Potluck With Dave 051910

8/9/2019 Potluck With Dave 051910

1/9

David A. Rosenberg May 19, 2010Chief Economist & Strategist Economic [email protected]+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Potluck with DaveDO YOU LONG (OR SHORT?) YESTERDAY?

The U.S. is inching closerto deflation: CPI down0.1% on the month and

the year-over-year paceslowed to 2.2%

Where is the housingrebound in the U.S.?

Train wreck coming in theU.S. housing market

Good as goldAnd you thought we were

bearish!

IN THIS ISSUE

Do you long (or short?)yesterday? Yesterdaysmarket action was a realexclamation mark, in

terms of representing theend of the bear marketrally

Yesterday, all my troubles seemed so far away

Now it looks as though theyre here to stay

Oh, I believe in yesterday.

Yesterday was a real exclamation mark in terms of representing the end of the

bear market rally:

Dow down 115 points to 10,510.95 S&P 500 down 1.4% to 1,120.8 TSX off 48.5 points (-0.4%) to 11,764.51 U.S. 10 year Treasury note yield rallied 9bps to 3.36% U.S. 2-year note yield rallied 5bps to 0.76% Canadian 10-year note yield rallied 10bps to 3.40% Canadian dollar sold off a bit yesterday, to 1.035 versus the U.S. dollar (from

1.0325). In U.S. cents, the loonie went from 96.85 to 96.39 cents. And so far

today, the CAD is down further, to 1.05 (or 95 U.S. cents) now below its

200-day moving average.

Euro hit a four-year low of 1.2211 from 1.2395 yesterday and the Euro/Yencross is near eight-year lows; 50% of Fibonacci retracement on the Euro is at1.2134 (from the October 2000 level of 0.8230 to the July 2008 level of

1.6038)

Crude oil price down 42 cents to $69.66/bbl, to October 2009 levels.Indeed, the S&P 500 has now sliced below the 50-day moving average and is

within 15 points of doing so with respect to the 200-day m.a., which would mean

a real rupture. The yield on the 10-year T-note has already dropped below

moving averages, and ditto for the oil price. There is a rally all right in risk

aversion trades.

Oh yes how can we forget? If you dont see deflation then you are obviously

not looking at lumber futures it seems that the market responded more to the

U.S. building permits data than the headline housing start number yesterdaybecause lumber prices were cut down a further 8.6% and have now plunged for

four straight sessions and is down 26% from the nearby April 21 high.

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

level of personalized client service. For more information or to subscribe to Gluskin Sheff economic reports,

visitwww.gluskinsheff.com


2/9

May 19, 2010 POTLUCK WITH DAVE

The pressures are continuing to build into the wee hours of today and it seems

as though Angela Merkels move to ban naked short selling on equities,

government bonds and CDS have done little more than cause investors to

become that much more panicky. A Bloomberg interview with Ken Rogoff who

said that the ballyhooed $1 trillion financial rescue plan will do little to prevent

an ultimate debt restructuring among Club Med sovereigns has not helped

matters at all at least for the bulls. As a result, government bond markets

retain a bid for the most part: Greece is up 8bps today across the yield

curve. Libor-OIS spreads widened a basis point to 25bps and CDS spreads for

Asian investment grade corporate bonds moved out 10bps to 132bps.

According to Ken Rogoff, the

$1 trillion financial rescueplan will do little to preventan ultimate debtrestructuring among ClubMed sovereigns has nothelped matters at all

No sooner did we print anegative U.S. PPI for Aprilthen we get a minus sign infront of the CPI figure down 0.1% sequentially

We also have global equities down 1.3% today (emerging markets lost 2.5% and

we have Asian markets down to three-month lows) and commodities sinking

across the board (copper -2.9%, nickel -5.5%, zinc -5.1% and platinum and

palladium down to seven week lows). Gold is off 0.7% but the overall long-run

picture for bullion is bright even if overbought technically right now.

Commodities and equities are now riding a five-day losing streak, which is not

something the green-shooty, rose-coloured glasses crowd were accustomed to

seeing for most of the past 14 months. For a sign of how quickly the global

investor base is shedding cyclical exposure, the Aussie dollar has dropped to

eight-month lows; and the kiwi down to three-month lows (aided and abetted by

dovish comments out of the Reserve Bank of New Zealand).

There was no data to speak of except for the news out of China that new home

sales in Shanghai have declined to a five-year low. It looks like some helium is

coming out of the balloon.

