David A.

Rosenberg December 20, 2010

Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

DUE TO BUSINESS TRAVEL, BREAKFAST WITH DAVE RETURNS ON
WEDNESDAY, DECEMBER 22, 2010 IN THIS ISSUE
• While you were sleeping:
European markets are up,
WHILE YOU WERE SLEEPING Asian markets a sea of
red; U.S. Treasuries
We have a strange brew to kick off the week. European equity markets are up continue to regain their
almost across the board while Asia is a sea of red (led by a 1.4% slide in the footing; U.S. dollar and
Shanghai index — the steepest decline in three weeks). Bonds are bid as U.S. commodities are up
Treasuries regain their footing for a third straight day. However, “govies” are
• Stimulus ... or restraint?
selling off in Ireland, Portugal and Spain as concerns over Europe’s debt In reality, the stimulus
backdrop continues unabated. And, Bloomberg News writes an article today only prevented the federal
questioning the sustainability of France’s AAA credit rating. government from being a
contractionary force in
The U.S. dollar is strong, which is not generally conducive to “risk on” trades, but 2011
here we have gold, copper and oil, the latter re-testing two-year highs, all firming • Buyers beware: when
so far today. The continuing tension on the Korean peninsula may be helping yields and equity values
out the commodity complex here too. (For a good look at how the fiscal stimulus soar in tandem, you
is going to be spent — in the gas tank — see Return of the Rising-Oil-Prices Peril almost always see a
reversal in both markets
on page A5 of today’s WSJ).
• When in doubt … go to the
STIMULUS ... OR RESTRAINT? year-ahead forecasts this
same time in 2009
The bond bears and equity bulls are placing much of their faith in the $858
billion tax package in the U.S. Most of this “stimulus” only prevented the federal • A deflating holiday
government from acting as a contractionary economic force in 2011. How much season? Maybe deflating
prices are helping drive
of the tax cuts will go into saving and imports remains to be seen. We think the
volumes
“stimulative” effects are over exaggerated.
• Pay attention to the
What we don’t see discussed that much are the spending cuts coming our way situation in Europe and
the not-so-stellar global
and these indeed will show up directly in GDP. There’s a new Congress in town
economic data
folks, and a showdown is coming with regard to the debt ceiling file. By the time
the second quarter rolls around, it will be time to buy volatility, S&P 500 puts, • Chicago … more bear than
bull: Chicago National
and gold. Right now the markets are overpopulated with growth bulls, which is
Activity Index portraying a
why it is essential to practice safe investing. pace of economic activity
that is well below
The front page of the weekend WSJ runs with Budget Brawl Looms in Congress potential
is a must read. The article states:
• Valuation updates for our
S&P 500, TSX, corporate
“Senate Republicans, facing an uproar from tea-party activists, rose up late bonds, and Canadian
Thursday to scuttle a 1.1 trillion dollar spending bill ... In the process, they dollar models
showed the power fiscally conservative activists now hold over even the most
seasoned lawmakers.”

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
December 20, 2010 – BREAKFAST WITH DAVE

Page A5 is also worth a look ― Package Adds Fuel to Fights Over Spending, Tax
Policy. To wit: We missed the bizarre late-
year melt-up in yield, but by
“Republicans are pushing for more spending cuts as the way to narrow the November the Treasury market
deficit. The disagreements among the White House, Senate Democrats and had delivered an 8.5% net
Republicans could all converge as the deadline for raising the debt ceiling nears positive return
in the first half of next year ... Administration officials say the debt ceiling must
be raised so the U.S. can fund its obligations next year. Republicans have said
they will demand major spending cuts to back any plan.”

So tell us now ― is gridlock good?

We should add that the Saturday NYT was also on top of this issue ― A Budget
Battle Looms Next Year (see the front page). Same conclusion:

“The 2011 spending fight could be complicated by the need to raise the federal
debt limit to avoid a federal default ― a vote that many new Republican
lawmakers have indicated they would not make. Republicans say the debt limit
vote could also present an opportunity, allowing them to tie a package of
spending reductions to the debt increase to make it more palatable.”

