Breakfast With Dave June 17

David A. Rosenberg Chief Economist & Strategist [email protected] + 1 416 681 8919

June 17, 2009 Economics Commentary

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave GREEN SHOOTS TURNING BROWNISH Well, we can forget about calling for an end to the recession. Three of the ingredients are still contracting: 1.

Industrial production is still contracting — down 1.1% in May and this came on top of a downwardly revised -0.7% print in April (was -0.5%). This was the SEVENTH decline in a row and left the level of production at an 11-year low (July 1998, believe it or not). Even outside of the auto industry (-7.9%), output was still down 0.7% last month and it is now very difficult to discern any improvement at all since the credit collapse started to subside in March. Every major industry posted a decline in May — so much for the ISM (then again, it is only a diffusion index). Oh yes, it is early days yet but we do have the NY Empire index and it fell back to -9.41 in June from -4.55 in May — and this is a proxy for tech spending. It’s a sign that we could see a setback for ISM this time around — though we will await the Philly Fed survey before making any definitive statement.

IN THIS ISSUE • With industrial production still contracting, employment falling and nominal wages contracting, we can forget about calling an end to the recession • Demand for newly-issued corporate paper has been extremely strong; make hay while the sun shines • Could the Dow Transports be signaling a sell signal?

2.

Employment fell in May — indeed, the 345k slide in May was worse than the depths posted in each of the last two recessions. Strange way for a recession to end. As for jobless claims, it is not enough that they have fallen from their near-depression highs — they have to break well below 500k before payrolls stop declining, and only then will it be safe to call for the end of the recession.

• Consumer spending on basic TV services expected to rise; all part of the cocooning wave coming our way in the frugal future

3.

Real organic personal income — one of the key ingredients (sorry, but the ECRI, which was predicting an ongoing boom in July 2007, doesn’t go into the NBER definition). Never mind ‘real’, in nominal terms, average weekly earnings fell 0.2% in May for the second time in the last three months.

• But for overall spending, frugality is a killer — just ask Best Buy

Yes, yes, the housing start number was a good number, especially the singlefamily result (+7.5% to 401k units at an annual rate — the third increase in a row); as well as the 7.9% MoM bounce in single-family permits. Still, it is difficult to really say anything except that perhaps the single-family sector has found bottom — after all, natural demographic demand for single-family homes is closer to 500k than 400k, the level at which starts are still hovering around. The report also lost part of its luster from the previously released NAHB index, which slipped back to 15 in June after two months of gains.

• Is booming money supply really inflationary? Not when we are in a liquidity trap

When multi-unit construction is added in, what we see is that total housing starts came in at 532k at an annual rate, which by today’s standards may qualify for a ‘green shoot’, but in reality was the third worst rally ever in the 50year history of the data series. Still, lumber futures managed to buck the overall down trend in commodity prices and closed at a nine-month high, and the homebuilding stocks outperformed.

Please see important disclosures at the end of this document.

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms. Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to 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, visit www.gluskinsheff.com

June 17, 2009 – BREAKFAST WITH DAVE

But the market for residential real estate, where the unsold inventory is close to 12 months’ supply when properly measured, remains in a very deep deflationary funk, with specific reference to the high-end where there will be multiple sellers by boomers seeking to downsize and fewer trade-up buyers since their demographic is much smaller and not to mention the fact that the new secular theme is ‘getting small’ and living below our means.

For all the talk about reflation or inflation, someone forgot to tell the PPI — the YoY rate is falling 5.0%

