Lunch With Dave 090409

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

September 4, 2009 Economic Commentary

MARKET MUSINGS & DATA DECIPHERING

Lunch with Dave NOT LABOUR’S DAY No matter how you slice it or dice it, the U.S. economy remains fundamentally weak. While it is 100% true that the earthquake is behind us, what follows next are the aftershocks. The government is doing its utmost to cushion the blow, and the magnitude of the intervention and incursion of the public sector into the private economy is breathtaking; for the time being, it has made the auto and housing data appear better than would otherwise be the case. The critical question, of course, is what happens once the heavy doses of medication wear off. We estimate that absent all the forms of government stimulus in the second quarter, real GDP would have contracted at a decidedly brown-shooty 6% annual rate as opposed to the posted 1% decline. And, while consensus forecasts are centered around 3.0-3.5% for current quarter growth, again the pace of economic activity would be flat-to-negative absent Cash-for-Clunkers, government auto purchases, and first-time homebuyer subsidies, not to mention the FHA’s best efforts to recreate the housing and credit bubble as it takes up 40% of new mortgage originations via a 96.5 insured loan-to-value ratio and a taxpayer on the hook for a 7% delinquency rate that is on the rise. This can’t possibly end very well, but for the time being, all these painkillers doled out by the federal government is … well, dulling the pain. While the Obama economics team is pulling rabbits out of the hat to revive autos and housing, there is nothing they can really do about employment; barring legislation that would prevent companies from continuing to adjust their staffing requirements to the new world order of credit contraction. While nonfarm payrolls were basically in line with the consensus, declining 216,000 in August, there were downward revisions of 49,000 and the details were simply awful. The fact that 65% of companies are still in the process of cutting their staff loads is quite disturbing — even manufacturing employment fell 63,000 in August, to its lowest level since April 1941 (!), despite the inventory replenishment in the automotive sector and all the excitement over the recent 50+ print in the ballyhooed ISM index. The fact that temp agency employment is still declining, albeit at a slower pace, alongside the flat workweek and jobless claims stuck at 570,000, are all foreshadowing continued weakness in the labour market ahead. Until we see signs of a sustained turnaround in the jobs market all bets are off over the sustainability of any economic recovery.

No matter how you slice and dice it, the U.S. economy remains fundamentally weak

The government is pulling rabbits out of the hat to revive autos and housing… but what about the employment situation?

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

September 4, 2009 – LUNCH WITH DAVE

What was really key were the details of the Household Survey, which provide a rather alarming picture of what is happening in the labour market. First, employment in this survey showed a plunge of 392,000, but that number was flattered by a surge in self-employment (whether these newly minted consultants were making any money is another story) as wage & salary workers (the ones that work at companies, big and small) plunged 637,000 — the largest decline since March (when the stock market was testing its lows for the cycle). As an aside, the Bureau of Labor Statistics also publishes a number from the Household survey that is comparable to the nonfarm survey (dubbed the population and payroll-adjusted Household number), and on this basis, employment sank — brace yourself — by over 1 million, which is unprecedented. We shall see if the nattering nabobs of positivity discuss that particularly statistic in their post-payroll assessments; we are not exactly holding our breath.

The Household Employment Survey depicts a rather alarming picture of what is happening in the labour market

Second, the unemployment rate jumped to 9.7% from 9.4% in July, the highest since June 1983 and at the pace it is rising, it will pierce the post-WWII high of 10.8% in time for next year’s midterm election. And, this has nothing to do with a swelling labour force, which normally accompanies a turnaround in the jobs market — the ranks of the unemployed surged 466,000 last month. CHART 1: RECORD 9 MILLION WORKING PART-TIME BECAUSE THEY HAVE TO, NOT WANT TO Employed Part-Time for Economic Reasons (thousands) 10000