BUYERS BEWARE
Not only is sentiment wildly bullish on stocks and equally as bearish on bonds,
but history says that when yields and equity values soar in tandem, as they did
in the summer of 2007, we almost always see a reversal in both markets. Have
a look at the Lex column (The Odd Decouple) in the weekend FT, which cites
some nifty research to that effect. On average, equity prices corrected 12% in
the next six months. Some food for thought perhaps to the seers partaking in
the Barron's Outlook 2011 ― none of the 10 strategist see a down market, the
average forecast is for a double-digit advance and the range is 1,250 to 1,450!

WHEN IN DOUBT …
...go to the year-ahead forecasts this same time in 2009.

Admittedly, we were not bullish enough on equities, but by the end of August,
just prior to Ben Bernanke’s attempt at market manipulation, it did look as
though our caution was warranted. Alas, we underestimated the Fed’s ability to
pull another rabbit out of its hat, and then President Obama’s ability to abandon
his left-of-center Democratic base in the aftermath of the mid-term elections.
Although curiously, he improved his 2012 re-election prospects by giving the
Republicans everything they wanted.

When we seek out solace what we like to do is go to the Barron’s bond outlook
in December 2009 ― it was actually titled Steeply Bearish Bond Outlook. We
proved to be too optimistic as far as the December 31 point forecasts are
concerned, but we had three percent penned in on the 10-year note by mid-
2010 and the only ones with both the nerve and verve to call for a move back to
a “2-handle” in the second half of the year.

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December 20, 2010 – BREAKFAST WITH DAVE

So we missed the bizarre late-year melt-up in yield, but by November the

Treasury market had delivered an 8.5% net positive return. Not bad, eh? A lot strange things are
happening on the U.S. pricing
But look at the consensus call this time last year and it’s a hall of shame ― 7 of front that do not comport with
the 11 forecasters had the Fed tightening and two were at 2% on the funds rate vibrant domestic demand
(!). And 8 of the 11 were 4% or higher on the 10-year note yield. Yikes!

Okay, enough back-slapping on the bond call. Time to get to work on 2011.

This year’s interest rate outlook for 2011 is on page M12 of Barron's. Once
again, we get the last word in and of the 13 economists polled this time around,
all but yours truly is bearish on the outlook for bond yields. Seven see 4% or
higher for the 10-year note yield by December 2011 and get this ― this crew is
populated with the same folks that were calling for roughly 4% or higher this
time last year.

To quote Mark Twain ...

“When I find myself on the side of the majority, I know it’s time to find a new
place to side.”

A DEFLATING HOLIDAY SEASON?

Maybe it’s a case of deflating prices helping drive volumes. All we can say is
that a lot of strange things are happening on the U.S. pricing front that do not
comport with vibrant domestic demand.

Some examples:

• Producer prices for boxes and containers are going down, not up. Maybe
FedEx is bullish on its outlook, but it begs the question as to why it is that
paper boxes and containers fell 0.4% in November after dropping 0.7% in
October ― a 6.7% annualized decline in the last 2 months for the steepest
falloff for this time of the year in 12 years. Go figure.
• This is Christmas time, following on the heels of Chanukah time. So what is
with toy prices sliding 1.7% in November ― the second decline in a row.
• What about our gift-wrapping price index from the personal care segment of
the CPI? Prices here have deflated at a 2.8% annual rate over the past three
months ― a huge swing from the +3% trend in November 2010 and the
softest pace in seven years. Then again, if you’re not buying any toys to stick
under the tree, then there’s no need for wrapping paper, is there?
• What about flowers? Prices are down at a 1.5% annual rate over the past
three months ― we haven’t seen a November performance like this since
1999 when all we were buying ahead of Y2K were flashlights and bottled
water.
• Turkey prices sank 2.5% in November ― the most important gobble time of
the year ― and the trend is flat for the past three months. This is amazing.

