Lunch With Dave 032910

8/9/2019 Lunch With Dave 032910

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David A. Rosenberg March 29, 2010Chief Economist & Strategist Economic [email protected]+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Lunch with DavePLEASE NOTE THAT WE WILL NOT BE PUBLISHING IN THE NEXT TWO DAYS.

THE NEXT PUBLICATION DATE IS THURSDAY, APRIL 1

Show me the money!

Who will buy U.S. bonds?Sentiment is so negativeon the U.S. Treasurymarket its not even funnyanymore

U.S. savings rate slidespurs spending

Why Canadiancommercial real estate isstill so firm

U.S. earnings update bottom-up analysts areexpecting another goodquarter of earnings in Q1

My take on the U.S. Q4GDP report

Whats on the worry list?April is a key month, nofooling

Market thoughts I knowwhat a broken recordsounds like and this hasbeen a confounding andconfusing market forboth the bears and many(though not all) of thebulls

IN THIS ISSUE

MARKET THOUGHTS

Well, well, the theory that the stock market has turned in a double top may not

have gone the way of the Dodo after all, following the reversals we saw in the

last two trading days of last week. Negative reversals and distribution days in

three of the last six sessions is something to be concerned about if you are long

this market and volume remains tepid at best.

The market is now overvalued by over 25% but is also extremely overbought

having gone 24 sessions without a decline of 1% or more, and 89% of the stocks

in the S&P 500 are now trading above their 50-day moving averages (see page

M3 of Barrons). The Dow has advanced in 17 of the past 21 days. I mean,

even if you are bullish on the outlook, one would have to admit that such a

parabolic move is vulnerable to at least a modest pullback or more. I know

what a broken record sounds like and this has been a confounding and

confusing market for both the bears and many (though not all) of the bulls.

Looking at the fund flows, there is only one conclusion that can be reached: This

market is being driven by pig farmers. Retail inflows may have picked up of late,

but only fractionally. The focus on the part of the individual investor remains on

the fixed-income market, for better or for worse (better from our standpoint,worse from the standpoint of my friend and fellow debater Jim Grant).

Institutional portfolio manager cash ratios are back to the rock bottom levels of

around 3% where they were back at the market peak in October 2007. The

shorts have all but been covered. Foreign investors have been few and far

between, based on the latest TICS data. The lack of volume speaks volumes

there are no sellers. Investors of all types have been content to just sit and

watch their equity position expand via the price appreciation, but there is scant

evidence of any follow-through this year in terms of volume buying.

So, that leaves me with a suspicion that the entities doing the buying are the pig

farmers. Who are they pray tell? They are the prop desks at the five large

banks. They buy and sell securities, with leverage ... to each other! And, thesetransactions often occur late in the day or in the futures pit after the market

closes. There is no sign of any other buyer out there, including the Fed who has

been too busy choking on mortgage backed securities and Maiden Lane assets.

To repeat, that is why the volumes have been so low.

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


2/19

March 29, 2010 LUNCH WITH DAVE

What we should be aware of about the pig farmers is that they could, at any

time, flick the switch in the other direction. What the trapped longs may be

forced to do the ones that have been sitting on their hands and have been

waiting for the bear market rally to take their portfolio back to where it was at

the peaks at that point is start to sell. That is when the volume picks up ...

and accelerates the downside pressure.

It is always difficult to

predict the future, but somany investors are

caught in the moment

Of course, it is always difficult to predict the future, but so many investors are

caught in the moment and are being told not to fight the tape and simply play

the momentum game. They do not see that the current rebound in the economy

is a statistical mirage orchestrated by record amounts of monetary and fiscal

stimulus that are simply unsustainable and actually risk precipitating a very

unstable financial and economic backdrop in coming years.

From our lens, the rally of the last 12 months smacks of the 1930 snapback,

and if memory serves us correctly, the S&P 500 went on to hit new lows in

subsequent years and the next secular bull market did not start until 1954. I

am sure that all the bullish pundits and tape watchers were ridiculing the

cautious folks back then just go and have a look at the Diary of Benjamin Roth

and you will see how much giddiness there was over the bear market rally and

that the worst was over back then. Meanwhile, the lows were still more than a

year away to everyones surprise except those who kept their eyes on the

forest, not the trees.

Deleveraging cycles take years to play out, even with massive doses of

government intervention.

