Breakfast With Dave June 8

8/14/2019 Breakfast With Dave June 8

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David A. Rosenberg June 8, 2009Chief Economist & Strategist Economics [email protected]+ 1 416 681 8919

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 networth private clients, we are dedicated to meeting the needs of our clients by delivering strong, risk-adjusted returns together with the highest

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MARKET MUSINGS & DATA DECIPHERING

Breakfast with DaveWHILE YOU WERE SLEEPING

Reversal of fortunes

Equity markets are lower today Europe off 1.8% thus far and Asia down 0.8%

even with a rally in the Nikkei (Korea, Hong Kong, Singapore and India all in the

red column).

Commodity prices are down across the board and resourced-based currencies

are under some downward pressure (CAD above 1.12). Note that while we had

been constructive on the commodity complex since last December, as with

equities, resource prices may have overshot the fundamentals after all, crudeoil prices are up more than 50% YTD and over 30% from a year ago even though

U.S. stockpiles have risen about 20% from a year ago (enough to meet 25 days

of usage, up from 20 days this time in 2008). Also, when one reads articles like

Caterpillars Hopes For Recovery Built on Shaky Foundations on page 19 of

todays Financial Times (FT), one wonders whether there is too much hype over

the sustainability of the global recovery (or the efficacy of the Obama

infrastructure package for that matter there is an interesting article on the

front page of todays New York Times (NYT), by the way, on the tensions

surfacing on the Presidents economics team) sales outside North America

account for over half of the worlds largest producer of construction equipment.

Credit default swap (CDS) spreads are widening as well but we see no flow into

government bond markets. In fact, Treasuries are selling off moderately yetagain as supply ($35 billion of 3-year notes, $19 billion of 10-year notes, and

$11 billion of long bonds hit the market this week another $65 billion of new

Treasury issuance) and stagflation concerns are on the front burner. In our view,

the economy is too fragile to withstand a 4%+ yield on the 10-year note its

one thing to have a Treasury selloff without private sector rates being affected

but that is no longer the case and the proof in the pudding is the fact that

mortgage refinancings have sunk nearly 60% in the last two months.

Problem for equities may transcend just a weak economic backdrop: According

to data compiled by Bloomberg, there has been so much in the way of secondary

offerings that the share count in the S&P 500 is rising at a 3.4% annual rate so

far this year. Tack on the fact that in this age of cash-conservation, companies

are also slashing their dividend payouts by more than 20%, the sharpest decline

since 1938, and the combination of these two effects is likely going to shave

more than 4% from S&P 500 total returns this year. Considering that the S&P

500 total return has averaged 6% per year since 1900, the trimming impact

from a higher share count and lower dividend yield looks to be rather significant.

IN THIS ISSUE

Problem with equities maytranscend just a weakeconomic backdrop

This is one very selectivemarket

Consumers paying down

debt in record amounts Secular labour market

headwinds


2/17

June 8, 2009 BREAKFAST WITH DAVE

Page 2 of 1

ONE VERY SELECTIVE MARKET

The markets are in a phase right now where they are picking and choosing how

to respond to the incoming data, and this is indeed a very fascinating process.

Equities roared ahead and bonds sold off violently after we heard that the ISM

index jumped in May to 42.8 from 40.1. We were put on notice from the experts

that this meant the recession was over. Then we saw the manufacturing

components of the nonfarm payroll survey on Friday, and in no way, shape or

form did it conform to the ISM poll. Manufacturing employment sagged

156,000. The factory workweek dropped at a 6.0% annual rate. The

manufacturing diffusion index one would think this would at least line up with

the ISM slipped from 19.9 to 12.0 in what was the steepest decline since

June 2008. In a month when the ISM jumps 2.7 points, the guts of the payroll

report point to a near 1% plunge in industrial output (believe us when we tell

that you that this is an extremely rare combination).

