David A.

Rosenberg January 20, 2011

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

MARKET MUSINGS & DATA DECIPHERING

Snack with Dave

THE FEELING IS … MUTUAL!
IN THIS ISSUE
One cannot read the headline on page 15 of the FT — U.S. Retail Investors
Return to Equities On Back of Price Rises — and not be reminded of Bob  The Feeling is … Mutual!
Farrell’s Rule #5: The public buys most at the top and the least at the bottom. retail investors return to
equities in early January;
municipal bond funds
Now ain’t that the truth! being hammered with
large net outflows; U.S.
Indeed, as they chase performance, retail investors plowed a hefty $6.54 billion state and local
into equity funds in the week of January 12. TD Ameritrade has reported that government cutbacks due
margin lending has soared 31% from year-ago levels. Uh oh. to fiscal crunch
 Impact of Higher
The one industry that is being hammered right now is the municipal bond fund Commodity Prices:
space — with net outflows last week of $2.37 billion, the tenth week in a row. It industries now most
would seem as though there has been a reallocation not just to equities but also affected by the surge are
the airlines and the retail
to other income-oriented strategies because taxable bond funds did see a $1.39
food industry
billion net inflow during the week and hybrids took in a net $2.14 billion and that
followed a $549 million intake the week before that. So our strategy of SIRP still  Earnings Results: this has
has many believers — Safety and Income at a Reasonable Price. While there is to be the most overbought
equity market in at least
no doubt that we remain cautious on the equity market as an asset class, we three years
like the large-cap, blue-chip, cash flow generators and reliable dividend payers.
So we continue to advocate income-oriented strategies that deliver an economic  Buy the dip? U.S. housing
starts down
rent to investors until such time as a very nice buying opportunity emerges in the
more cyclical capital-appreciation vehicles. That time will come.  Canada Update: mixed
economic news
As an aside, there are now long-term, closed-end muni funds yielding in excess
of 8%. So the question then becomes: when do potential rewards start to
outweigh the risks? No doubt there are major financial problems among state
and local governments but the sector has cheapened up radically in recent
weeks and months. We are more worried about the economic impact from the
spending cuts and tax hikes than we are about a wave of defaults, which could
well be overblown. But the economic damage is going to be severe and catch
the bullish economics community by surprise this year.

But the editorial board at the FT won’t be surprised — see U.S. States Face a
Fiscal Crunch on page 10 of today’s paper): “Undue budget tightening will
jeopardize recovery whether applied at federal level or lower down … The
squeeze is now upon them; the federal stimulus is fading away, and the
gimmicks are all used up. For state finances, the year of reckoning has arrived,
and the timing could hardly be worse.”

Wow, talk about hard-hitting stuff. See what the current drag looks like below on
the economy and how important state/local government spending is — second
largest contributor to GDP.

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
January 20, 2011 – SNACK WITH DAVE

CHART 1: STATE AND LOCAL GOVERNMENT CUTBACKS REMAIN A KEY

MACRO RISK
United States
(year-over-year percentage change)
Real Gross Investment: State & Local Government Employment: State & Local Government

4%
7%

6%
3%
5%

4% 2%

3%
1%
2%

1% 0%

0%
-1%
-1%

-2% -2%
'90 '93 '96 '99 '03 '06 '09 '90 '93 '96 '99 '02 '05 '08

Shaded region represent periods of U.S. recession

Source: Bureau of Economic Analysis, Bureau of Labor Statistics

CHART 2: STATE AND LOCAL GOVERNMENTS ARE THE SECOND LARGEST

CONTRIBUTOR TO GDP
United States: Contribution to GDP
(percentage)
Capital
Spending State & Local Gov't
Fed Gov't

Housing

Comm' Construction

Consumer

Source: Bureau of Economic Analysis, Gluskin Sheff

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January 20, 2011 – SNACK WITH DAVE

IMPACT OF HIGHER COMMODITY PRICES

The industries most affected
Currently, the industries most affected by the surge in commodity prices are the by the surge in commodity
airlines and the retail food industry. The airlines are nudging prices higher and prices are the airlines and
we are even seeing the discounters (i.e. Southwest) follow suit for a change, but retail food industry
not nearly enough to prevent margin compression. There is a great article on
page B7 of the WSJ — As Food Prices Soar, Eateries Scramble — showing how
anyone who sells food for a living (including the hotels and the cruise lines) is
having a really tough time passing the higher costs through to their customers.

