David A. Rosenberg January 5, 2011Chief Economist & Strategist Economic Commentary [email protected]+ 1 416 681 8919MARKET MUSINGS & DATA DECIPHERING Breakfast with Dave WHILE YOU WERE SLEEPING •What the bulls may be ignoring ... at their peril ... plus some ideas for 2011 •Fed less than impressed with the economic backdrop •Troubles with the profit forecasts •ADP surges! But is it for real? •Slowing trend in core capital expenditure orders ... this may throw a wrench into bullish business spendingforecasts for 2011 •U.S. consumer finished the year in decent shape •While you were sleeping: wave of selling across Europe and Asia; U.S. dollar firming; euro slipping; commodity complex heading south; Aussie and Kiwi down; loonie declined from its lofty perch IN THIS ISSUE The markets have turned completely manic. After starting off the year on a very strong footing on virtually no net new information over the outlook, we see a wave of selling today across Europe and Asia (Asian equities were due for a breather — this was the first decline in eight days). Bonds have turned the corner and are back in rally mode . The U.S. dollar, predicta bly since it is still considered to be a less-cyclical and more-safe unit, is firming and is retesting the 100-day moving average (m.a.) after briefly breaking below the 50-day m.a. exactly 24 hours ago. Even though U.S. auto sales came i n a smidgen above expectations at 12.5 million units annualized in December (barely meeting replacement demand), the whispered numbers were far higher due to the huge discounting that had been going on to close the calendar year . And, the news from Reis that sho ppingcenter vacancy rates jumped to 10.9% in Q4 from 10.6% a year ago served as a stark reminder that sorry, no, the American consumer is not really operating on all engines despite a better than expected holiday shopping season that was aided and abetted by what will likely turn out to be a temporary equity wealth effect that pulled down the savings rate for a brief time. Inflationist 's may love the fact that G.E. just announced a hefty price hike on appliances, but there are still other significant pockets of deflation, such as the fact that shopping mall rents are down 1.5% over the past year. The euro is slipping again as Eurozone refinancing challenges come back onto the front burner and People’s Bank of China officials are openly discussing their concerns surrounding China’s disturbing inflation backdrop — hinting at more policy tightening. As a result, the commod ity complex, as well as the resource - based currencies, is heading south (copper is down 1.4% today and oil is off the boil, though the damage to the economy has already been done as we explain below — also see Oil Price Enters Danger Zone on the front page of today’s FT); gold is hugging the 100-day m.a. line nicely a fter yesterday’s descent. The Aussie and Kiwi are down now for three days in a row and the loonie has declined from its lofty perch for the first time in ten sessions. As for credit, it remains to be seen whether we see some spread widening given the massive slate of new corporate issuance on tap for this quarter (see Bond Wave Strikes on Both Sides of the Atlantic on page 12 of th e FT). Pound for pound, we still prefer corporate bonds to equities, which would have been a very good call for 2010 by the way, and we would view any widening in spreads as a terrific buying opportunity. 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, visitwww.gluskinsheff.com
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David A. Rosenberg January 5, 2011 Chief Economist & Strategist Economic [email protected]+ 1 416 681 8919
MARKET MUSINGS & DATA DECIPHERING
Breakfast with DaveWHILE YOU WERE SLEEPING
• What the bulls may beignoring ... at their peril ...plus some ideas for 2011
• Fed less than impressed
with the economicbackdrop
• Troubles with the profitforecasts
• ADP surges! But is it for
real?
• Slowing trend in corecapital expenditure orders... this may throw awrench into bullishbusiness spending forecasts for 2011
• U.S. consumer finished the year in decent shape
• While you were sleeping:wave of selling acrossEurope and Asia; U.S.dollar firming; euroslipping; commoditycomplex heading south;Aussie and Kiwi down;loonie declined from itslofty perch
IN THIS ISSUEThe markets have turned completely manic. After starting off the year on a very
strong footing on virtually no net new information over the outlook, we see a
wave of selling today across Europe and Asia (Asian equities were due for a
breather — this was the first decline in eight days). Bonds have turned the corner
and are back in rally mode. The U.S. dollar, predictably since it is still considered
to be a less-cyclical and more-safe unit, is firming and is retesting the 100-day
moving average (m.a.) after briefly breaking below the 50-day m.a. exactly 24
hours ago.