INCHING CLOSER TO DEFLATION

No sooner did we print a negative U.S. PPI for April then we get a minus sign in

front of the CPI figure down 0.1% sequentially, pulling the year-over-year trend

down to 2.2% from 2.3% in March and the base effects from a year ago are so

high from June to November that we are going to see the YoY pace melt away

before the year is out. As an aside, seeing both the CPI and PPI decline in the

same month is literally more than a 1-in-10 event. Remember, we have not

come close to seeing the effects of the commodity price falloff and U.S. dollar

strength hit the data yet.

Looking at the components of the CPI report, the deceleration in pricing in the

retail sector was fairly broad based. Rents were flat so this was only part of the

story. Auto prices fell 0.2% MoM, prices for personal care products deflated0.5% and communications and restaurants were basically unchanged. If there

was a big story, and this also showed through in the retail sales number, it was

in apparel where pricing slumped 0.7% MoM (the steepest decline since the

onset of recession back in February 2008) and the fourth decline in a row (on a

seasonally adjusted basis).

Page 2 of 9


3/9


What investors should focus on for cyclical pressures is the core consumer

goods CPI component, which fell 0.3% MoM in April and is now down three

months in a row. That has not happened since the depths of despair as 2008

drew to a close. The critical difference is that back then, the core services CPI

index was running close to a 3% annual rate and today the trend is sub-1%. This

is why deflation risks are so high we are on the precipice.

And, core CPI came in flat

and the YoY rate has slowedto 0.9% from 1.1% in Marchand 1.9% from a year ago

The core CPI (which excludes food and energy) came in flat and the YoY rate is

now down to 0.9% from 1.1% in March and 1.9% a year ago the last time

when the core inflation rate was this low was back in March 1961 when, like

today, the yield on the 10-year Treasury note was locked below the 4% threshold

(the six-month core CPI trend is all the way down to a 0.28% annual rate last

there in December 1960). As for the equity market and the view that low

inflation rates deserve higher-than-normal multiples, well just point out that the

P/E ratio on the S&P 500 is at least three points higher today than it was the

last time core rates of inflation were where they are today.

CHART 1: CORE INFLATION INCHING CLOSER TO DEFLATION TERRITORY

United States: CPI less Food and Energy(six-month percent change at an annual rate)

0505050505

16

12

8

4

0

Shaded region represent periods of U.S. recession.

Source: Haver Analytics, Gluskin Sheff

Page 3 of 9


4/9


CHART 2: CORE INFLATION NOW RUNNING AT 0.9% YOY SLOWEST PACE SINCE MARCH 1961

United States: CPI less Food and Energy

(year-over-year percent change)

0505050505

15.0

12.5

10.0

7.5

5.0

2.5

0.0

Shaded region represent periods of U.S. recession.

Source: Haver Analytics, Gluskin Sheff

As an aside, this relentless deceleration in the price data is not a statistical

illusion nor a government concoction just related to rents (CPI excluding rent

also fell 0.1% last month). The downdraft is far too widespread to pin it solely on

the treatment of housing costs. This is the by-product of what we left the

recession with: near-record excess capacity in real estate, labour and

manufacturing in conjunction with an ongoing debt deleveraging cycle. That is a

deflationary brew, especially since the peak of the inventory cycle and

government stimulus is now behind us.

The relentless decelerationin the U.S. price data is not astatistical illusion nor agovernment concoction justrelated to rents

As for the direction of bond yields in the U.S., remember this: the trend in core

inflation is statistically more than twice as important as fiscal deficits (or

surpluses for that matter) in determining the trend in market interest rates.

WHERE IS THE HOUSING REBOUND?

Not only was the NAHB index completely at odds with the UofM homebuying

intentions index and the sharp falloff in building permits, but look at what the

mortgage application data showed us this morning for the week of May 14: a

27% plunge in the new purchase index to the lowest level since May 1997. (At

that time we were worrying about Thailand, not Greece, which still had its own

currency!) This slide in the purchase index followed on the heels of the 9.5%

slide the week before.

All the homebuyer tax credit did (like cash for clunkers before it) was to distort

spending patterns and bring forward demand. Mortgage purchase applications

surged 13% in the final week of April but thats history. The U.S. homebuilders

are vulnerable as are the housing-sensitive retailers.

Page 4 of 9


5/9


MORE DEFLATIONARY ANECDOTES

This one is a response from one of our faithful subscribers (priceless in

Seattle?): We often receive commentsfrom our readers about thecurrent economic landscapeand sometimes theseinformal anecdotes are morerevealing than the officialpress releases

This is a great story on signs of global deflation. These informal anecdotes are

often more revealing than official releases.