All we know is that on a day when we had the mother of all green shoots, a

payroll headline that came in 200,000 better than expected, the S&P 500 could

not finish the session higher. The rally has finally taken us all the way back to

the intra-day high for the year established back on January 6, but even as it

kisses the 200-day moving average, the S&P 500 seems to be struggling to

pierce this technical threshold and establish a whole new trading range:

June 1st: 942.87 June 2nd: 944.74 June 3rd: 931.76 June 4th: 942.46 June 5th: 940.09Remember, the intra-day high on January 6 was 943.85. That the S&P 500

could not be sustained above that level in the last five sessions despite the ISM

and nonfarm green shoots suggests that the second derivative improvement is

already fully priced; the next leg up needs to see a sustained first derivative

turnaround in the economic data.

Oil prices just below $70/barrel have more than doubled from their lows; and

10-year note yields approaching 4% (which are now pulling up mortgage rates

the 30-year fixed rate is all the way back to 5.45% not to mention competing

now with a near 4% earnings yield on the S&P 500) are starting to put a bit of a

crimp in this rally. Once it becomes clear, before Labour Day, that the recession

is not coming to an end quite so soon (as the National Bureau of Economic

Researchs Robert Hall said Friday, its way too early to make that call), wewould be looking for a corrective phase to start taking place.

On a day when we had

the mother of all

green shoots, the

S&P 500 could not

finish the session

higher


3/17


Page 3 of 1

Yes, yes, we are going to be hearing a lot of background noise about the ECRI

leading index improving to a 45-week high of -7.1% in the final week of May

(from -9.3% the week before and the record low -29.7% in December 2008).

The reality is that during the expansion this index peaked in January 2004 oh,

about four years before the cycle ended. We want to be early, but not that early.

That sharp selloff in the bond market may well end up sowing the seeds for a

sizeable rally because it has driven a hole in the mortgage refinancing boom,

which began in February and ended with a thud in May the Mortgage Bankers

Associations refinancing index is now 57% below the early April peak. Not only

that, but new home-buying activity has stalled out too, as the MBA purchase

index sagged at a 20% annual rate in May the first time it has declined in

three months. Some of these green shoots just got shot!

Chart 1: THE ECRI LEADING INDEX IS IMPROVING

United States

ECRI Weekly Leading Index Growth Rate

Avg, %

050505050

30

20

10

0

-10

-20

-30

Source: Haver Analytics, Gluskin Sheff

As an aside, the part of the yield curve that got smoked the most following the

nonfarm payroll figure was not the reflation-sensitive long bond but rather the

2-year T-note whose yield soared 34bps to 1.29%. One would have thought we

printed +345,000 instead of -345,000 based on that reaction. Indeed, the

markets have now price in three Fed rate HIKES over the coming year. We

doubt this happens until the unemployment rate peaks and heads lower, and

that is likely going to take at least a year to unfold and/or until home prices stopdeclining, and this could also take at least another year (see Robert Shillers

column on page 4 of the Sunday NYT business section Why Home Prices May

Keep Falling).

At this point in time,

dont be fooled by theimprovement in the

ECRI leading index


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Page 4 of 1

CONTRARIANS NOTE

There is a lot of good news priced into equities after an eight multiple-point

expansion and a 45% price surge in the S&P 500 over the last four months.

Moreover, there is a lot of reflation priced into the Treasury market, where 10-

year yields exceed the inflation rate now by 450bps. Sentiment has swung

wildly at the March lows in the equity market, there were 31,332 net short

contracts on the CME (futures and options) as per the Commitment of Traders

report; today there are 23,096 net longs. During that same time period, the net

shorts for the 10-year T-note has risen from 60,500 to 127,188 and few times

have the bond pits been this bearish (the last time the CBOT showed a net long

position in the 10-year was late January).

CONSUMERS PAYING DOWN DEBT IN RECORD AMOUNTS

Ever heard of a plastic-burning party? Americans are cutting back on their credit

cards and other forms of debt at a record rate paying down $15.7 billion oftheir obligations in April on top of $16.5 billion in March and $10.9 billion in

February. In total, this three-month slide amounts to a credit contraction (not

including mortgages) of $172 billion, which is truly historic and deflationary too.