In todays context, once again few, if any, will know when we reach the peak

since there is no perfect market-timer out there that we know of. But the

pattern of the past 12 years, when Alan Greenspan embarked on the bailout

path with LTCM back in 1998, and the roller-coaster ride that ensued since, it

has been just as prudent to take profits after a 70% bounce as it would have

been to start adding to equity positions after a 50% decline.

It is clear from the volumes of emails I receive daily that there is frustration

among those who think they have somehow missed something important by not

being overweight cyclical stocks over the past year. The tone of the responses

to my daily musings is eerily similar to the complaints I saw frequently back in

2006 and 2007 and the advice not to fight the tape or to fight the Fed.

These are just glib after-the-fact excuses for going long the market when nobody

really has a good idea on why we should be bullish in the first place.

We hate to break it to the bulls but even with the pleasant rally in risk assets

over the past year, there really is nothing to be bullish about when it comes to

how the economy is performing now or in the future as all the monetary and

fiscal largesse is unwound. Have a look at States Look to Tax Services, From

Head to Toe on the front page of the Sunday NYT, as well as Moves to Tax Banks

to Pay for Bailouts Gain Steam on page C1 of todays WSJ.

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3/19


As an aside, if the Administration does not enact a new tax law, the tax rate on

dividends reverts to the pre-2001 rates, which are the same as rates on ordinary

income 39.60% at the top bracket. Recall that by the time the 1930s came to

an end, FDR paid for the massive fiscal expansion by lifting top marginal tax

rates, to 80%.

What we have to

constantly remindourselves is that we are

still in a secular bear

market

What we have to constantly remind ourselves is that we are still in a secular

bear market, that the S&P 500, through all the numerous peaks and valleys, is

still in the hole to the tune of 25% over the past decade, that we are in the

classic Bob Farrell stage 2 of the long cycle, which is the reflexive rebound

phase, and that frankly, there is really no reason to add undue risk to the

portfolio except perhaps for the most ardent day-trader.

Its remarkable how so many people still refuse to accept what history has

taught us about post-bubble credit collapses they do indeed require ongoing

government support, but even then we endure five to seven years of economic

stagnation. And, that flat line will involve periods of growth followed by periods

of contraction but the lasting theme is one of volatility.

For a long while, I have recommended that investors have a read of The Great

Depression: A Diary. It is the story of Benjamin Roth (a Youngstown lawyer) the

only detailed personal account of the 1930s that has been published. On July 31,

1931, he entered this into his journal: Magazines and newspapers are full of

articles telling people to buy stocks, real estate etc. at bargain prices. Of course,

this was right during the reflexive rebound and the market still had 35% to go on

the downside before the triple waterfall bear market was complete.

On March 6, 1933, he lamented that When I started in 1930 to jot down the

happenings during the depression I had no idea it would last as long and I did

not think I would require more than one small notebook. Now after 3 years of

the worst depression has even seen, the end is not in sight.

Through all the

numerous peaks and

valleys in the market,

the S&P 500 is still in

the hole to the tune of

25% over the past

decade

It is very important not to get caught up in the euphoria in the business media

and the mania in the financial markets. The most dangerous thing anyone can

do right now is extrapolate the stimulus-led bounce of the past year into the

future. As Mr. Roths diary shows, these post-bubble bouts of giddiness were

not sustained, even with the New Deal.

As was the case back then, the investors who end up succeeding are not the

ones who are able to play the flashy bear market rallies but the ones who opt for

strategies that minimize volatility and optimize risk-adjusted returns. Income,whether it be from paper assets (bonds, dividends) or hard assets (oil and gas

royalties, REITs), is going to emerge as king in an environment where the primary

trend is one of deflation, which is indeed the case as private sector credit

contracts.

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The U.S. dollar has been strengthening, gold is sputtering, rents are declining,

wages decelerating, core consumer prices flattening and now money supply

growth is vanishing. It may take the equity market time to absorb all of this, but

for those who believe that at some point the economic fundamentals will come

to dominate the landscape, it may pay to gaze at the charts below that depict

the current economic cycle relative to the average of its predecessors. These

charts show everything from real GDP, to real final sales, to employment, to

industrial production, to retail sales, to housing and it is plain to see that this

goes down as the weakest post-recession recovery on record despite the fact

that it is being underpinned by the most intense level of government support on

record. That indeed is cause for pause.