8000

6000

4000

2000

0 55

60

65

70

75

80

85

90

95

00

05

Source: Haver Analytics, Gluskin Sheff

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As with the headline data, the details beneath the surface of the unemployment rate figure are very troubling. The adult male unemployment rate has already climbed above the 10% level. When all the labour market slack is included, for example, the fact that full-time employment cratered 336,000 and those working part-time for economic reasons surged 298,000, the all-inclusive U6 jobless rate rose to an all-time high of 16.8% from 16.3% in July. Unless the laws of supply and demand have been permanently repealed, this record and growing amount of slack in the labour market is only going to exert more downward pressure on wages at a time when organic personal income is deflating at nearly a 5% annual rate. Unless Uncle Sam extends his generosity, the outlook for the consumer is fraught with fragility, and all one has to do is have a read of those tortured FOMC minutes that were released earlier this week from the August meeting to see how nervous the Fed really is over prospects for a sustainable recovery.

The adult male jobless rate has already climbed above the 10% level … the all encompassing U6 jobless rate is at a record high

CHART 2: THE “REAL” UNEMPLOYMENT RATE HITS A NEW HIGH U6 Unemployment Rate* (percent) 18 16

14

12 10

8

6 95

00

05

*Includes all marginally attached workers and those employed part-time for economic reasons Source: Haver Analytics, Gluskin Sheff

The number of people not on temporary layoff surged 220,000 in August and the level continues to reach new highs, now at 8.1 million. This accounts for 53.9% of the unemployed — again a record high — and this is a proxy for permanent job loss, in other words, these jobs are not coming back. Against that backdrop, the number of people who have been looking for a job for at least six months with no success rose a further half-percent in August, to stand at 5 million — the long-term unemployed now represent a record 33% of the total pool of joblessness.

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September 4, 2009 – LUNCH WITH DAVE

CHART 3: A RECORD 33% OF UNEMPLOYED HAVE BEEN ON THE HUNT FOR OVER SIX MONTHS Unemployed for 27 Weeks and Over as a Percent of Total Unemployed (percent) 37.5

30.0

22.5

15.0

7.5

0.0 50

55

60

65

70

75

80

85

90

95

00

05

Source: Haver Analytics, Gluskin Sheff

Our advice to the Obama team would be to create and nurture a fiscal backdrop that tackles this jobs crisis with some permanent solutions rather than recurring populist short-term fiscal goodies that are only inducing households to add to their burdensome debt loads with no long-term multiplier impacts. The problem is not that we have an insufficient number of vehicles on the road or homes on the market; the problem is that we have insufficient labour demand.

Our advice to the Obama team would be to create and nurture a fiscal backdrop that tackles this labour crisis

Two final items: First, some will point to the fact that average hourly earnings were up 0.3% MoM in August as a sign of a renewed wage growth. Sorry, but what this represented was the spillover from the minimum wage hike, which was so evident in the 1% surge in retail sector earnings and the 0.5% boost in leisure/hospitality — the two sectors most affected. Outside of these sectors, wages barely rose at all last month. Second, aggregate hours worked fell 0.3% MoM in August and so far in the third quarter, aggregate hours declining at a 2.5% annual rate. Think about that statistic for a moment, in order to achieve the 3.5% consensus estimate for current quarter real GDP growth, productivity would have had mushroomed at a 6% annual rate, mirroring the 2Q performance. We’re not saying this is impossible, but we are saying that you pretty well have to go back 40 years to see the last time the economy achieved such a feat.

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The S&P 500 has been flirting around the 1,000 threshold now for a good five weeks. Green shoots, when and if they do appear, are not generating the enthusiasm they did back in April and May, but then again, Mr. Market must have a pretty full tummy 50% and eight multiple points later. At the same time, as we have seen time and again during this very impressive bear market rally, there appears to be a well-ingrained ‘buy-the-dip’ mentality in place. It will be interesting to see which way Mr. Market breaks — the technicals may look good, but what doesn’t look too good is: 1) valuation, which shows the S&P 500 to be trading at its most expensive levels in seven years; 2) liquidity, with M1 down three weeks in a row and M2 and MZM down for four straight weeks; and, 3) the fundamentals with the prospects of a 4Q GDP post-stimulus relapse running pretty high — and not currently priced in.