Chart 2: U.S. CONSUMERS GOING ON A DEBT DIET

United States

Consumer Credit Outstanding

(3-month change at an annual rate, blns)

050505050

300

200

100

0

-100

-200


Although we are likely past the worst point of the recession, consumer spendinghabits do not seem to be changing the new frugality theme is very much

intact. This also happened in the Great Depression the economy may have

bottomed in the summer of 1932 but attitudes towards discretionary spending

and credit changed for an entire generation. Have a look at the terrific article on

this enduring theme on page 4 of the Week in Review section of the Sunday New

York Times The Recession, Wal-Mart Style. As the caption reads Pasta is

Big. Prime Cuts Arent. Toilet training is being fast-tracked.

Sentiment has swung

wildly in the equitymarket


5/17


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The article quotes John E. Fleming, chief merchandising officer for WMT, who

says: Were seeing a movement away from protein into carbohydrates. It

stretches the dollar a lot further. This whole idea of staying home and

entertaining at home, were seeing that everywhere.

Whats hot?

LCD televisions Popcorn/microwave poppers Take and Bake pizzas Home repair products Car maintenance/motor oil/filters Pull-ups Vitamins/sleep aids/pain relievers Vegetable and herb seedSECULAR LABOUR MARKET HEADWINDS

It was quite an experience sitting down and reading the assessment of Fridays

employment data in the morning papers this past weekend:

Hints of Hope in Jobless Data Even as Rate Jumps to 9.4% (NYT) Slower Jobless Lift Hopes (Wall Street Journal) Jobs Data Fuel Hopes Worst of Recession is Over(Financial Times)All this excitement over a 345,000 payroll decline tells us that we have been in a

recession for so long now that we have all forgotten what an economic

expansion looks like. A 345,000 job slide is double what we were experiencing

before the Lehman collapse and is worse than the worst months in each of the

last two recessions. Admittedly, with the help of a 220,000 boost from the Birth-

Death model (compared with 174,000 in May 2007 at the peak of the cycle),

the nonfarm data was better than consensus estimates and not nearly as bad

as what we had been seeing through most of this year when the declines were

hovering around 700,000 per month. Then again, the economy is no longer

contracting at a 6% annual rate, so why should anyone really be expecting

detonating job losses any more? The fact that the employment data are less

bad than a depression-style experience misses the point. Beneath the veneer,

there are secular deflationary headwinds in the labour market that the bond

market has a right to know before building on the knee-jerk reaction to Fridays

headline data because we are concerned that the data are being misdiagnosed.

The number of full-time jobs that were cut in May totalled 407,000 and this

brings the tally since the recession began to 8.6 million, which is by far a record.

A normal recession typically sees 2.0-2.5 million full-time job losses. As

businesses see that the amount of credit to support the economy is going to be

at least $5 trillion lower than it was during the positive credit cycle, they are

looking to permanently adjust the size of their workforce.

The new frugality

theme remains intact


6/17


Chart 3: SINCE THE RECESSION BEGAN,

8.6 MILLION FULL-TIME JOBS HAVE BEEN SHED

United States

Employed: Employed Full-Time

(18-month change, thousands)

050505050

8000

4000

0

-4000

-8000

-12000


The number of part-time workers rose 129,000 last month and by 2.5 million

since the recession began a year-and-a-half ago. So its not as if all the laid

off full-time workers are losing their jobs; nearly one-in-three are being pushed

into part-time work. But a record share of the 2.7 million working part-time

more than one-third are working part-time because they have no choice (due

to the weak economy). The number of people working part-time but want full-

time work has risen a record 70% over the past year. Remarkable and

disturbing.

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Chart 4: MORE PEOPLE ARE BEING PUSHED TO WORK PART-TIME

United States

Employed: Part-Time/Economic Reasons: All Industries

(thousands)

05050

10000

8000

6000

4000

2000


While there was so much focus on the change in the nonfarm payroll headline

figure, it was easy to miss the important shift taking place beneath the surface.