EARNINGS RESULTS
Another interesting feature of yesterday’s market action was that it took place
with most of the news coming in positive. Perhaps not housing starts or the
weekly chain store sales data, but most of the earnings results are being spun
very positively. We have 24 S&P 500 companies reporting thus far and 17 have
topped consensus views on the bottom line and — get this — 18 have topped on
the top-line too (though the banks look pretty shaky in terms of revenue growth).
I see that S&P’s investment committee just lifted its 12-month target on the S&P
500 to 1,370 from 1,315, basically stating that $95 on operating EPS this year
is a lock. Unlike March of 2009 when the bar was extremely low, the bar has
now been set very high for the year and that is likely the largest hurdle for Mr.
Market as far as 2011 is concerned — it is going to be tough to generate upside
surprises in earnings from where the consensus is right now.

BUY THE DIP?

Well, was it really that much of a surprise to see a giveback in the equity market
yesterday? This has to be the most overbought market in at least three years
and investor sentiment is so nutty that the latest Investors Intelligence survey
showed there to be three times as many bulls as there are bears — even at It is going to be tough to
these three-year highs. Talk about chasing performance. We are at the point generate upside surprises in
now of maximum bullishness and we say this when at least one venerable earnings from where market
market pundit publishes a report questioning whether this is in fact a secular consensus is right now
bear market.

With policy rates at zero for over two years now, the Fed feeling the necessity of
having to embark on QE2 after it hinted loudly a year ago of an exit strategy, and
then the government feeling compelled to extend a tax-rate cut that was brought
in a decade ago to fight a recession two cycles ago, are rather telling. Maybe
Wall Street and Main Street can stay divorced forever. Somehow, we doubt it.
Perception and reality will meet up once Wile E. Coyote starts to look down.

All the bulls in the past four months were saying to buy the dip. Well, in all
honesty, there was no dip to buy. It was a straight line up as the shorts got
squeezed in an unprecedented fashion. Maybe now we'll see if this is a dip to
buy, now that we actually saw one — for a single session.

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January 20, 2011 – SNACK WITH DAVE

STARTS FINISHED
U.S. housing starts slid 4.3% MoM in December to 529k units at an annual rate, According to the National
which was short of the 550k mark that the consensus had penned in. This was Association of Home Builders:
the lowest reading since October 2009 when the economy was struggling to We can look forward to
emerge from the recession. ongoing weakness in new
sales activity and construction
What was even more disconcerting was the 9% plunge in new single-family
construction (multi-family is more prone to sharp fluctuations and popped 18%)
to a mere 417k annualized units — this was the second decline in the past three
months. The past weakness in single-family starts is also filtering into units
under construction, which sank 1.1% MoM in December, and down seven of the
past eight months. This spells bad news for the residential construction
component of the GDP accounts.

With four million foreclosures widely expected this year and next, an already
enormous backlog of six million homes in serious delinquency and four million
housing excess units already sitting vacant for sale, we can look forward to
ongoing weakness in new sales activity and construction, as the National
Association of Home Builders revealed yesterday.

Yes, yes, building permits did surge 17% MoM in December but consider that to
be a one-month wonder because of a builder rush to get applications in ahead
of some building code changes that were going into effect on January 1 in New
York, Pennsylvania and California. This is why permits soared 81% in the
northeast and 44% in west. In the rest of the country, building permits sagged
5%.

Housing has always been the quintessential leading indicator for the broad
economy — on the way up, and on the way down. It is the proverbial canary in Housing has always been the
the coal mine. While its direct share of GDP has always been small, the quintessential leading
multiplier impact through the rest of the economy is huge. So, as everyone indicator for the broad
seems to think that some semblance of normality has returned, the answer is economy — on the way up, and
“no” ... nothing is normal. We merely have a central bank that has decided for on the way down
the greater good (for those that reside in the here and now) that jeopardizing the
sanctity of its balance sheet is a good thing and a federal government that has
continued to probe the outer limits of deficit finance in order to keep the
spending psyche alive.

Policymakers have done an admirable job of creating the illusion of recovery,

and it has worked because it would seem based on asset pricing that the vast
majority of investors have bought into this illusion hook, line and sinker.
Doubters are either cast aside as traitors, idiots or stubborn perma-bears who
don’t get it ... the “it” being that the government will simply not allow another
bear market or downdraft in economic growth from taking hold again!

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January 20, 2011 – SNACK WITH DAVE

The business cycle has miraculously been repealed, and the shorts have been
scared off for good. But you can’t tinker with human nature for very long. What Go back to every other post-
people should put in their back pocket is how surreal this so-called recovery war recovery, and never before
really is. With yesterday’s data, housing starts are now down 9.3% since the were housing starts still down
recession apparently was stopped in its tracks in June 2009. Go back to every from the point that the
other post-WWII economic recovery, and never before — 18 months into it —were recession ended… Until now
housing starts still down from the point that the recession ended … until now,
that is. On average, starts were up 33% at this juncture, with the median
increase at +29%. If housing starts being negative 9% at this stage of the cycle
is not a “new normal”, then frankly, I don’t know what is.