Even though U.S. auto sales came in a smidgen above expectations at 12.5
million units annualized in December (barely meeting replacement demand), the
whispered numbers were far higher due to the huge discounting that had been
going on to close the calendar year. And, the news from Reis that shopping
center vacancy rates jumped to 10.9% in Q4 from 10.6% a year ago served as a
stark reminder that sorry, no, the American consumer is not really operating on
all engines despite a better than expected holiday shopping season that was
aided and abetted by what will likely turn out to be a temporary equity wealth
effect that pulled down the savings rate for a brief time.
Inflationist's may love the fact that G.E. just announced a hefty price hike on
appliances, but there are still other significant pockets of deflation, such as the
fact that shopping mall rents are down 1.5% over the past year.
The euro is slipping again as Eurozone refinancing challenges come back onto
the front burner and People’s Bank of China officials are openly discussing their
concerns surrounding China’s disturbing inflation backdrop — hinting at more
policy tightening. As a result, the commodity complex, as well as the resource-
based currencies, is heading south (copper is down 1.4% today and oil is off the
boil, though the damage to the economy has already been done as we explain
below — also see Oil Price Enters Danger Zone on the front page of today’s FT);
gold is hugging the 100-day m.a. line nicely after yesterday’s descent. The
Aussie and Kiwi are down now for three days in a row and the loonie has
declined from its lofty perch for the first time in ten sessions.
As for credit, it remains to be seen whether we see some spread widening given the massive slate of new corporate issuance on tap for this quarter (see Bond
Wave Strikes on Both Sides of the Atlantic on page 12 of the FT). Pound for
pound, we still prefer corporate bonds to equities, which would have been a very
good call for 2010 by the way, and we would view any widening in spreads as a
terrific buying opportunity.
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,
Barrons.com ran an article yesterday quoting some obscure analyst criticizing
our macro economic and bond yield call for 2010, basically ridiculing us, calling
for a contraction in either Q3 or Q4 and for the yield on the U.S. 10-year note to
get as low as 2% or below. Here is the reality. The U.S. economy was clearly
sputtering by the spring and summer and we were calling for that early on as the
consensus was gazing at 5%+ fourth quarter growth in Q4 of 2009 and 3%+ in
the first quarter of 2010. Only when the long arm of the law — another round of
monetary and fiscal stimulus — was extended to give Mr. Market a nice lift did
the clouds part. That shows how fragile this recovery has been and remains —
just read the FOMC minutes to get a glimpse of the array of downside risks cited
(more on this below). While the 10-year yield did not finish the year at 2%, it
almost got there in the fall and nobody, except us, was calling for that a year
ago. So put that in your pipe and smoke it.
Only when the long arm of the
law — another round ofmonetary and fiscal stimulus —
was extended to give Mr.
Market a nice lift did the
clouds part
There is no doubt that we have had an incredible bear market rally on our
hands. But that is exactly what it is. As we noted yesterday, as per Bob Farrell,
even these spasms can go further than anyone thinks. But after a monstrous
80%-plus rally from the March 2009 lows (over such a short time frame, and the
most pronounced bounce since 1955) this market has become seriously
overextended in our view. Meanwhile, we have practically every market pundit
extrapolating the recent trend into the future because that is the easy thing to
do. But the Farrell’s and Walter Murphy’s of this world have become very
cautious and frankly, that is good enough for us. The fact that Laszlo Birinyi
published a report yesterday concluding that the S&P 500 will rally to 2,854
(what … no decimal place?) by September 4, 2013 (oh, only another 125% from
here) is perfect. Absolutely perfect.
Meanwhile, the masses only see the returns, they do not see the risks that arenearly invisible to the naked eye. But we see the risks. We assess them; we
measure them, and we benchmark the returns against them. I recall all too well
that 2003-07 bear market rally — yes, that is what it was. It was no 1949-1966
or 1982-2000 secular bull run. It was a classic bear market rally, and did last
five years. I was forever skeptical because what drove that bear market rally
was phony wealth generated by a non-productive asset called housing alongside
wide spread financial engineering, which triggered a wave of artificial paper
profits. I knew it would end in tears … sadly, I didn’t know exactly when. I was
constantly defensive in my investment recommendations at the time and there
was a huge price to be paid for being bearish when there is a bull on your
business card, trust me on that one.