It may be true that companies are not cutting back on bodies as much as they

were earlier this year because nobody wants to let their skilled staff go despite

the lingering weakness in sales. So the strategy remains one of cutting back

on hours worked at the same time not as many layoffs but the effort to

economize on the wage bill remains intact. What has happened this cycle is

that the shift towards part-time and away from full-time has led to a dramatic

reduction in the average workweek to a record low 33.1 hours. If we took into

account the total decline in labour input in May the aggregate hours worked

index sagged 0.7% MoM the total job loss in May exceeded 900,000. In

fact, this was almost exactly what the population and payroll concept adjusted

Household Survey showed, to very little fanfare (-833,000).

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Chart 5: THE AVERAGE WORKWEEK IS NOW AT A RECORD LOW

United States

Average Weekly Hours: Total Private

(hours)

05050

34.8

34.4

34.0

33.6

33.2

32.8


The combination of slowing wage growth and declining hours is helping

Corporate America save on the wage bill, but of course this comes at the

expense of personal income and then aggregate demand; the aggregate

demand that is needed to grow top-line revenues. It is one thing when a few

companies do it, but right now two out of every three companies are shedding

labour. Average weekly earnings the wage-based proxy for personal income

has slowed to a mere 1.2% YoY, and as Chart 6 illustrates, is testing critical

support levels. They actually fell 0.2% MoM in May and over the last three

months, have deflated in rare fashion at a 0.7% annual rate. This is the

critical deflation that the bond bears do not see not yet anyway but the

Fed surely knows this and the view being expressed in the futures market that

we will see three rate hikes in the next year seems to be out of touch with this

wage contraction reality.

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Chart 6: GROWTH IN THE AVERAGE WORKWEEKHAS SLOWED TO 1.2% YEAR-OVER-YEAR

United States

Average Weekly Earnings: Total Private

(year-over-year percent change)

087654321098765

5.25

4.50

3.75

3.00

2.25

1.50

0.75


The chart below is some evidence that the bearish view on Treasuries, with all

deference to the fiscal outlook, may be overdone. There is over a 50%

correlation between wage growth and the 10-year T-note yield, and note the

divergence between the blue and red lines over the past couple of months.

Chart 7: TEN-YEAR NOTE YIELD FOLLOWS WAGE GROWTHUnited States

Average Weekly Earnings: Total Private(year-over-year percent change: thick line, right hand side)

10-Year Treasury Note Yield(percent: thin line, left hand side)

0876543210987

5

4

3

2

1

6.75

6.00

5.25

4.50

3.75

3.00

2.25

r = 0.53


Page 9 of 1


10/17


What makes this cycle totally different is that it is coming off three shocks: 1) a

housing shock; 2) a commodity shock, and; 3) a credit shock. The labor market

is adjusting to all three shocks, whose effects are going to linger for years, in our

view. In other words, there is a greater sense of permanency to the job losses

this time around compared to the past. In fact, permanent job losses came to

287,000 in May and 3.9 million since the recession began. Around two-thirds of

the employment decline this down-cycle has been permanent, which is

unprecedented.

Chart 8: 3.9 MILLION PERMANENT JOB LOSSES

SINCE THE RECESSION BEGAN

United States

Unemployed: Permanent Job Losers

(year-over-year difference)

0876543210987654

4000

3000

2000

1000

0

-1000


Again, all the headlines over the weekend were about how the smaller decline

in nonfarm payrolls was heralding in the end of the recession. This is amazing

since the recessions of 2001 and 1991 never saw a number as bad as

-345,000, which we just saw on Friday. Be that as it may, what is important is

the growing pool of unemployed, which soared 787,000 in May the fifth

highest on record. There are 14.5 million in the ranks of the unemployed, and

this swelled by a record six million over the last 12 months. So, it really is only

one part of the story that companies are no longer cutting as many jobs as

they were at the peak of the firing wave at the start of the year nobody is

hiring the new entrants who are coming into the labour force (the labour forceexpanded 350,000 last month). There is currently a record 12.8 million

unemployed Americans who are now looking for full-time positions that do not

exist almost doubling in the last year. Now what do you suppose that is

going to do to the prevailing wage rates?

