06-11-10 Breakfast With Dave

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David A. Rosenberg June 11, 2010Chief Economist & Strategist Economic [email protected]+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Breakfast with DaveWHILE YOU WERE SLEEPING

We are getting an important follow-through rally today on global equities.

Practically every region is in the green column. The key 1,040 technical level

on the S&P 500 held, at least for now.

Treasuries are consolidating after the snapback in yields this week, though

there was a mild backup in yields overseas today.

Commodities are performing nicely with copper coming off its best week in

three months and oil inching its way back to $75 a barrel.

The U.S. dollar is losing steam and while gold is up a tad, the nice bull run of

the past few weeks seems to be fading. The euro is rebounding as the shorts

get covered until the next round of bad news, which seems inevitable.

While an uneasy calm has suddenly appeared and a view is being born that

the dramatic fiscal tightening in Europe and recent tightening in financial

conditions will not cut into global growth, we were served a reminder today

that the world expansion is more fragile than generally acknowledged. U.K.

industrial production posted a surprising 0.4% MoM decline in April

manufacturing output the consensus messed up on both the digit and the

sign (+0.5%!). Just because China posted +50% export growth, New Zealand

raised rates and Australia posted a decent jobs report, doesnt mean cracksarent about to appear in this global growth story of the past year and change.

It is more fragile than commonly perceived. In fact, the Chinese data out

today inflation up to 3.1% in May from 2.8% and industrial production

slowing to 16.5% from 17.8% should also be raising some eyebrows over the

outlook for the both the economy and monetary policy for the country that

ignited the resumption of global growth back in late 2008.

It should be duly noted that as impressive as yesterdays gains were, this is

nothing more than a thinly traded technical bounce. The moving averages

have rolled over and volume yesterday was down across the board, lessening

the relevance of the overall advance. Yesterdays dramatic move a day after

a huge outside reversal attests only to the surreal degree of volatility

permeating the market. In the last month, we have endured daily swings of200 points or more fully 80% of the time. The Dow has actually swung at least

100 points for 24 sessions in a row. For those who dont like to live in the wild

west, there is always the relative safety and calm waters in the bond market

and true hedge fund strategies.

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

IN THIS ISSUE

While you were sleeping:global equity markets areclosing off the week in thegreen column; cracks areappearing in the globalgrowth revival story

Labour pains in the U.S.:Jobless claims have now

been above 450k for fourweeks running

Housing heading intoanother deep funk

Upside growth risks forCanadian Q2 GDP aresubsiding

The Fed Flow of Fundsdata contained a stream ofgood news in terms ofbalance sheet quality in

the corporate sector

Surprising sector strengthin the latest Fed BeigeBook


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June 11, 2010 BREAKFAST WITH DAVE

Although we arent so hot on the income statement and the view that earnings

are going to new highs in the coming year especially with little prospect of

more margin expansion, little pricing power and slowing nominal growth we

think the corporate balance sheets are in great shape. The quality of the

balance sheet and the associated default/delinquency risks, carries with it

less uncertainty than the outlook for earnings hence the preference for

spread product here. The Fed just reported that the nonfinancial corporate

sector has built up its cash hoard to a record $1.84 trillion up 26% from a

year ago and now representing a 47-year high of 7% of total assets. This does

nothing to help equity investors in their ROE assumptions but it sure is a

positive for bond investors because all they care about in the end is ...

receiving their coupon payments and being paid out at par upon maturity.

Moreover, there has been a dearth of supply of late with new-issue activity

declining for seven weeks in a row. Yet, the weekly mutual fund data show no

decline at all in what is increasingly proving to be a secular drive for income

from a 78 million-strong boomer population whose median age is 55, not 25

or 35 and prepped for capital appreciation strategies. Hate to break it to you

but that theme ended a decade ago.

LABOUR PAINS

U.S. jobless claims fell 3k in the June 5th week, to 456k, but from an upwardly

revised 459k the prior reading. The key here is that claims have now been

above 450k for four weeks running and the four-week moving average has

drifted up, to 463k, the highest it has been since mid-March. Over half the

time in the past, such a level of claims was consistent with net job loss so

barring any improvement, one would expect to see the June nonfarm payroll to

look a lot more like the tepid May report than what we saw in April, as far asprivate payrolls are concerned.

CHART 1: TREND IN JOBLESS CLAIMS STILL VERY HIGH

United States: Initial Jobless Claims

(four-week moving average)

109876

675

600

525

450

375

300

225

Source: U.S. Department of Labor, Gluskin Sheff

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The key here is that claims

have now been above 450k for

four weeks running

It should be noted that as

impressive as yesterdays rallywas in the U.S., it is nothing

more than a thinly traded

technical bounce


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There is little doubt that claims are going to rise quite sharply over the near-

term as the fallout from the oil spill hits the data. Recall that in the six weeks

following the Katrina disaster in 2005, claims jumped by 133k over a six-week

time span. So expect to hear calls for a double-dip if claims surge above

500k and end up staying there.

Chart 2 puts the latest 463k reading on the four-week moving average into

some perspective.