We have been patient and will remain so, with an eye towards maximizing risk-adjusted returns, not merely gross nominal returns, which are the only ones that
get reported. Remember those returns only count if they aren’t ultimately
reversed by excessive greed. At the current time, we believe our clients are well
served by our equity strategies (minimal cyclical exposure and a focus on an
income equity-hard asset barbell); our long-short strategies (vital in controlling
risk in the portfolio and underscore our focus on capital preservation thematic)
and our fixed-income products (outside of commodities, deflation in the
developed world remains the primary trend and is in such a backdrop that
“yield” makes perfect sense). Bear market rallies are not the
same as secular bull markets — the former are to be rented,
the latter are to be owned
How the Fed and the federal
government in the future
manage to redress their
pregnant balance sheetswithout creating a major
disturbance for the overall
economy is a legitimate
question
As investors discovered that the world wasn’t flat after all from late 2007
through to early 2009 as the roof caved in for most, who remembered that I was
just plain wrong in 2003 when the S&P 500 surged 26% or even in 2006 when
it rallied 13%. It is quite amazing that as the market rolled over, nobody
remembered how “wrongly bearish” I was during those years in the wilderness
when everyone believed in the wonders of financial market innovation and the
democratization of the housing market. I recall a senior portfolio manager in
Texas scolding me in 2005 about how his nanny just got a subprime mortgage
to buy her first home … let’s hope he didn’t co-sign).
It is an amazing commentary on human behaviour that I was forgiven for having
been more focused on bonds and gold during those go-go leveraged years of
2003-2007, and then treated like a hero after the financial system collapsed
under its own weight of dramatic excess. It goes to show that in the final
analysis, as much as it hurts, not to be involved in a speculative rally that sees
the market surge more than 80%, it is much much tougher to actually
experience a correction in the other direction. For the time being, it takes
extreme courage and resolve to not jump on the bandwagon (“don’t fight the
Fed”) and buy “the market” at current expensive pricing points.
As far as equities are concerned, make no mistake, we are in the throes of an
intense bear market rally, which is likely at the very late stage. Nobody will know
to get out at the peak and as we saw in late 2007 and into 2008, many of the
“longs” will be trapped. Bear market rallies are not the same as secular bull
markets — the former are to be rented, the latter are to be owned. Those
claiming to be adept market timers today that have been and are staying long
will be repeating the same mistake they made three-years ago.
This is not the 1949-66 secular bull market that was underpinned by troops
coming home and spurring on a baby-boom that would unleash years of
tremendously strong domestic demand growth. The demographics in the U.S.A.
are now downright poor — just look at the ratio of the working age population to
the total population. Nor is this the 1982-2000 secular bull market that saw the
central bank usher in years of disinflation (the current one is trying desperately
to create inflation!) and a wave of innovation that saw the mainframe, the
personal computer, the Internet, and then the smartphone, a boom in the
capital stock that enhanced structural productivity growth and led to sustained
gains in private sector economic activity, which by the end of that secular bullrun, allowed the government to actually start to record budgetary surpluses.
What is the major innovation today? The iPod? The iPad? Facebook? These
may be fun, but they don’t do much to promote the growth rate in the nation’s
capital stock or productivity.
What we have on our hands has been an economic revival and market bounce
back premised on unprecedented monetary and fiscal stimulus. How the Fed
WHAT THE BULLS MAY BE IGNORING ... AT THEIR PERIL ... PLUS SOME
IDEAS FOR 2011 Obama just enhanced his
2012 re-election chances byappointing Daley as his chief
of staff
Nothing of course says that
the market can’t keep goingup over the near-term
The bullish case is pretty well established right now and there is no sense
repeating them but what may be ignored are these half-dozen risks:
1. How much of 2011 growth was borrowed from 2012 (the payroll tax cutand bonus depreciation allowance end in December 2011). This may bean issue heading into Q4.