In Seattle, we have two tales. The cruise ships to Alaska ports from

here (after the mandatory Jones Act stop in Vancouver, Canada.). We

handle reservations for the ships at the piers (port of Seattle). The

most recent report is that cruise sales are lagging last year (which

was down 20-30% from prior years) and the number of ships this

year will be about 70% of last year. This in spite of significant

discounts for the 7 day trips on some of the newer, most elegant

ships in the cruise fleet. Bigger discounts could be on the way for last

minute sales.

Then, Boeing says landing the new DOD tanker contract is

important, then we learn its 737-800 (bread and butter ship) is

being back ordered by airlines in China and Europe. This is a tale on

the overseas markets and U.S. exports. Either caution or real slack,

no one seems to want to say what is happening, and Boeing lets the

airlines slide orders for a fee. But the bottom line is clear,

aircraft deliveries will be down this year, 2010, and maybe 2011.

TRAIN WRECK COMING?

Sometimes one email correspondence with one reader goes a long way. This

contact of ours has a slightly less ebullient view of the housing market thanMessrs Paulsen and Paulson.

His firm had a meeting with the entire management team of a leading mortgage

REIT. Apparently, a very impressive presentation the one thing that caught my

friends attention was that a second shoe was seen as likely dropping in the

housing market starting in September/October. The reason apparently is resets

for option ARMS created in large numbers by the likes of Golden West

Financial/Wachovia. The senior managers of this REIT indicated that they spend

a great deal of time with the folks at Fannie and Freddie, as well as the

Congressional oversight people. As our contact poignantly said, open ended

disaster with no end in sight!

GOOD AS GOLDYet another letter in a day of anecdotes this one from a long-term friend. Im

not in the inflation camp but if hes right, just another reason to ensure that

precious metals comprise a core part of anyones portfolio. To wit:

Page 5 of 9


6/9


You might be interested in this. A client points out that over a 5-

year period ALL currencies are down by about the same amount

(165-190%) versus gold. Its not like one is underperforming

another. Did you read Cochranes op-ed? While we face a

deflationary near-term future, the temptation will be to go through a

door which, somewhat inevitably, will lead to inflation. While it was

hard for me to imagine how developments in the housing market in

2007 would not be ruinous to the brokers (with MER trading at $78)

it is equally hard to see how the western hemisphere can withstand

the temptation to inflate their way out of this mess.

AND YOU THOUGHT WE WERE BEARISH!

Here is one of the most insightful if frightening emails we have received in

some time. We still maintain that portfolios should have a concentration in

securities that spin off an income stream. But again, a barbell approach with

hard assets such as commodities will act as an effective hedge if government

policies produce inflation. Have a read of this zinger below:

I dont know if you remember but we worked together at Merrill. I

ran emerging markets from 1985 to 1996. Ive always been a loyal

fan and kept up with your writings.

As you know, I used to specialize in what we called then toxic waste

countries. Reality has obviously taken a turn and what was toxic now

is golden and the prime is now toxic. Our best countries are being

run like banana republics and the famed moral hazard issues are

now at the individual level with the strategic mortgage defaults. Keep

in mind that in Mexico, it moved to wholesale credit card defaults atthe last stage of the correction.

It is interesting to note that back then (the 80s) without currency

zones but a fixed dollar, the order was devaluation, default,

restructuring and budget balance with exports beginning the process

of recovery. It was not until Summers bailout of Mexico that we

entered this ridiculous world of constant bailouts, raising the size of

them at every turn and lowering the bar to what constitutes risk.

Now, its worst than ever. The developed economies have huge fiscal

deficits with no state assets to sell. The balance sheets of the

developed nations are over leveraged. The deficits have taken a

permanence to them. In the case of Europe with no individualdevaluation alternative and their new massive debt load, the EU must

now make huge fiscal cuts to get credibility. This is very reminiscent

of the pre-depression year. If the EU follows through it will push a

weak world into a severe double dip and bring the question of

capacity to repay to the forefront anyways.

Page 6 of 9


7/9


Page 7 of 9

Monetization or printing may end up being the only end alternative. I

know, and agree with you, that to have inflation you need demand.