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December 20, 2010 – BREAKFAST WITH DAVE

• The prices of sweets sank 1.4% in November, the steepest decline on record.
No demand for chocolate covered reindeers this year? The little kiddies shouldn’t feel
bad about the lack of demand
• Wine prices fell 0.4% in November ― they hardly ever decline during this time
driving toy prices down
of the year ― and are down in three of the past four months! This hasn’t
happened in over two decades. Then again, if the turkey price is going down,
then complements like sauvignon blanc should be doing likewise, n’est-ce
pas?
• Not only wine but liquor prices declined down 0.8% in the last two months,
despite the fact that this is the most lubricating time of the year. Come to
think of it, I thought I did see someone buy a 15-year Balvenie for under $70
at an LCBO last week.
• Well, the little kiddies shouldn’t feel bad about the lack of demand driving toy
prices down. For the rest of us, the price of electronic goods is now down five
months in a row. And books fell 0.2% last month and are down in four of the
past five.
• But ... not everything is deflating for the retail sector. The areas that seem to
have at least a modicum of pricing power so far in this holiday shopping
season is apparel, sporting goods and jewellery (that little blue box never
does go out of fashion, does it?).
PAY ATTENTION!
The situation in Europe remains untenable. Last week’s Spanish 10- and 15- FDIC sure intends on closing
year bond issues, insofar as they represent a litmus test of any kind, went the year in style ...
poorly. European leaders have decided to address the issues surrounding
insolvency in 2013 and after, for whatever reason, ignoring the intense
problems in the here-and-now. Meanwhile, shortly after severely downgrading
Ireland’s rating by five-notches, Moody’s placed six Greek banks on review for
possible downgrade.

Not all of the global data have been stellar ― Japan's Tankan showed renewed
slippage in Japanese business sentiment and U.K. consumer confidence took
a big dive in November to its lowest level since March 2009. As for the U.S.A.,
while the belief in a sustainable vigorous growth has now become so well
entrenched, we see that the state payroll data showed a cumulative
employment DECLINE of 22k in November and the jobless rate rose in 21
states ― the most since August when “double dip” was dripping off everyone’s
tongues. Moreover, the FDIC sure intends on closing the year in style ... it
closed four more banks over the weekend! Finally, the question must be
asked as to what corporate insiders know that we don't know ― executives … it closed four more banks
were in a rush to offload an aggregate $19 billion of their company stock over over the weekend
the past two months!

Page 4 of 8
December 20, 2010 – BREAKFAST WITH DAVE

CHICAGO ... MORE BEAR THAN BULL

The headline on the Chicago National Activity Index, a composite measure that
closely tracks real U.S. GDP, came in on the grinchy-side of expectations in
November. The headline came in at -0.46 (consensus was 0.00) and the prior
monthly reading was at -0.25. The index is now down four months in a row,
something we have not seen since mid-2009 when the U.S. economy was hitting
the recession’s depth. On a three-month basis, the “smoothed” index remains
at -0.4 for the past two months (-0.41 in November and -0.42 in October). This
has now been negative since May, portraying a pace of economic activity that is
well below potential and hence disinflationary.

Personal consumption and housing remains very weak — closer to recessionary

levels. It is difficult to “square” this result with anecdotal signs of improved
holiday shopping.

The employment component swung back to negative — down 0.16 from +0.10 in
October. So while initial jobless claims suggest that the pace of firings has
subsided, they say nothing about hiring trends. (For a good “:take” on how
cautious companies still are in terms of making commitments to the labour
market, have a look at Weighing Costs, Companies Favor Temporary Help on the
front page of today’s NYT).

Production is flat in November and sales remain flat as well. not exactly
comporting with a ripping ISM index.

VALUATION UPDATES FROM OUR MODELS

S&P 500: No surprise here, the U.S. market continues to be overvalued.
According to our proprietary models, the median fair-value for the S&P 500 is
1,120 (with a range of 1,000 to 1,200) suggesting the market is overvalued by
over 10%. The fair-value line has actually been creeping upwards as
earnings/revisions have recently improved.

Another metric we watch is the Shiller P/E ratio (uses cyclically-adjusted

earnings), which moved up again to 21.9x (the highest since June 2006). Using
this metric, the market is overvalued by over 30%.

In terms of sectors, Financials, Materials, Industrials are the most overvalued

while Health Care, Technology and Telecommunication offer the most
compelling value at the current time.