Canadian employment surprised to the high side in August in a complete reversal of the July data

CANADIAN JOBS DATA — NICE HEADLINE, SHAME ABOUT THE DETAILS Canadian employment surprised to the high side in August in a complete reversal of the July data. Employment was up 27,100 versus expectations of down 15,000. While it can certainly be argued that the August turnaround in job growth is the start of a new trend, it can also be argued that it merely offsets the surprising weakness in July, leaving employment down 17,400 over the twomonth period, though that indeed still compares favourably to the -49,000 over the May-June period. Sector composition was mixed. Financials are hiring again with 17,500 gains; retail/wholesale trade was up 21,200; construction rose 12,100. But in a clear sign that the Canadian dollar is an ongoing albatross around the neck of the manufacturing sector, there were 17,300 factory jobs that were shed even in the face of the renewed production growth in the auto sector — 108,000 manufacturing jobs have been lost since May. The factory workweek was also sliced a massive 4.3% MoM in August, the sharpest decline since March. So, as good as the headline was, and the Canadian dollar loves it, there was less strength in this report than meets the eye.

In terms of describing how businesses are approaching the labour market, the best word is probably “tentative”

Tempering the good headline news was the fact that the ranks of the unemployed rose 21,900 (trust us, this number will not be quoted anywhere), the 12th increase in the past 13 months, and the jobless rate edged up to a fresh 11-year high of 8.7% from 8.6%. The average duration of unemployment jumped from 14.8 weeks in July to 15.8 in August. In terms of describing how businesses are approaching the labour market, the best word is probably “tentative” because all the of the job gains were in parttime work (+30,600) — full-time positions were actually reduced by 3,500, which brings the cumulative decline to 138,800 since May (and the level of full-time employment is now at a three-year low). Permanent job losses last month actually totaled 26,700 and 281,100 over the last three months — again, more than 100% of the gain was in temporary positions. Moreover, hours worked were cut back by 0.7% MoM for the first time in four months. Page 5 of 12

September 4, 2009 – LUNCH WITH DAVE

CHANGE IN SENTIMENT TURNS FOR THE BETTER The U.S. stock market has managed to stop declining after a brief four-day 3% giveback — there obviously remains a very strong psychology to ‘buy the dips’ and there are some very good technical strategists that think we can still push to new post-Lehman highs from here, but in the context of what is still a bear market rally. The Chinese government’s veiled hint to intervene in the stock market seems to have helped the Shanghai advance in each of the past four sessions following a sizeable 20%+ correction. The Baltic Dry Index turned the corner on August 25. The CRB index looks to be carving out a bit of a bottom here too. The VIX index has similarly come down two points in the past two days after approaching 30.0 at the very beginning of the month. The yield on the 10year Treasury note managed to drop below 3.30% for a nanosecond two days ago and has bounced 8bps since. Gold is at very critical resistance levels and seems to be struggling now in terms of taking out the February 20 highs of $1006/oz. (We remain long-term bulls but keep in mind that gold has struggled each of the four times it has tested the $1,000 threshold over the past year, though the shiny metal has very clearly broken out in euro and sterling terms.)

There obviously remains a very strong psychology to “buy the dips”

SALES BETTER THAN EXPECTED BUT STILL SOFT Chain store sales came in at -2.9% YoY, which did beat the consensus by a tad, but today’s WSJ (front page story) shows that consumers are still bargain hunting and many browsing but not shopping. The trend of late was -4.0% to -5.0% so the August data did represent sequential improvement even if still negative. Early surveys did hint at declines closer to 7.0% or 8.0% in the back to school season. Indeed, 46% of retailers did manage to beat their estimates versus just 38% in July, and we should now start to see some pickup in the YoY comparables from the depressed levels in the fall of 2008. At the same time, perhaps the better than expected mall traffic reflects the fact that many civil servants have more time on their hands — see States Shut Down to Save Cash on the front page of the WSJ as well. For a sign of how consumer spending habits are shifting — eating in is in while eating out is out — have a look at the article on Del Monte’s earnings results on page B5 of the WSJ. Discount stores and to some extend mid-priced chains, did okay last month, sales-wise, but luxury stores lagged behind (-12% YoY). Also, we can see increasing signs that the problems in the housing market have spread to the higher-end of the market — see More Pain Is Being Felt By Prime Borrowers on page C1 of the WSJ.