Where I disagree is that you cant have inflation with such a

significant slack in the economy. For those of us that lived or worked

in the hyperinflationary South American zone of the seventies and

eighties, inflation comes when people lose faith in the currency and

see material goods as a store of value. Because commodities rise

and the goods can no longer be expected to be made at the same

cost structure, people assume that they will be worth more in the

future creating a self fulfilling upward spiraling effect. You can

anticipate that these state governments will introduce price controls

as well as potentially fixing exchange rates worsening the situation.

My biggest fear is that these politicians and advisors have little

experience in this area and are more concerned about controlling the

political short term without regard to the longer term implications. I

see this like an attempt at covering holes in a cracking dam with your

fingers while the cracks are spreading. Bonds in the thirties were not

a safe haven because they were restructured into 30 to 40 year

bonds at 1.0-2.0% interest. Ultimately spending habits must decline,

debt must be restructured, and growth must be promoted through

the private sector.

Political interests must be aligned with long term economic objectives

and I dont see that any time soon. Obviously, Im very negative right

now. What am I missing?

ON A LIGHTER NOTE...

Or should I say heavier note? The only putting on weight is ... me. This is from

another reader.

Blintzes!

I love these titles. Youve still got babkas, hamentashen, knishes, latkas, matzah balls,

bagels, mandelbread, komish bread, (my family had a Jewish bakery

in Philadelphia).


8/9


Gluskin Sheffat a Glance

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

As of March31, 2010, the Firm managedassets of$5.6 billion.

Gluskin Sheff became a publicly tradedcorporation on the Toronto StockExchange (symbol: GS) in May2006 andremains54% owned by its senior

management and employees. We havepublic company accountability andgovernance with a private companycommitment to innovation and service.

Our investment interests are directlyaligned with those of our clients, asGluskin Sheffs management andemployees are collectively the largestclient of the Firms investment portfolios.

We offer a diverse platform of investmentstrategies (Canadian and U.S. equities,Alternative and Fixed Income) andinvestment styles (Value, Growth and

Income).1

The minimum investment required toestablish a client relationship with theFirm is $3 million for Canadian investorsand $5 million for U.S. & Internationalinvestors.

PERFORMANCE

$1 million invested in our Canadian ValuePortfolio in 1991 (its inception date)

would have grown to $11.7million2

onMarch31, 2010 versus $5.7million for theS&P/TSX Total Return Index over the

same period.$1 million usd invested in our U.S.Equity Portfolio in 1986 (its inceptiondate) would have grown to $8.7millionusd

2on March 31, 2010 versus $6.9

million usd for the S&P500TotalReturn Index over the same period.

INVESTMENT STRATEGY & TEAM

We have strong and stable portfoliomanagement, research and client serviceteams. Aside from recent additions, ourPortfolio Managers have been with theFirm for a minimum of ten years and wehave attracted best in class talent at all

levels. Our performance results are thoseof the team in place.

Our investmentinterests are directlyaligned with those ofour clients, as Gluskin

Sheffs management andemployees arecollectively the largestclient of the Firmsinvestment portfolios.

$1 million invested in our

Canadian Value Portfolio

in 1991 (its inception

date) would have grown to

$11.7 million2 on March

31, 2010 versus $5.7

million for the S&P/TSX

Total Return Index over

the same period.

We have a strong history of insightfulbottom-up security selection based onfundamental analysis.

For long equities, we look for companieswith a history of long-term growth andstability, a proven track record,shareholder-minded management and ashare price below our estimate of intrinsic

value. We look for the opposite inequities that we sell short.

For corporate bonds, we look for issuers

with a margin of safety for the paymentof interest and principal, and yields whichare attractive relative to the assessedcredit risks involved.

We assemble concentrated portfolios our top ten holdings typically representbetween 25% to 45% of a portfolio. In this

way, clients benefit from the ideas inwhich we have the highest conviction.

Our success has often been linked to ourlong history of investing in under-followed and under-appreciated smalland mid cap companies both in Canada

and the U.S.

PORTFOLIO CONSTRUCTION

In terms of asset mix and portfolioconstruction, we offer a unique marriagebetween our bottom-up security-specificfundamental analysis and our top-downmacroeconomic view.

For further information,

please contact

[email protected]

Notes:

Page 8 of 9

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.


9/9


IMPORTANT DISCLOSURES

Copyright 2010 Gluskin Sheff + Associates Inc. (Gluskin Sheff). All rights

reserved. This report is prepared for the use of Gluskin Sheff clients andsubscribers to this report and may not be redistributed, retransmitted ordisclosed, in whole or in part, or in any form or manner, without the expresswritten consent of Gluskin Sheff. Gluskin Sheff reports are distributedsimultaneously to internal and client websites and other portals by GluskinSheff and are not publicly available materials. Any unauthorized use ordisclosure is prohibited.