Finally, for all the talk about reflation or inflation, somebody forgot to tell the PPI, which rose just 0.2% MoM in May (consensus was around +0.6%) and this dragged the YoY down to a 50-year deflation low of -5.0%. The core was off 0.1% MoM too. Even better, the core intermediate PPI deflated 0.2% and has declined now for eight months in a row, which is epic — this metric leads core CPI inflation so this was quite bond bullish. While the core crude PPI did bounce back 6.7% MoM on the back of the commodity rebound, it is still down 37% on a YoY basis and the fundamental trend is still … down. As the Feds’ Beige Book notified us last week, both WAGES and PRICES are either flat or falling in most areas of the United States. In other words, deflation, fully two years into the Fed’s great easing experiment, remains the predominant macro risk. Policyinduced reflation remains at best a consensus forecast; at worst, a false hope. As an aside, Martin Wolf writes a brilliant exposé today on how this current economic downturn is tracking the 1930s — and it is not that far off despite all the gobs of policy stimulus and booming money supply. See page 9 — the title says it all: How Today’s Global Recession Tracks the Great Depression. This is why it is so irresponsible to be drawing inferences (the fabled ECRI comes to mind) from relationships that held in the post-WWII manufacturing inventory downturns because what we have on our hands is a deleveraging cycle and they take years, not months, to play out, and metrics such as unsold home inventories, the savings rate, cash/asset ratios on commercial bank balance sheets, labour turnover, debt/assets and debt/net worth in the household sector matter far more than the ISM or other little ‘rules of thumb’ that so many pundits rely on instead of recognizing that this is a different animal altogether. At least we have a template from Rogoff and Reinhart (quoted in the article) that shows that these types of balance sheet recessions lasts two years, the bear market lasts three years, unemployment rises for four years and home prices do not bottom for six years. So even if we manage to post a fractionally positive GDP number in 3Q it will very likely mean as much as the one we managed to experience — and was not sustainable which is the key — in last year’s second quarter. That too was initially met with a certain degree of euphoria, pundit calls that the lows (March at that time) were turned in, and a brief but ill-fated rally in the so-called ‘early cyclicals’. The only difference between now and then is that the stock market bounced off a deeper oversold low.

Page 2 of 7

June 17, 2009 – BREAKFAST WITH DAVE

There seems to be this universal belief that policymakers “get it” and that the countercyclical policies that extended the economic malaise will simply not be repeated this time around. As for the folks that lay claim to this — while they focus on the Fed’s efforts to save the RV industry with its balance sheet — are they also watching the belt-tightening moves by the fiscally-challenged state governments who are now raising taxes at the worst possible time in the business cycle. For the latest, see Plan to Raise Income Tax in Pennsylvania on page A14 of the New York Times (the state intends to boost its income tax rate by 16% in the next three years). MAKE HAY WHILE THE SUN SHINES There is no doubt that in contrast to the Treasury auctions, the demand for newly-issued paper in the corporate market for debt and equity has been extremely strong. Issuers are well advised to tap the sentiment now because there is no guarantee in an extended sub-par economic cycle that the window is going to remain open. Moody’s sure seems skeptical — see Moody’s Warns on Funding Problems on page 21 of the FT. The rating agency found that $615 billion of corporate paper globally is set to mature in the coming 12 months. Also, as many as 46% of speculative-grade companies are less than 20% below their debt covenants (up from 20% a year ago); the comparable figure for investment-grade is 17% (triple the 6% share a year ago). DOW TRANSPORTS — SELL SIGNAL? It’s the irony of ironies that when so much was made of the fact that the S&P 500 kissed its 200-day moving average a short two-weeks ago that the event would mark the end of the bear market rally. Then again, Mr. Market is a malevolent beast and full of surprises in both directions. Guess what? The Dow Transports never did confirm this wonderful 40%+ rally from the lows, which just ended. As Chart 1 shows, the rally in this critical economic-sensitive barometer posted a most unimpressive rally from its oversold March lows, and put in a classic double top. The peak was turned in back on May 6 when nobody was looking, and after yesterday’s 1.0% drubbing, the Transports are now down 6.5% from the nearby high (and down 10.0% for the year). The Dow Utilities index, by way of comparison, is holding in comparatively well and the ratio to the Dow Transports looks consistent with a further down-move in 10-year Treasury note yields, to a 3.00 - 3.25% zone — adding some much-needed confirmation to this positive reversal we are seeing in the bond market.