Yes, chain-store sales did come in a tad better than consensus estimates, but the bottom line is that consumers are still in bargain-hunting mode

SORRY, BUT JOBLESS CLAIMS ARE STILL IN RECESSION TERRAIN Jobless claims continue to “improve” from ever-upwardly-revised data — declining 4k in the August 29th week to 570k (somehow the change in the data don’t look that bad because — guess what? — they have been revised higher in each of the past 23 weeks!). The key four-week moving average rose 4,000, to 571,250, the highest since July 18th. So the bulls claim that the fact that jobless claims are no longer at their 670,000 peaks, and that 570,000 is acceptable is akin to saying that you’re happy that your golf score is 130 and not 150. Give me a giant break.

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At 570,000, claims are actually higher now than they were at the peaks of the 2001 and the 1991 recessions. To be calling for the recession to be ending with claims as high as they are currently is definitely in the “new normal” zone for most economists. For the consumer, it is still a recession (even if chainstore sales did come in better than expected at -2.0% YoY in August) — a CNN poll just found that 9 in 10 think the economy is still in a recession.

At 570k, claims are actually higher now than they were at the peaks of the 2001 and 1991 recessions

Continuing claims rose 92k in the August 22nd week to 6.234 million as well and indicative of how tough the hiring situation is, which of course was ratified in the latest Challenger data (hiring announcements fell 24k in August). And, those on extended benefit programs jumped 50k to a new high of 3.46 million. Jobless claims started off August at 554k and closed the month at 570k. So it seems as though we enter September with the prospect of yet another month of declining payrolls because claims have to break decisively below 500k before jobs stop vanishing and below 400k before the unemployment rate stops rising. Remember, in the early 1990s credit crunch the recession ended in March 1991 and yet the unemployment rate did not peak until June 1992; and in the last cycle, which was an asset deflation phase, the recession ended in November 2001 and yet the jobless rate did not peak until June 2003. So in the last two cycles, it took 15-20 months for the unemployment rate to peak even after the economic downturn officially ended. This was both a credit crunch and an asset deflation cycle so why would anyone think that the jobless rate is going to peak out before the end of 2010. And, the next question is at what level? Don’t think for a second that 11% or 12% is not reachable — breaking the post-WWII highs of 10.8% set in Nov-Dec 1982. SERVICE SECTOR CONTRACTION The U.S. ISM non-manufacturing index ticked up to 48.4, which was modestly above expectations — an 11-month high. This still points to a moderate contraction in economic activity, largely because of ongoing job losses. This index has lagged far behind the manufacturing comparable (52.9) but that is because the service sector is not being juiced up. Only six of 18 industries reported growth in the month, which is all anyone needs to know in terms of assessing whether this recession is over and done with or not. The employment index at 43.5 is still pointing to hefty job losses. NIFTY STUFF FROM THE LATEST CONFIDENCE SURVEYS Low-end income confidence is at a four-month low and high-end income consumer sentiment is now at an 11-month high. Maybe this explains Tiffany’s latest results (though the likes of Saks and Neiman Marcus have lagged). Even though the number of millionaires globally has taken a hit this cycle, the ones remaining still seem to find some solace in buying luxury goods.