CHART 1: NOT YOUR TYPICAL RECOVERY REAL GDP

United States

(data indexed to 100 = start of recession)

95

96

97

98

99

100

101

102

103

104

105

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Number of Months from the Start of Recession

Represent average length of a recession

Expansion Phase

Recession

End of Current Recession

Source: Haver Analytics, Gluskin Sheff

CHART 2: NOT YOUR TYPICAL RECOVERY FINAL DOMESTIC SALES

United States: Real Final Domestic Sales


97

98

99

100

101

102

103

104

105

106

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 2

Number o f Months f rom the S tar t o f Recess ion


Expansion Phase

Recession



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CHART 3: NOT YOUR TYPICAL RECOVERY EMPLOYMENT

United States: Nonfarm Payrolls(data indexed to 100 = start of recession)

93

94

95

96

97

98

99

100

101

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26



Expansion Phase

Recession



CHART 4: NOT YOUR TYPICAL RECOVERY INDUSTRIAL PRODUCTION

United States: Industrial Production


85

87

89

91

93

95

97

99

101

103

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26



Expansion Phase

Recession



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6/19


CHART 5: NOT YOUR TYPICAL RECOVERY RETAIL SALES

United States


88

90

92

94

96

98

100

102

104

106

108

110

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26



Expansion Phase

Recession



CHART 6: NOT YOUR TYPICAL RECOVERY HOUSING STARTS

United States


40

50

60

70

80

90

100

110

120

130

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25



Expansion Phase

Recession



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7/19


WHATS ON THE WORRY LIST?

April is a key month, no fooling:

April will be a key month

no fooling

Last weeks bond auctions did not go well. It seems that Japan and China didnot show much interest. The lack of bids was no better underscored than in

the 7-year Treasury note auction where the median yield was 3.29% versus

3.05% a month earlier. April is a cruel month for the U.S. Treasury market,

with 10-year yields rising in each of the past 4 Aprils and in 6 of the past 7,

and by an average of 25 basis points. (As Alan Greenspan said on Bloomberg

News last week, higher yields are the canary in the mine.)

That, in turn, could spook the equity market since another 25bps of upsidepressure could then generate a fund-flow spiral as was the case in the

summer of 2007 3.85% (where we are now) ostensibly is a trigger point for

selling of mortgage bonds. As rates rise, homeowners are less likely to pay

their mortgages early, which extends the life of the mortgage and that in turnencourages mortgage investors to neutralize the duration of their portfolios by

selling T-bonds and notes. We have seen this happen before and while it will

likely provide a nice buying opportunity given the deflationary headwinds the

economy now faces, the prospect of a spasm in the Treasury market is worth

considering. Every equity market correction in the past 1987, 1994, 1998,

2000, and 2007 was preceded by what turned out to be a brief but

significant runup in yields. See Stock Rally at Mercy of Rising Rates on page

C1 of todays WSJ). And, the more overvalued the equity market is, the more

the downside risks if bonds begin to provide greater yield competition in the

near-term. Jeffery Hirsch over at the Stock Traders Almanac is in todays NYT

predicting a 20-30% correction ahead (see Stocks Soar, But Many Ask Whyon

page B1) he notes the modest number of stocks hitting new 52-week highs

with every new interim peak being reached by the overall market.

The leading indicators are all pointing to a slowdown, and this could show up ina critical data-release week in mid-April with retail sales on the 14th, industrial

production on the 15th, and housing starts, as well as consumer sentiment, on

the 16th. The broad money supply measures are contracting again as the Fed is

no longer boosting its balance sheet at a time when both the money multiplier

and money velocity are showing no signs of turning higher.

Greece will be put to the test in April when 15 billion of bonds have to berolled over (through the end of May).

The Fed ceases to buy mortgage securities on Wednesday and this ishappening at a time when mortgage rates have already climbed back above

5% and the housing market is showing signs of rolling over again. See Spikein Treasury Yields Jolts Mortgages on page C2 of todays WSJ. There is also

pressure from within the Fed (Plosser the latest) to soon begin to sell

securities outright. One thing that is very likely on its way again is another

50bps hike on the discount rate has anyone noticed the TED spread

beginning to widen ahead of this? The banks, going forward, will not have

easy access to the window and will have to rely on each other for funding.