The Dow Transports never did confirm this wonderful 40%+ rally from the lows

Page 3 of 7

June 17, 2009 – BREAKFAST WITH DAVE

Chart 1: DOW TRANSPORTS — SELL SIGNAL? Dow Transportation Index 5,500

5,000

4,500

4,000

3,500

3,000

2,500

2,000 Jun 2008

Aug 2008

Oct 2008

Dec 2008

Feb 2009

Apr 2009

Jun 2009

Source: Haver Analytics, Gluskin Sheff

THE CONSUMER FRUGALITY IS GOOD FOR THIS It's called the TV set — sales volumes are up more than 10.0% year-on-year. A new forecast published by the Global Entertainment and Media Outlook found that by 2013 U.S. consumer spending on basic TV services will have risen 33% from 2009 levels to $68.3 billion. Video-on-demand movies and shows are seen almost doubling from $2.7 billion to $4.5 billion. This is all part of the cocooning wave coming our way in the frugal future. BUT FOR OVERALL SPENDING, FRUGALITY IS A KILLER Just ask Best Buy, who woefully missed its fiscal 1Q estimates (not to mention its cautious guidance, which definitely did not fit in well with the ‘green shoot’ mood the economists and strategists are still in) and saw its stock crater 7.0% yesterday. Also, as we have said in the past, the 78 million boomer population is clearly in hunker-down mode after seeing their retirement assets take a giant hit from the bursting of two bubbles less than seven years apart. They are not going to line up at the trough a third time as the median age of this critical demographic group moves through his/her mid-50s. It’s all about savings. See For Boomers, Recession is Redefining Retirement on the front page of the USA Today. A survey by the AARP (American Association of Retirement Professionals) found that 56% of the boomer population is now putting off a major purchase; 24% have postponed retirement (supporting our ‘income’ theme).

The 78 million boomer population is clearly in hunkerdown mode

Page 4 of 7

June 17, 2009 – BREAKFAST WITH DAVE

IS BOOMING MONEY SUPPLY REALLY INFLATIONARY? Not when you are in a liquidity trap, which is where we are. The problem with the Fed's monetary experiment is that the money supply boost is still not circulating through the economy but rather sitting on bank balance sheets. At least there's no delinquency risk with net free reserves. Paul Krugman uses some great historical examples in his Monday column in the NYT (Stay the Course). Between 1929 and 1939, the monetary base doubled (and the dollar devalued) and yet prices deflated 19%. In fact, despite seven years of New Deal stimulus and rampant FDR incursion into the economy, the 1930s ended with the unemployment rate at 15%, the CPI declining at a 2% annual rate and the level of GDP still below its 1929 peak. Between 1997 and 2003, Japan's monetary base surged 85% — deflation pressures remained intact. We just do not believe it is still appreciated that when the economy slips into a deleveraging phase, which by its nature involves asset liquidation, debt repayment and rising private sector savings rates, it takes years before the economy makes the transition to the next up-cycle and only then with massive amounts of fiscal and monetary stimulus. HOW PRO-GROWTH IS FISCAL POLICY? Let's not forget that fiscal policy is still not nearly as stimulative as it could be. How can we possibly say that with a U.S. fiscal deficit/GDP ratio at a record 13%? Because part of the federal pump-priming is only serving as an antidote to the restraint at the state and local government level — an estimated $230 billion gap has to close between now and 2011. For a look at how the severe the fiscal restraint actually is at the lower levels of government, have a read of Children Suffer As States Cut Health Budgets on page D1 of the WSJ and California Schools’ Tough Choices on page A3.

Page 5 of 7

June 17, 2009 – BREAKFAST WITH DAVE

ABOUT US

Gluskin Sheff at a Glance Our mission is to be the pre-eminent wealth management firm in Canada serving high net worth investors PRIVATE CLIENT FOCUS

PERFORMANCE

Gluskin Sheff is an independent wealth management firm focused primarily on high net worth private clients, including entrepreneurs, professionals, family trusts, private charitable foundations and estates. We also benefit from business relationships with a number of institutional investors.

Gluskin Sheff has a 24-year track record of solid investment performance. Clients investing in our GS+A Value Portfolio from inception (January 1, 1991) have achieved a total net return of 773.8% to May 31, 2009, outperforming the 379.1% return of the S&P/TSX Total Return Index over the same period. Our other longer-term investment models also have impressive performance records.