Gluskin Sheff may own, buy, or sell, on behalf of its clients, securities ofissuers that may be discussed in or impacted by this report. As a result,readers should be aware that Gluskin Sheff may have a conflict of interest

that could affect the objectivity of this report. This report should not beregarded by recipients as a substitute for the exercise of their own judgmentand readers are encouraged to seek independent, third-party research onany companies covered in or impacted by this report.

Individuals identified as economists do not function as research analystsunder U.S. law and reports prepared by them are not research reports underapplicable U.S. rules and regulations. Macroeconomic analysis isconsidered investment research for purposes of distribution in the U.K.

under the rules of the Financial Services Authority.

Neither the information nor any opinion expressed constitutes an offer or aninvitation to make an offer, to buy or sell any securities or other financialinstrument or any derivative related to such securities or instruments (e.g.,options, futures, warrants, and contracts for differences). This report is notintended to provide personal investment advice and it does not take intoaccount the specific investment objectives, financial situation and theparticular needs of any specific person. Investors should seek financialadvice regarding the appropriateness of investing in financial instrumentsand implementing investment strategies discussed or recommended in thisreport and should understand that statements regarding future prospectsmay not be realized. Any decision to purchase or subscribe for securities inany offering must be based solely on existing public information on suchsecurity or the information in the prospectus or other offering documentissued in connection with such offering, and not on this report.

Securities and other financial instruments discussed in this report, orrecommended by Gluskin Sheff, are not insured by the Federal DepositInsurance Corporation and are not deposits or other obligations of anyinsured depository institution. Investments in general and, derivatives, inparticular, involve numerous risks, including, among others, market risk,counterparty default risk and liquidity risk. No security, financial instrumentor derivative is suitable for all investors. In some cases, securities andother financial instruments may be difficult to value or sell and reliableinformation about the value or r isks related to the security or financialinstrument may be difficult to obtain. Investors should note that incomefrom such securities and other financial instruments, if any, may fluctuateand that price or value of such securities and instruments may rise or fall

and, in some cases, investors may lose their entire principal investment.

Past performance is not necessarily a guide to future performance. Levelsand basis for taxation may change.

Foreign currency rates of exchange may adversely affect the value, price orincome of any security or financial instrument mentioned in this report.Investors in such securities and instruments effectively assume currencyrisk.

Materials prepared by Gluskin Sheff research personnel are based on publicinformation. Facts and views presented in this material have not beenreviewed by, and may not reflect information known to, professionals inother business areas of Gluskin Sheff. To the extent this report discussesany legal proceeding or issues, it has not been prepared as nor is itintended to express any legal conclusion, opinion or advice. Investorsshould consult their own legal advisers as to issues of law relating to thesubject matter of this report. Gluskin Sheff research personnels knowledgeof legal proceedings in which any Gluskin Sheff entity and/or its directors,officers and employees may be plaintiffs, defendants, co-defendants or co-plaintiffs with or involving companies mentioned in this report is based onpublic information. Facts and views presented in this material that relate to

any such proceedings have not been reviewed by, discussed with, and maynot reflect information known to, professionals in other business areas ofGluskin Sheff in connection with the legal proceedings or matters relevant

to such proceedings.

Any information relating to the tax status of financial instruments discussedherein is not intended to provide tax advice or to be used by anyone toprovide tax advice. Investors are urged to seek tax advice based on theirparticular circumstances from an independent tax professional.

The information herein (other than disclosure information relating to GluskinSheff and its affiliates) was obtained from various sources and GluskinSheff does not guarantee its accuracy. This report may contain links to

third-party websites. Gluskin Sheff is not responsible for the content of anythird-party website or any linked content contained in a third-party website.Content contained on such third-party websites is not part of this report andis not incorporated by reference into this report. The inclusion of a link in

this report does not imply any endorsement by or any affiliation with GluskinSheff.

All opinions, projections and estimates constitute the judgment of theauthor as of the date of the report and are subject to change without notice.Prices also are subject to change without notice. Gluskin Sheff is under noobligation to update this report and readers should therefore assume thatGluskin Sheff will not update any fact, circumstance or opinion contained in

this report.

Neither Gluskin Sheff nor any director, officer or employee of Gluskin Sheffaccepts any liability whatsoever for any direct, indirect or consequentialdamages or losses arising from any use of this report or its contents.

Page 9 of 9

Documents

Potluck With Dave 051910