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April 15 looms as a critical day from a geopolitical standpoint. It is the day thatthe Treasury Department will issue its report concluding whether or not China is

a currency manipulator. If it is viewed as such then trade sanctions are likely to

ensue and very likely some bilateral tensions. This could be very good news for

the bullion market (as well as the Bloomberg News report today stating that gold

imports in India are surging right now up six-fold from a year ago as there

are an expected 1 million marriages planned for April and May).

Sentiment is so negative

on the U.S. Treasurymarket its not even

funny. Everyone seems

to focus strictly on

supply without realizing

that the only way to

predict a price is by

forecasting both supply

and demand

Speaking of geopolitical risks, President Obama has allowed U.S. relations withIsrael to deteriorate to such an extent, and is handling the Iran nuclear situation

with such a kid-gloves approach, that disturbing columns like this are now

popping up in newspapers like the NYT (Rift Exposes Larger Split In Views On

Mideast page A4), the National Post (Iran Preparing to Build Two More Secret

Nuclear Sites in Mountains, Experts Say page A8), and the WSJ (How the Next

Middle East War Could Start page A23). Even the prospect is enough to

underpin the energy stocks, which are currently priced for $69/bbl on WTI.

WHO WILL BUY U.S. BONDS?

Sentiment is so negative on the U.S. Treasury market its not even funny.

Everyone seems to focus strictly on supply without realizing that the only way to

predict a price is by forecasting both supply and demand. On its own, supply looks

worrisome given the Administrations bent on running huge fiscal deficits (and it

just unveiled a new set of initiatives to reverse the foreclosure crisis).

What is ignored in so much analysis is the demand side of the equation boomer

households, for example, have only 6% of their assets in bonds versus nearly 30%

in real estate and equities. They have about $8 trillion that they can put to use

towards income-oriented portfolio strategies and in fact this powerful demographic

trend is already underway. The banking sector is sitting on $1.3 trillion in cash

and if it ever decided to play the yield curve, as it did coming out of the credit

crunch of the early 1990s, it too could provide up to a trillion dollars of support for

the bond market (even if Bill Gross sits on the sidelines).

Finally, it may pay to have a look at what is happening at the State and local

government level when it comes to unfunded pension liabilities and the

modifications that are coming from the General Accounting Standards Board

(GASB). The era of relying on 8% return assumptions are no longer tenable in

a world of sub-4% nominal GDP growth. Looking at the latest Fed Flow of

Funds report, State and local government pension funds are sitting on an

equity allocation of nearly 60%, but only have 6.5% of their financial assets in

treasury, notes and bonds.

From the mid-1960s up until the mid-1990s, the bond share was consistently

between 20-30% and moving back into this range would involve roughly $500

billion of an allocation shift towards the fixed income market. I highly urge

everyone to read the article on page A2 of todays WSJ titled Showing the

Woes in Public Pensions.

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9/19


Ignoring the demand for fixed income product would have left you with a

dramatically incorrect forecast of where JGB yields were headed in the

aftermath of its credit collapse two-decades ago. There were at least seven

spasms to the upside, but the primary trend in bond yields was down.

Run-down in the U.S.

savings rate funded the

0.3% consumer

spending rate in

FebruarySAVINGS RATE SLIDE SPURS SPENDING

U.S. consumer spending rose an as-expected 0.3% MoM in February, even

though there was no growth in disposable income. So, the gain was funded by

a rundown in the savings rate, which went from 3.4% in January to 3.1% just

as the +0.4% print in January was underpinned by a drop in the savings rate

from 4.0% to 3.4%. At 3.1%, the savings rate is all the way back to levels last

seen in October 2008. At play seems to be the effects of lower gasoline prices

during the month as well as the prospect that the wave of strategic defaults

has left consumers with enough cash flow to propel consumption at a 1%

annual rate on its own.

Based on what is built in already, it looks as through real consumer spending

is on track for a near 3% annualized gain in Q1, which would be double what

we saw in Q4 of last year. But there are an array of offsets, from sharply

slower capex growth, depressed commercial construction and the renewed

turndown in the housing market. It looks like the economy will eke out

something close to a 2% annual rate this quarter as this still goes down as

one of the weakest post-recession recoveries in real final sales ever recorded

despite all of the fiscal and monetary stimulus in the system.

If you do the math, it is fascinating (and disturbing) to see that if not for the

rundown in the savings rate, consumer spending would have been negative in

both January and February and the build in for Q1 would be -0.6% annualrate (as opposed to +3%).

