repeal of the estate tax is
off the table. A 5.4% tax on millionaire couples is coming if Nancy Pelosi has her
way; ditto for medicare payroll taxes.

The U.K.’s move to tax bank bonuses seems to be gaining some appeal elsewhere
as well (such as France). And you can forget about the punitive Alternative
Minimum Tax ever being touched as well — talk about a backdoor revenue grab.
And now the NYT (Friday’s edition) suggests that a European-style national
consumption (sales) tax will ultimately be on its way.

In any event, it looks like the top marginal tax rate in many U.S. states are going to
breach 55% — pre-Reagan levels — which inevitably will require pre-Reagan P/E
multiples.

UTILITY IN UTILITIES
Several weeks ago, we highlighted that utilities may be a sector worth looking at in
the looming environment of where boring is sexy. Financials have stopped leading
this bear market rally months ago — peaking back on October 14 and down 9%
since then. Tech stocks are now having problems breaking out. But the utilities
have, with very little fanfare, just broken out to new post-October 2008 highs:

1. Since the S&P 500 first crossed the 1,100 mark back on November 16,
the utilities sector has advanced 6.6%.
2. During the rally from the March lows, the utilities group has
underperformed the broad market by 2,200 basis points so there is still
room for outperformance.
3. If the market pulls back, this is the one sector that will tend to outperform
the most since it is a “defensive” and “low beta” sector (it, along with
telecom services, has among the lowest correlations with the S&P 500).
4. The charts/technicals look very compelling right now.
5. As Bill Gross, has said, if you’re looking for income, this sector provides a
4.1% dividend yield — no maturity across the Treasury curve to the 10-
year segment is as high as this; only the telecom sector provides a better
yield in the equity market (financials offer just 1.5%); and the overall
market is just 1.9% so utilities give investors a huge 210 basis point
premium.
6. Barron’s recently ran a cover story on preferred shares — yield focused
cover story: once investors realize they can get 4-5% safe yield — a yield
well above norms versus Treasurys — they will be more attracted to this
sector.
7. Utilities are starting to get some pricing power — in the CPI, the group has
seen prices rise at over a 7% annual rate in the past three months, well
above the 3.6% rate for the overall economy. Not since August 2008 has
the sector seen price performance like these both on a relative and
absolute basis.

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December 14, 2009 – BREAKFAST WITH DAVE

8. It pays to note that the utility sector is NOT homogenous and that the
pricing power in both the CPI and PPI are running at much faster rates in
the electrical power segment than is the case with gas utilities and this
dichotomy has also been evident in relative equity price performance
between these two segments of the same sector. Investors have been
discriminating in favor of electricity producers because that is where both
the pricing and volumes have been rising materially. In terms of volume
demand from the consumer sector, over the three months to October,
real spending on electric power surged at a 40% annual rate, ten times
the growth rate in demand for gas utilities.

COULD Q4 U.S. REAL GDP GROWTH COME IN AT 5%?

The answer is yes it can, but not before Q3 gets revised down again to around
2.5%. But make no mistake, the combination of government support, net exports,
the consumer (moderately) and now inventories, we could well see something
close to 5% for current quarter growth. We kid you not.

The latest bump-up to Street forecasts came from Friday’s data on business
inventories for October. Led by autos and food, business inventories nudge up
0.2% MoM to end a 13-string of monthly declines. This could be a very powerful
force in Q4 — remember, it was just the reduced pace of destocking that
accounted for nearly one-third of the headline growth we saw in Q3 (that
contribution is going to be much higher this time around).

The inventory-to-sales ratio dipped from 1.31 in September to 1.30 in October —

the lowest level since August 2008 — with business sales improving across the
board and by a respectable 1.1%.

Yes, yes, 5% growth would be a big deal if we end up seeing it, but still totally
consistent with an ongoing deleveraging depression. Go back to the 1930s — we
had 10.8% real GDP growth in 1934, for crying out loud, and the Great Depression
still didn’t end for another eight years.

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December 14, 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 September 30, 2009, the Firm
managed assets of $5.0 billion.
Gluskin Sheff became a publicly traded
corporation on the Toronto Stock
Exchange (symbol: GS) in May 2006 and
remains 65% owned by its senior
management and employees. We have
public company accountability and
governance with a private company
commitment to innovation and service.
Our investment interests are directly
aligned with those of our clients, as
Gluskin Sheff’s management and
employees are collectively the largest
client of the Firm’s investment portfolios.
We offer a diverse platform of investment equities that we sell short. For corporate
strategies (Canadian and U.S. equities,
Alternative and Fixed Income) and
investment styles (Value, Growth and
1 September 30, 2009
Income).
The minimum investment required to
establish a client relationship with the
Firm is $3 million for Canadian investors
and $5 million for U.S. & International
investors.
PERFORMANCE
$1 million invested in our Canadian Value
Portfolio in 1991 (its inception date)
would have grown to $15.5 million on
2 followed and under-appreciated small
September 30, 2009 versus $9.7 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 $11.2 million
usd on September 30, 2009 versus $8.7
2
We have strong and stable portfolio
management, research and client service
teams. Aside from recent additions, our Our investment
Portfolio Managers have been with the interests are directly
Firm for a minimum of ten years and we
aligned with those of
have attracted “best in class” talent at all
our clients, as Gluskin
levels. Our performance results are those
Sheff’s management and
of the team in place.
employees are
We have a strong history of insightful collectively the largest
bottom-up security selection based on client of the Firm’s
fundamental analysis. For long equities, we
investment portfolios.
look for companies with a history of long-
term growth and stability, a proven track
record, shareholder-minded management
and a share price below our estimate of $1 million invested in our
intrinsic value. We look for the opposite in Canadian Value Portfolio
in 1991 (its inception
bonds, we look for issuers with a margin of date) would have grown to
safety for the payment of interest and $15.5 million2 on
principal, and yields which are attractive
relative to the assessed credit risks involved. versus $9.7 million for the
We assemble concentrated portfolios S&P/TSX Total Return
— our top ten holdings typically Index over the same
represent between 25% to 45% of a period.
portfolio. In this way, clients benefit
from the ideas in which we have the
highest conviction.
Our success has often been linked to our
long history of investing in under-
and mid cap companies both in Canada
and the U.S.
PORTFOLIO CONSTRUCTION
In terms of asset mix and portfolio For further information,
construction, we offer a unique marriage
please contact
between our bottom-up security-specific questions@gluskinsheff.com

fundamental analysis and our top-down

million usd for the S&P 500 Total
macroeconomic view, with the noted
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 15 of 16
December 14, 2009 – BREAKFAST WITH DAVE
IMPORTANT DISCLOSURES
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Page 16 of 16