CHART 3: THIS INDEX NEVER CAME OUT OF THE RECESSION

United States: Housing Starts per month: Single Unit Structures
(thousands of units, seasonally adjusted)
2000

1600

1200

800

400

0
60 65 70 75 80 85 90 95 00 05 10
Shaded regions represent periods of U.S. recession
Source: Census Bureau / Haver Analytics

LOOKING SOFT FOR JANUARY RETAIL SALES

The Redbook and ICSC (International Council of Shopping Centers) survey data
through mid-month are not looking particular encouraging. It could be part
weather but most likely it reflects a post-holiday hangover as well as “consumers
appetite for clearance bargains” as the Redbook put it in its press release. How
you get an inflationary outcome out of that is truly a mystery. Month-to-month
sales are flagging a 0.6% decline and the YoY trend for the ICSC data is down to
+1.4% from over 3% at the start of the year.

Maybe there was something to that unexpected decline in consumer sentiment

that we saw last week. And maybe the hike in food and energy prices is taking a
bite out of the Fed-led equity market rally. Just to remind you — real wages have
declined outright now in three of the past four months. That is not good.

In another sign that January sales will likely be soft, the ICSC reported that it
expects that only 36.3% of gift cards will be redeemed this month, down from
45% last year and 46.4% in 2009.

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January 20, 2011 – SNACK WITH DAVE

SOME GOOD NEWS HERE

The architectural billings index jumped 3.2 points in December to a three-year
high of 54.2. We have done the statistical work and found that this index leads
the growth rate of non-residential construction by just over a year and with an
80% historical correlation. This is very positive for the design and construction
industry in general.

CHART 4: COULD BE GOOD NEWS FOR COMMERCIAL CONSTRUCTION

AIA: Architectural Billings Index
Seasonally adjusted, +50 = Increasing
67.5

60.0

52.5

45.0

37.5

30.0
95 00 05 10
Source: American Institute of Architects/Haver Analytics

CANADA UPDATE
We received a mixed batch of Canadian economic data. Today’s wholesale
sales were better than expected. We focus on real wholesale sales (which feeds
into the monthly GDP accounts) and on that score, they were up 1.3% MoM in
November. This helps temper yesterday’s very disappointing manufacturing
shipments, which on an inflation-adjusted basis collapsed by 1.4% MoM, the
second such decline in three months. It’s worth noting that real manufacturing
sales are at the lowest level since February 2010 — so it’s clear that the strong
loonie is taking a toll on the manufacturing sector. All in, we continue to track
fourth-quarter GDP at below 2%, slightly off from the Bank of Canada’s (BoC)
new (downwardly) revised Q4 GDP forecast of 2.3%.

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January 20, 2011 – SNACK WITH DAVE

The BoC also provided some more colour to its thinking after Tuesday’s press
release (where it kept interest rates on hold as expected) in yesterday’s
Monetary Policy Report. For this year and next, we saw major upgrades to
forecasts outside of Canada especially in the U.S. They now expect U.S growth
to come in a full percentage point higher than expected a few months ago at
3.3% for 2011. And it wasn’t just the U.S. that was updated. It was across the
board, with forecasts for the Euro area (now 1.5% growth), Japan (1.4%), China
(9.3%), and the rest of the world (4.0%) all being lifted. Even with the material
increase of U.S. growth prospects, Canadian GDP was increased by a scant 0.1%
to 2.4% for this year (in other words, underperforming the U.S. by nearly 1%).
We continue to believe the BoC will be on hold for some time, especially after
the Federal Government announced more restrictive mortgage lending
measures, which takes some of the pressure off the Bank to hike rates.

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January 20, 2011 – SNACK WITH DAVE

Gluskin Sheff at a Glance

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms.
0

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 December 31, 2010, the Firm
managed assets of $6.0 billion*.
Gluskin Sheff became a publicly traded
corporation on the Toronto Stock
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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
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
between 25% to 45% of a portfolio. In this
way, clients benefit from the ideas in
which we have the highest conviction.
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,
H

million usd for the S&P 500 Total construction, we offer a unique marriage please contact
Return Index over the same period. between our bottom-up security-specific questions@gluskinsheff.com
fundamental analysis and our top-down
Notes: macroeconomic view.
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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. Page 8 of 9
January 20, 2011 – SNACK WITH DAVE
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