It would be more encouraging if the spending data were being funded by

organic income growth, but that is not happening at least not yet. Despite

the so-called improvement in labour market conditions in February, wages and

salaries were flat, and outside of government support, fell 0.2% for the second

month in a row. Real personal income excluding government transfers is one

of the four main components that comprise the NBERs formula for

determining whether the economy is in recession or expansion and it covers

about two-thirds of the economy it remains squarely in recession terrain.

The savings rate was 6.4% last May and running this down by half has

certainly given the household sector some leeway to continue to spend as hasbeen the case. But with fiscal and monetary support in the process of

subsiding, even with the improvement in the jobs market, the lack of income

growth and the depleted savings rate point to a subdued spending pattern

ahead. This was confirmed by the recent downleg in the UofM consumer

expectations survey, which is down to a four-month low and is foreshadowing

a 1.0-1.5% consumption trend in the next two quarters.

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10/19


Page 10 of 19

The bond market is obviously going to be a possible headwind for equities if the

backup in yields persists. Much of the spasm is technical in nature there is

certainly nothing to be concerned about with regard to the inflation background,

and it is inflation that ultimately drives the trend in bond yields, not fiscal policy.

Not only have wages stagnated in two of the past three months, but the PCE

deflator, both the headline and the core (which excludes food and energy), came

in flat in February. While the CPI is maligned for having too strong a weighting in

housing, the PCE deflator does not share this problem and the core index is

now running at a mere 1% annual rate over the past three months down from

the 1.5% trend at the end of 2009.

The Commerce Department also publishes a market based PCE number, which

excludes prices that the government imputes. On this score, underlying

inflation has been falling even faster +0.3% at annual rate over the past three

months and at +1.2% YoY, it is now at the slowest pace since September 2003

when the unemployment rate was around 6%, not 10%.

CHART 7: LOOK WHERE UNDERLYING INFLATION IS HEADING

United States: Market Based PCE: Excluding Food & Energy

(year-over-year percent change)

05050

5.25

4.50

3.75

3.00

2.25

1.50

0.75



11/19


WHY CANADIAN COMMERCIAL REAL ESTATE IS STILL SO FIRM

We are not talking about residential real estate, which is in some form of a

bubble, especially in Toronto and Vancouver. But anecdotally, commercial

real estate is holding in very well and one of the reasons could well be foreign

expansion into Canada.

In Canada, thecommercial real estate

market is holding in very

well compared to the

residential sector, which

is in some form of a

bubble

For a sign of what is happening in the retail sector, as one example, have a

read of the article on page B4 of todays WSJ (U.S. Apparel Retailers Map an

Expansion to the North). What does Canada offer to American companies who

want to grow but cannot do it without moving aggressively to gain market

share in an oversaturated U.S. backdrop? Well, as the article asserts, Canada

offers a way to expand internationally but in a market thats closer and more

familiar than Europe or Asia.

The prospect of more U.S. money being put to work north of the border is of

course also long-term bullish for the Canadian dollar, which may be

overvalued now by about a nickel; however, at the same time, the fair-value

line keeps moving higher, which is a hallmark of a secular uptrend.

EARNINGS UPDATE

Bottom-up analysts are expecting another good earnings quarter; up 37% in Q1,

following the 200% YoY Q4 results (excluding financials, it was much tamer at

17%).

However, we would say that there are three items that need careful

consideration with regards to the seemingly bullish Q1 profit number.

1.Easy comparisons from last years very poor results. Financials are onceagain expected to see a large jump of 180% but also Materials andConsumer Discretionary are penciled in as growing +100% YoY. The other

thing to be mindful of is that oil prices were up nearly 100% as well on a YoYbasis from last year and this explains why the consensus is expecting +40%for energy earnings.

2.Revenues. Last quarter saw revenues up only 6% despite the massiveincrease in profits. This quarter, analysts are more bullish, thinking thatrevenues will be up closer to 10%. Unit labour costs in the nonfarmbusiness sector were down nearly 5% year-over-year and the question goingforward is how much more can firms cut in terms of costs. As HowardSilverblatt points out over at S&P, if we dont see sustained revenue growthgoing forward, then we wont see job creation.