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This is hard to square, mind you, with the report we saw in the Wall Street Journal that champagne producers, in response to weaker demand, are going to be picking 32% fewer grapes this year. Demand for high-end homes is also vanishing — the National Association of Realtors data shows that a mere 2.5% of the 460k homes sold in July were in the $500k+ category — this was well below the 11.2% share at the peak of the housing boom. At the same time, the volume of coupon redemptions at U.S. stores rose 23% YoY in the second quarter — a sign that the low and medium-end consumer is still under some strain. As for the low-low end, keep in mind that food stamp recipients reached 35.1 million in June — a new record high and up now for seven months running. There was also an article in yesterday’s Wall Street Journal (The Reluctant Landlords) on this latest trend; homeowners are now converting their homes to rentals to garner income — at the same time when apartment vacancy rate is at a record high of 10.6%. Rest assured that we are going to see continued downward pressure on the rental component of the CPI, which represents 30% of the index and 40% for the core index (and rents are now deflating for the first time in 17 years). This is a big deal. CHART 4: HIGH-END INCOME CONSUMER CONFIDENCE AT AN 11-MONTH HIGH… Conference Board Consumer Confidence Survey: Consumer Confidence: Annual Income Over $50,000 (index) 175 150

125

100 75

50

25 99

00

01

02

03

04

05

06

07

08

09

Shaded area represent periods of U.S. recession Source: Haver Analytics, Gluskin Sheff

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CHART 5: … BUT LOW-INCOME EARNERS’ CONFIDENCE AT A FOUR-MONTH LOW Conference Board Consumer Confidence Survey: Consumer Confidence: Annual Income Under $15,000 (index) 140 120

100

80 60

40

20 99

00

01

02

03

04

05

06

07

08

09

Shaded area represent periods of U.S. recession Source: Haver Analytics, Gluskin Sheff

1930s DÉJÀ VU An old contact of ours at Merrill Lynch pointed out these articles from the Wall Street Journal after the initial post-crash rally that took the market up some 50% from the interim lows. Sounds eerily similar to what we hear today: August 28, 1930: There’s a large amount of money on the sidelines waiting for investment opportunities; this should be felt in market when “cheerful sentiment is more firmly entrenched.” Economists point out that banks and insurance companies “never before had so much money lying idle.” September 3, 1930: Market has now reached resistance level where it ran out of steam on July 18 (240.57) and July 28 (240.81). Breaking through this level would be considered a highly bullish signal. General confidence that this will happen based on recent market action; many leading stocks have already surpassed July highs. Further positive technicals seen in recent volume pattern (higher on rallies and lower on pullbacks), and in continued large short interest. Some wariness based on recent good rally recovering all of drought-related break; some observers advise taking profits on at least part of long positions, to be in position to rebuy on good pullbacks.

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Most economists agree business upturn is close; peak in business was reached July 1929, so depression has lasted about 14 months. “Those who have faith and confidence in the country and its ability to come back will profit by their foresight. This has also been the case over the past half century.” Harvard Economic Society points to steady rise in bond prices as favorable for stocks. Says there is “every prospect that the [business] recovery ... will not long be delayed,” although fall period may not be strong as expected. Notes worldwide decline in business, but 1922 recovery demonstrates U.S. due to “great size, natural advantages, and diversity of conditions ... can lift itself out of depression without the stimulus of improved foreign demand.” We only know now with perfect hindsight what these pundits did not know back then — that there was another 80% of downside left in the bear market.

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Our success has often been linked to our $1 million invested in our Canadian Value long history of investing in underfollowed and under-appreciated small Portfolio in 1991 (its inception date) 2 would have grown to $9.0 million on July and mid cap companies both in Canada and the U.S. 31, 2009 versus $5.0 million for the S&P/TSX Total Return Index over the PORTFOLIO CONSTRUCTION same period. In terms of asset mix and portfolio $1 million usd invested in our U.S. construction, we offer a unique marriage Equity Portfolio in 1986 (its inception between our bottom-up security-specific date) would have grown to $10.7 million fundamental analysis and our top-down 2 usd on July 31, 2009 versus $8.1 million macroeconomic view, with the noted usd for the S&P 500 Total Return Index addition of David Rosenberg as Chief over the same period. Economist & Strategist.

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