TSX: There was a big jump in the median fair-value estimate in the last month,
owing in large part to upgrades in aggregate forward earnings estimates. Our
internal models are now suggesting a fair-value level of 11,200, versus 10,700
last month (this is the highest valuation since June). This still points to an
overvaluation of over 15% ― the actual market price continues to outpace the
improvement in the fair-value line, hence our caution on the equity market. In
Canada, Utilities, Health Care and Materials are the most expensive while
Technology, Telecommunication and Industrials are the cheapest.

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December 20, 2010 – BREAKFAST WITH DAVE

Corporate Bonds: The aggregate fair-value models suggest that BBB spreads
are about 50bps undervalued versus 80bps undervalued last month. BB and B
rated product offer the most relative value while AAA and AA are the most
expensive. So the lower-quality segment of the corporate universe still appears
to offer the best value as the year draws to a close.

Canadian dollar: Fair-value (based on the Bank of Canada model using

commodity prices and short-term interest rate spreads) continues to increase.
This month, it moved up to 94 cents versus 93.5 on higher commodity prices,
which means that with the Canadian dollar, at near parity, remains overvalued
by about a nickel. But it is important to see the fair-value line continue to move
higher as this underscores our view of the loonie being in a secular bull market.

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December 20, 2010 – BREAKFAST WITH DAVE

Gluskin Sheff at a Glance

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 the
prudent stewardship of our clients’ wealth through the delivery of strong, risk-adjusted
investment returns together with the highest level of personalized client service.

OVERVIEW INVESTMENT STRATEGY & TEAM

As of September 30, 2010, the Firm
managed assets of $5.8 billion.
Gluskin Sheff became a publicly traded
corporation on the Toronto Stock
Exchange (symbol: GS) in May 2006 and
remains 49% owned by its senior
management and employees. We have
public company accountability and
governance with a private company
commitment to innovation and service.
Our investment interests are directly
aligned with those of our clients, as
Gluskin Sheff’s management and
employees are collectively the largest
client of the Firm’s investment portfolios. shareholder-minded management and a
We offer a diverse platform of investment
strategies (Canadian and U.S. equities,
Alternative and Fixed Income) and
investment styles (Value, Growth and
1 September 30, 2010
Income).
The minimum investment required to
establish a client relationship with the
Firm is $3 million.
PERFORMANCE
$1 million invested in our Canadian
Equity Portfolio in 1991 (its inception
date) would have grown to $9.1 million
on September 30, 2010 versus $5.9 million
for the S&P/TSX Total Return Index
over the same period.
$1 million usd invested in our U.S.
Equity Portfolio in 1986 (its inception
date) would have grown to $11.8 million
usd on September 30, 2010 versus $9.6
2 In terms of asset mix and portfolio
million usd for the S&P 500 Total
Return Index over the same period.
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.
We have strong and stable portfolio
management, research and client service
teams. Aside from recent additions, our Our investment
Portfolio Managers have been with the interests are directly
Firm for a minimum of ten years and we
aligned with those of
have attracted “best in class” talent at all
our clients, as Gluskin
levels. Our performance results are those
Sheff’s management and
of the team in place.
employees are
We have a strong history of insightful collectively the largest
bottom-up security selection based on client of the Firm’s
fundamental analysis.
investment portfolios.
For long equities, we look for companies
with a history of long-term growth and
stability, a proven track record,
$1 million invested in our
Canadian Equity Portfolio
share price below our estimate of intrinsic
in 1991 (its inception
value. We look for the opposite in
date) would have grown to
equities that we sell short.
$9.1 million2 on
For corporate bonds, we look for issuers
with a margin of safety for the payment
versus $5.9 million for the
of interest and principal, and yields which
S&P/TSX Total Return
are attractive relative to the assessed
Index over the same
credit risks involved.
period.
We assemble concentrated portfolios -
our top ten holdings typically represent
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way, clients benefit from the ideas in
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2
Our success has often been linked to our
long history of investing in under-
followed and under-appreciated small
and mid cap companies both in Canada
and the U.S.
PORTFOLIO CONSTRUCTION
For further information,
construction, we offer a unique marriage please contact
between our bottom-up security-specific questions@gluskinsheff.com
fundamental analysis and our top-down
macroeconomic view.
Page 7 of 8
December 20, 2010 – BREAKFAST WITH DAVE
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