3.S&P 500 profits versus NIPA (national accounts) profits. We took a quicklook at consensus estimates for Q1 (the S&P 500 profits) and seasonally-adjusted them to get a sense where economy-wide profits may be heading.To reiterate, the consensus is expecting a near 40% increase for Q1, butonce we translate this into seasonally adjusted terms, profits actuallydecline on the quarter (sequentially from Q4).

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Page 12 of 19

MY TAKE ON THE U.S. Q4 GDP REPORT

For the second quarter in a row, we saw the final tally for U.S. GDP come in below the

initial estimate. Real GDP was marked down to a 5.6% annual rate in Q4 from 5.9%

in the second revision and from 5.7% in the advance reading. Recall that what was

once a giddy 3.7% annualized pace for Q3 was shaved to 2.2% in the final reading.

The overall contours of the fourth quarter data did not really change that much. Two-

thirds of the headline growth was accounted for by the arithmetic of a lesser

inventory drag and the remainder pretty well coming from net exports and capital

spending. However, these two areas cannot be relied upon based on the latest set

of monthly core shipments and new orders data, alongside what the stronger U.S.

dollar and Europes deepening fiscal woes will imply for U.S. corporate sales abroad

(Europe is twice as important as the B.R.I.C.s are, as an aside).

While business spending on equipment and software was revised up as companies

took advantage of the about-to-expire tax breaks, we saw nonresidential

construction, housing and consumer spending all marked lower. Ditto for State &

local government spending, which contracted at a 2.2% annual rate in real terms as

the contraction intensifies.

What was really key was the downward revision to overall real final sales, to a mere

1.7% annual rate from 1.9% in the previous version and 2.2% in the first release of

Q4 GDP. Ultimately, it is final sales that determine the veracity of the economic

expansion and the extent to which a lasting inventory cycle takes hold.

CHART 8: THIS IS A V-SHAPED RECOVERY?

United States: Final Sales of Domestic Product


05050505050

10.0

7.5

5.0

2.5

0.0

-2.5

-5.0

Shaded region represent periods of U.S. recession



13/19


The 1.7% annualized pace to real final sales in Q4 followed an almost equally tepid

1.5% gain in the third quarter, which makes this the very weakest post-recession

performance (assuming we can call it that) on record outside of the extremely soft

rebound in early 2002. The only difference is that back then, Mr. Market was not

lulled into the belief that the economy had actually turned the corner.

So far in this post-recession recovery, real final sales have only managed to rebound

at a 1.6% annual rate despite all the gobs of government stimulus. To put it into

perspective, real final sales, by now, are usually rising at a 5% annual rate at this

point of other cycles, not sub 2% and those 5% growth rebounds did not require

nearly as much government support. If we do not see an improvement from this

trend, it would be consistent with profit growth of 5%, which at best would mean $70

for operating EPS for 2010. In other words, the market is possibly trading close to a

17x multiple on forward earnings (forward P/E ratio in the past has averaged 14.7x).

Going forward, the softer tone to demand means that we should not be expecting

inventories to add that much to overall growth. The capex orders and shipments

data are pointing to renewed stagnation in business spending and while commercial

real estate values have picked up from the floor, volumes are still extremely weak.

The accelerating decline in spending at the lower levels of government is offsetting

the stimulus efforts in Washington.

One of the best leading indicators of consumer spending is the expectations

component of the University of Michigan sentiment index, which just hit a four-month

low and is foreshadowing a halving in the underlying rate of household expenditures

to between 1.0% and 1.5% by the summer. Moreover, the latest data on housing

sales and starts are foreshadowing a renewed leg down in residential construction

after a brief recovery in that past two quarters. And net exports, given the strength in

the dollar and the clouded economic outlook in Europe, not to mention the after-

effects of the credit-tightening moves in India and China, cannot be relied upon to

contribute much, if anything, to headline GDP growth for the remainder of the year.

Its not so much a double dip outlook as one of very weak growth as far as the

outlook for the rest of 2010 is concerned both fiscal and monetary stimulus

will have faded and the impetus from inventory adjustments will have largely run

its course. The broad monetary aggregates have now either begun to stagnate

or decline outright; the ISM orders-to-inventory ratio has peaked out and leading

indicators, as well as their diffusion components, have rolled over across a

broad front.