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The question is whether President Obama, as he takes more and more

feathers out of FDRs interventionist hat, also embarks on programs that

enforce wage hikes in the unionized sector of the economy in this new populist

swing-the-pendulum era of income redistribution.

Chart 9: THE NUMBER OF UNEMPLOYED SOARED

SIX MILLION FROM A YEAR AGO

United States

Unemployment

(year-over-year difference)

0505050505050

8000

6000

4000

2000

0

-2000

-4000


It is taking far longer for the pool of unemployed to find a new job compared to

any other cycle in the past five decades. The median length of time it is taking

to find a new job has risen sharply to a record 14.9 weeks in May from 12.5

week in April and 8.3 weeks a year go. Until this cycle, it was practically

unheard of for this metric to cross above 12 weeks and we are now 25%

above that traditional peak of the past.

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12/17


Chart 10: IT IS TAKING FAR LONGER TO FIND A JOB THIS CYCLE

United States

Unemployed: Weeks Unemployed: Median

SA, Number (I)

050505050

16

14

12

10

8

6

4


Indeed, the number of people who have now been unemployed for at least a

half-year has surged 150% over the last year to stand at four million or double

the peaks of the past two recessions and one-third above the peak of the early

1980s downturn.

Chart 11: IT IS TAKING FAR LONGER TO FIND A JOB THIS CYCLEUnited States

Unemployed: 27 Weeks & Over

SA, Thous (I)

0505050

4000

3000

2000

1000

0


Page 12 of 1


13/17


There is a prevailing focus on the unemployment rate, which rose to 9.4% in

May, but a much more reliable measure of labour market slack is the

employment-to-population ratio which fell to 59.7% from 59.9% the lowest

since October 1984.

Chart 12: EMPLOYMENT/POPULATION RATIO LOWEST SINCE OCT 1984

United States

Employment-Population Ratio

(percent)

0505050

66

64

62

60

58

56


The unemployment rate for full-time workers has already crossed into double-

digit terrain (10.2%) it was 5.5% a year ago! This is the sharpest increase

(470 basis points) over a 12-month span ever.

Chart 13: JOBLESS RATE FOR FULL-TIME WORKERS NOW AT 10.2%

United States

Unemployment Rate: Full-Time Workers

(percent)

0505050

12

10

8

6

4

2


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The broadest measure of the unemployment rate that includes all measures of

labour market slack jumped in May to 16.4% from 15.8% in May and 9.8% a

year ago. So think about that; 1 in 6 Americans are either unemployed or

underemployed. Again, is it reasonable to assume, as the bond vigilantes

have, that we will experience a sustained inflationary surge out of this excess

labour supply environment?

Chart 14: THE ALL ENCOMPASSING JOBLESS RATE AT 16.4%

United States

U-6 Unemployment Rate: Unemployed+Marginally Attached+Part-Time Econ Reasons

(percent)

0876543210987654

18

16

14

12

10

8

6


A record seven percentage point gap has opened up between the officially

reported unemployment rate and the broader U-6 measure this spread is

important as it captures the incremental headwind for the consumer sector

and by extension, a further problem for mortgage, housing, credit cards, home

equity lines of credit as well as car loans. Financials are going to be as

negatively influenced by this development down the road as retailers. The

labour market parameters for the Geithner stress tests are looking

increasingly out of date.

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Chart 15: A RECORD SEVEN PERCENTAGE POINT GAP BETWEEN THEOFFICIAL JOBLESS RATE AND THE U-6 UNEMPLOYMENT RATE

United States

Official Unemployment Rate minus U-6 Jobless Rate

(percentage points)

0876543210987654

8

7

6

5

4

3

2



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Breakfast With Dave June 8