OUR PEOPLE At Gluskin Sheff, having the best people allows us to deliver strong investment performance and the highest level of client service. Our professionals possess the experience, dedication and talent to meet the individual needs of our clients. RISK MANAGEMENT Our unique dual risk management approach focuses on meeting the needs of our clients by preserving their capital, managing risk and delivering strong longterm investment returns through various economic and market cycles.

CLIENT SERVICE At Gluskin Sheff, our clients are our most important asset. Serving them is a core value maintained throughout the Company. Clients receive individual attention and investment advice customized to their specific investment objectives and risk profile. INVESTMENT PHILOSOPHY Our investment decisions are based on “bottom-up” research that looks for companies with a history of long-term growth and stability, a proven track record, shareholder-minded management and a share price below our estimate of intrinsic value.

Page 6 of 7

June 17, 2009 – BREAKFAST WITH DAVE

IMPORTANT DISCLOSURES Copyright 2009 Gluskin Sheff + Associates Inc. (“Gluskin Sheff”). All rights reserved. This report is prepared for the use of Gluskin Sheff clients and subscribers to this report and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Gluskin Sheff. Gluskin Sheff reports are distributed simultaneously to internal and client websites and other portals by Gluskin Sheff and are not publicly available materials. Any unauthorized use or disclosure is prohibited.

and, in some cases, investors may lose their entire principal investment. Past performance is not necessarily a guide to future performance. Levels and basis for taxation may change.

Gluskin Sheff may own, buy, or sell, on behalf of its clients, securities of issuers 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 be regarded by recipients as a substitute for the exercise of their own judgment and readers are encouraged to seek independent, third-party research on any companies covered in or impacted by this report.

Materials prepared by Gluskin Sheff research personnel are based on public information. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of Gluskin Sheff. To the extent this report discusses any legal proceeding or issues, it has not been prepared as nor is it intended to express any legal conclusion, opinion or advice. Investors should consult their own legal advisers as to issues of law relating to the subject matter of this report. Gluskin Sheff research personnel’s knowledge of legal proceedings in which any Gluskin Sheff entity and/or its directors, officers and employees may be plaintiffs, defendants, co-defendants or coplaintiffs with or involving companies mentioned in this report is based on public information. Facts and views presented in this material that relate to any such proceedings have not been reviewed by, discussed with, and may not reflect information known to, professionals in other business areas of Gluskin Sheff in connection with the legal proceedings or matters relevant to such proceedings.

Individuals identified as economists do not function as research analysts under U.S. law and reports prepared by them are not research reports under applicable U.S. rules and regulations. Macroeconomic analysis is considered 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 an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. Securities and other financial instruments discussed in this report, or recommended by Gluskin Sheff, are not insured by the Federal Deposit Insurance Corporation and are not deposits or other obligations of any insured depository institution. Investments in general and, derivatives, in particular, involve numerous risks, including, among others, market risk, counterparty default risk and liquidity risk. No security, financial instrument or derivative is suitable for all investors. In some cases, securities and other financial instruments may be difficult to value or sell and reliable information about the value or risks related to the security or financial instrument may be difficult to obtain. Investors should note that income from such securities and other financial instruments, if any, may fluctuate and that price or value of such securities and instruments may rise or fall

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

Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Investors are urged to seek tax advice based on their particular circumstances from an independent tax professional. The information herein (other than disclosure information relating to Gluskin Sheff and its affiliates) was obtained from various sources and Gluskin Sheff does not guarantee its accuracy. This report may contain links to third-party websites. Gluskin Sheff is not responsible for the content of any third-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 and is 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 Gluskin Sheff. All opinions, projections and estimates constitute the judgment of the author 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 no obligation to update this report and readers should therefore assume that Gluskin Sheff will not update any fact, circumstance or opinion contained in this report. Neither Gluskin Sheff nor any director, officer or employee of Gluskin Sheff accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents.

Page 7 of 7