So, I would be looking for a second-half growth relapse that sees theunemployment rate climb back to a new cycle high once the Census hiring effect

subsides and sees the stubbornly high unsold housing inventory drag home prices

down by at least another 10% in a scene that will look highly reminiscent of what

we saw in the back half of 2002. It wasnt a classic double dip recession like we

saw in the early 80s, but it was a growth relapse that defied V-shaped recovery

hopes at the time and ended up precipitating the unthinkable at the time and sent

both bond yields and equity indices back below their cycle lows.

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As an aside, the Gross Domestic Income (GDI) results for were also released for

Q4, and it came in better than I thought, at +6.7% annual rate (nominal), which

translates into +6.2% in real terms. That sounds good but Q3 was revised down

not just down but into negative terrain at -0.02% nominal and -0.4% in real

terms. What this means is that even though based on GDP, the recession

seems to have ended in Q2, on an income basis it only ended in Q3 and that is

only if the Q4 spurt in GDI is sustained.

The split was striking within the GDI report corporate profits soared at a 40%

annual rate while labour compensation only rose at a 1% annual rate. If you are

looking for a V, it has indeed been on profit margins or corporate earnings

relative to the economy, which have surged from a low of 7.4% a year ago, to

11.3% currently. Not only is that an unprecedented swing (mostly on cost

cutting) and now matches or exceeds every prior peak, save for the financial-

induced earnings bubble in the last cycle (see Chart 9). This occurred despite

the lack of top-line growth per unit pricing in the nonfinancial sector deflated

0.2% YoY, but unit labour costs have been cut for three quarters in a row and by

2.7% something we have not see happen in five decades.

CHART 9: CORPORATE PROFITS RELATIVE TO GDP

United States: Corporate Profits Before Tax to Nominal GDP

(percent)

05050505050

14

12

10

8

6

4




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Page 15 of 19

CHART 10: STILL NO PRICING POWER

United States: Price per Unit of Real Nonfinancial Corporate Gross Value Added(year-over-year percent change)

05050505050

12.5

10.0

7.5

5.0

2.5

0.0

-2.5


CHART 11: UNIT LABOUR COSTS HAVE

DRIVEN THE PROFIT IMPROVEMENT

United States: Employee Compensation per Unit of

Real Nonfinancial Corporate Business Gross Value Added


05050505050

16

12

8

4

0

-4



SHOW ME THE MONEY!

Liquidity conditions are beginning to tighten up with the just-released weekly

data from the Fed showing M2 growth slowing precipitously and now negative

on a year-over-year basis in real terms. MZM is already contracting in both

real and nominal terms. Bank credit continues to shrink by 8.6% YoY and

over 11% on a 13-week rate of change basis.


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Page 16 of 19

CHART 12: M2 GROWTH AT A 15-YEAR LOW

United States: Money Stock: M2


050505

15.0

12.5

10.0

7.5

5.0

2.5

0.0



CHART 13: MZM NOW CONTRACTING

United States: Money Stock: MZM


050505

40

30

20

10

0

-10




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CHART 14: BANK CREDIT CONTRACTION GAINS DOWNSIDE MOMENTUM

United States: Loans & Leases in Bank Credit for Commercial Banks(year-over-year percent change)

05050505

20

15

10

5

0

-5

-10



The money supply data is suggesting that the contraction in credit is now

starting to dwarf the Feds efforts at bolstering bank reserves efforts that

will subside after March 31 when the central bank stops buying MBS and lifts

the discount rate another 50 basis points to re-establish the pre-crisis spread

off of Fed funds.

No doubt there were periods in the past when the equity market did just fine

with lackluster money supply growth, but that only happened when economicand earnings growth really kicked into high gear. Not only is the consensus

currently looking for the YoY EPS growth numbers to soon subside, albeit from

blowout numbers last quarter due to depressed 2008 and early 2009 levels, but

in seasonally adjusted terms the bottom-up consensus is actually looking for

EPS to decline this quarter from the fourth-quarter level. Receding liquidity

coupled with a slower earnings profile promises to shift the investment landscape

towards a more defensive tilt over the near- and intermediate-term, in my 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 December31, 2009, the Firmmanaged assets of$5.3 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 $10.7million2

onDecember31, 2009 versus $5.5 million forthe S&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 $11.7millionusd

2on December 31, 2009 versus $9.2

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.

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.

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

$10.7 million2 on

December 31, 2009

versus $5.5 million for the

S&P/TSX Total Return

Index over the same

period.

For further information,

please contact

[email protected]

Notes:

Page 18 of 19

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.


19/19


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