CHART 2: PUTTING TODAYS 463,000 LEVEL ON

INITIAL JOBLESS CLAIMS IN PERSPECTIVE

United States: Initial Jobless Claims

(four-week moving average)

445

330 330

320

388

400405

385

348

445

463

300

320

340

360

380

400

420

440

460

480

Desert Storm Mexico Asian Crisis LTCM/

Russian Crisis

Tec h Wre ck 9 /1 1 Enro n/

Worldcom

Fannie and

Freddie

Bear Stearns Lehman

Collapse

Now

Source: U.S. Department of Labor, Gluskin Sheff

HOUSING HEADING INTO ANOTHER DEEP FUNK

Ivy Zelmans research is already showing a huge post-subsidy hangover in the

real estate market. Below is an email from a reader who says much the same.

Housing-related investments are to be avoided at all costs.

Dave,

I appreciate your daily updates and a real life accurate analysis of

government statistics and CNBC spin.

For what it's worth, we are in the home inspection business, and things

here have indeed gotten very ugly.

After the tax credit expiration date came, the inspection spillover made

the first half of May very strong. (Once under contract they call us with

about 10-14 days to get the home inspection done.)

Since then things have dropped dramatically, from ~25-50%

depending on what state and area you are in. Since May and June are

usually the busiest months of the year, we were counting on continuedmomentum from the regular market to take over after the expiration.

No such luck. This June is already shaping up to be much worse than

last year's bad numbers.

Hold onto your hat. We are. Take care, Ken

Page 3 of 8

Ivy Zelmans research is

already showing a huge post-

subsidy hangover in the real

estate market


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EXPORTS DOWN, IMPORTS TOO

There was not a whole lot of information in the U.S. and Canadian trade data

that came out yesterday for April, but there was a whole lot of news beneath the

surface.

Upside growth risks forCanadian Q2 GDP are

subsiding

The U.S. trade deficit barely budged at $40.3 billion from $40.0 billion in March,

but the two-way trade flows did show a big decline in inflation-adjusted terms

a signpost that the V-shaped global demand recovery may be behind us. Real

exports sagged 2.5% MoM with a steep decline in consumer goods and stagnant

shipments of capital goods. At the same time, import volumes slumped 1.5%

and again the softness was centered in the consumer products segment.

Canada posted a very small surplus of $200 million, which was below the $600

million consensus estimate and again, two-way trade deflated with exports down

1% and imports down a sharper 2.2% (these are in nominal terms). In volume

terms, imports were flat while exports fell 1.6% in what was the second

contraction in the real trade balance in a row. Upside growth risks for Canadian

Q2 GDP are subsiding if fact, we are at 3.3% (annual rate) right now versus

3.6% as per the consensus and we believe the risks are to the downside,

especially in light of the weak May housing data.

As for the U.S., we have yet to even see the full effects of the stronger dollar and

weaker European economy hit the trade data just yet. The deficit is going to

soar again and this is downside risk to GDP growth going forward.

CORPORATE BALANCE SHEETS VERY COMPELLING

The Fed Flow of Funds data just came out for Q1 and contained a stream of

good news in terms of balance sheet quality in the corporate sector. Here arethe four major takeaways:

Debt-to-equity ratio for the nonfarm nonfinancial corporate sector fell to55.0% from 57.1% in Q4 of last year. This metric is now down four quarters in

a row and well below the cycle high of 79.5%.

Ratio of long-term debt-to-total debt edged up to a new high of 73.9% from73.7%, the sixth straight increase. Companies ran down bank lines by

$108bln at an annual rate and tapped the bond market to the tune of

$413bln (at an annual rate) in Q1.

Liquid asset ratio (cash/equivalents normalized by short-term liabilities) roseto 51.2% from 50.4% also sixth consecutive increase and the highest since

1956. We went into this recession at 38%.

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The Fed Flow of Funds data

contained a stream of good

news in terms of balance sheet

quality in the corporate sector


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CHART 3: PUTTING TODAYS 463,000 LEVEL ON

INITIAL JOBLESS CLAIMS IN PERSPECTIVE

United States: Nonfinancial Corporate Business:Liquid Assets/Short-Term Liabilities

(percent)

050505050505

70

60

50

40

30

20

10

Source: Federal Reserve Board, Gluskin Sheff

Capital outlays/internally generated funds rose to 99.4% from 94.4% stillbelow 100% for fifth quarter in a row. Net of capex, cash flow is still positive.

SURPRISING SECTOR STRENGTH

The Beige Book, as we have said in the past, is a timely and detailed account of

what is happening at the grass roots level across regions and sectors. This

latest version covered the six-week period up to May 28 when the corrective

phase in the equity market was in full swing and the escalating debt problems in

Europe percolating.

Yet, for the first time since October 2007, all 12 Fed districts reported improved

economic conditions, and we were also surprised at the broad strength across

industries contained in the report. We always look at the sectors mentioned in

the Beige Book and lump them into two categories strong/improving and

weak/deteriorating. We provide the lists below you may be surprised:

Strong/Improving:

Tourism Steel Autos Consumer staples Staffing firms Commercial real estate Metal fabrication Petrochemicals Airlines

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Trucking


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Rail stock Agri-business Food processing Energy/mining Home improvement Jewellery AutosWeak/deteriorating

Construction Media Banking Department stores Medical supplies/pharma AppliancesThere are almost three strong or improving sectors for every one that was weak

or deteriorating. You would have never thought that the leading indicators and

the equity market were both rolling over as this book was being written.

Anyways, it never hurts to do a gut-check over ones view.


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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

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PORTFOLIO CONSTRUCTION

For further information,

please contact

[email protected]

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

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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.


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