2. Energy prices ― if oil breaks above $100 and gasoline prices approach$3.50/gallon then expect the consumer to sputter. Every penny at thepumps drains $1.5 billion out of household cash flow. At the moment, U.S.gas prices at the pumps are at $3.15/gallon, but consider that back inSeptember, it was closer to $2.70/gallon. This increase in energy prices ishardly the result of booming consumer demand, which we know from themonthly personal consumption expenditure data is down more than 2%from a year ago. This is nothing more than an exogenous negative shock,
which, at current levels, is approximately a $50-60 billion annualized drag from the U.S. household cashflow (basically absorbing half of the payroll
tax relief). If, as many experts predict, gas prices ultimately go to $4/gallon, then this would siphon another $100 billion into the gas tank. As for oil, the rule of thumb is that a 10% increase in prices shaves off 25 percentagepoints off GDP. This means that oil could be a near-one percentage pointhit to GDP growth.
3. The GOP-led House is pressing for $100 billion of spending cuts for thisyear. If enacted, and this could be part of a deal to resolve the debt ceiling issue looming this spring, could cause GDP estimates to be trimmed.
4. Obama just enhanced his 2012 re-election chances by appointing Daley ashis chief of staff. Either he is really going to move to the center, or he is
trying to cement the next election.
5. Everyone believes that a better employment picture will brighten the stockmarket’s prospects even more but in fact the opposite will happen asmargins get squeezed by rising labour costs. Remember what happened in1994. Be careful what you wish for.
6. I am hearing that the Fed is moving further away from entertaining thenotion of a QE3 program in the second half of the year. Something themarket will be grappling with in the second quarter, and I see that thesecond quarter may well offer up the best buying opportunity of the yearsince that is the quarter where the concern list will likely start to grow;lagged impact of China tightening shows through, big Europeanrefinancings, signs of no more QE, and the debt-ceiling issue hitting itspeak.
Nothing of course says that the market can’t keep going up over the near-term.
All I hear is about “not fighting the Fed” and “how great the economy is doing”
and maybe this will lure some fence-sitters into equities (as has already beenevident in the December fund-flow data). To be sure, the U.S. consumer has
surprised to the upside even with still-sluggish job market conditions, and the
stimulus impact will be most felt this quarter re: tax relief. But surely this is
already priced in. What may not be priced in is that much like 2010, the peak
rate of GDP growth for this year will be the quarter we are in right now (the peak
in 2010 was 3.7% in Q1). Until Bernanke uttered the words QE2 in late August,
the market was beginning to recognize the slowing pattern that was underway in
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 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 September 30, 2010, the Firmmanaged assets of $5.8 billion.
Gluskin Sheff became a publicly tradedcorporation on the Toronto Stock Exchange (symbol: GS) in May 2006 andremains 49% owned by its senior
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Income).1
The minimum investment required toestablish a client relationship with theFirm is $3 million.
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$1 million invested in our CanadianEquity Portfolio in 1991 (its inceptiondate) would have grown to $9.1 million
2
on September 30, 2010 versus $5.9 millionfor the S&P/TSX Total Return Indexover the same period.
$1 million usd invested in our U.S.Equity Portfolio in 1986 (its inceptiondate) would have grown to $11.8 millionusd
2on September 30, 2010 versus $9.6
million usd for the S&P 500 TotalReturn Index over the same period.
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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.
Our investment interests are directlyaligned with those of our clients, as Gluskin
She ff ’s management and employees are collectively the largest client of the Firm’sinvestment portfolios.
$1 million invested in our
Canadian Equity Portfolio
in 1991 (its inception
date) would have grown to
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September 30, 2010
versus $5.9 million for the
S&P/TSX Total Return
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period.
We have a strong history of insightfulbottom-up security selection based onfundamental analysis.
For long equities, we look for companies with 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 in which 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
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In terms of asset mix and portfolioconstruction, we offer a unique marriagebetween our bottom-up security-specificfundamental analysis and our top-downmacroeconomic view.
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Notes:Unless otherwise noted, all values are in Canadian dollars.
Page 14 of 15
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