David A.

Rosenberg August 9, 2010

Chief Economist & Strategist Economic Commentary
[email protected]
+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING
IN THIS ISSUE
It’s literally a sea of green out there with practically every equity market on the
planet rallying, save for the Nikkei (for a sobering look at what can happen in • While you were sleeping:
virtually every stock
August, check out E.S. Browning’s Fear of a Jolt column in today’s WSJ).
market on the planet is
rallying today, save for the
Solid earnings reports out of Europe and above-expected German export data Nikkei; solid earnings and
(+3.8% in June and this is on top of a 7.9% surge in May — the consensus for June economic report out of
was +1.5%, so this was a big miss to the upside). Corporate default risks are Europe
fading, as per the narrowing in CDS spreads, down another 4bps in Europe. The • Some salient facts about
safe-haven government bond markets are relatively flat despite what appears to the July U.S. payroll report
be a serious bout of investor enthusiasm to kick off the week. Basic material
• Take Mr. Bond very
stocks are pacing the advance along with a rebound in the commodity space and
seriously
lingering weakness in the U.S. dollar as it breaks below its 200-day moving
average and further enhances its new reputation as being the world’s “carry trade” • Deflation now a
currency. Though we caution that, as per the CFTC data, the net speculative short mainstream view?
position is starting to approach extreme levels — remember the unexpected “pop” • A weak U.S. consumer
in the euro when it experienced a similar situation a couple of months ago. Also outlook
have a read of Dollar Poised for Further Declines on page C2 of the WSJ — this has
• Greenspan weighs in on
become too much of a consensus view, in our opinion. taxes

Meanwhile, the “butterfly” spreads evident in the behaviour of the 5-year • A nice run for the
commodity complex
Treasury note yield signals that the market is pricing in more easing in Fed policy
ahead — see Medium-term Treasurys Draw Fans in today's WSJ (page C2) on • Profit update: of the 443
how segments of the yield curve are progressively flattening on this Fed view. S&P 500 companies that
This is all the more so with former Treasury Secretaries Rubin and O’Neill saying have reported, 75% have
beaten their forecast…
in a CNBC that at this stage more fiscal largesse would do more harm than good.
what a surprise

Despite the good economic news in Europe (most of it transitory and reflecting
the brief effects of the earlier slump in the euro), Asia is showing fatigue signs.
China just reported an 11.9% MoM decline in July auto sales. Home prices in
New Zealand slowed the most last month — the most this year. That knocked
the kiwi down.

Our friend, Paul Ashworth, from Capital Economics, tells the USA Today that
“Clearly, now everybody is looking for the Fed to do something.” That is, indeed,
a remarkable statement when one considers how aggressive the Fed has been
— taking policy rates to zero and becoming the lender of last resort for Uncle
Sam and Ma and Pa Kettle by stepping in and buying $1.7 trillion of mortgage
securities and Treasury securities over the past year-and-a-half.

Please see important disclosures at the end of this document.

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August 9, 2010 – BREAKFAST WITH DAVE

To then find out that more needs to be done, especially considering the massive
degree of fiscal stimulus and the vast array of programs aimed at stabilizing Upon second look, last
home prices and easing mortgage debt servicing burdens, just about says it all. Friday’s U.S. nonfarm
Not to mention that a year after an illusory recovery begins, the yield on the 2- payroll report was even
year T-note sits at a record low (50 basis points north of zero). There’s no sense weaker than we thought
being in denial. It is indeed Japan all over again, let’s just hope the deflationary
malaise doesn't last as long as 20 years.

Then again, the Nikkei did manage to rack up over 434,000 in cumulative daily
rally points along the way, even as the stock market there is down 70% from
where it was two decades ago. This means that recoveries will come, and they
will also go — as we are seeing unfold in the western world right now — but that
these are trading rallies, and not the road towards sustainable wealth creation
(though some company stocks are — we are talking about equities as an asset
class). Just keep in the back of your mind that the Dow, in a similar vein to the
Nikkei, has managed to accumulate 130,000 rally points when they are all
added up over the past 11 years, and yet the index is no higher today than it
was back then (and still 25% below its 2007 peak).

The resolution, which we underscore below, likely resides with bold initiatives to
entice capital formation through the tax system rather than these ongoing
efforts to distort pricing in asset markets, such as housing, and the flush-down-
the-toilet fiscal fine-tuning initiatives that have done little more than skew the
economic data with no sustained impact, especially as it pertains to the
moribund labour market. The latest stop-gap is a $26 billion in new aid to the
states to prevent layoffs of teachers and other civil servants.

Maybe the effort made by the Canadian government to deal with its financial
problems and tax competitive challenges in the 1990s is a place to start in
terms of addressing real solutions. The op-ed article by Jason Clemens in
today’s WSJ may be a good place to start (Canada, Land of Smaller Government:
It’s Corporate Income Tax Rate is 18% and Falling. America's is 35%).

And, if you are wondering why American companies are in the process of
increasing the capital-labour ratio and are loathe to embark on anything
remotely close to a hiring spree a full year into a statistical recovery, see Why I'm
Not Hiring by Michael P. Fleischer, also in today’s WSJ op-ed section.

SOME SALIENT FACTS ABOUT THE JULY PAYROLL REPORT

Upon second look, last Friday’s U.S. nonfarm payroll report was even weaker
than we thought. Consider the following:

• Forget about private payrolls, which for some reason the markets have
been brainwashed into watching (though these did come in well below
market expectations, at +71k versus +90k expected) — we should be
adding in state/local government employment. Bottom line is that when
adjusting for the Census worker effect, the economy only generated 12k
net new jobs last month. Pathetic.

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• The Birth-Death adjustment factor tacked in 16k jobs to the seasonally

adjusted data, so actually, that 12k number was probably more like When adjusted for the
-4k. Doubly pathetic. Census worker effect, the
U.S. economy only
• The Household survey showed a 159k loss, which was the third decline in a generated 12k net new jobs
row — something that in the past occurred outside of recessions a mere 2% last month … How pathetic
of the time. Full-time employment tanked 570k (on top of a 70k falloff in is that
June) which was the steepest decline since the depths of economic and
market despair in March 2009.
• The Household Survey, on a population and payroll concept adjusted basis,
posted a decline of 315k and this followed a 363k loss the month before.
• If not for the near one million decline in the labour force since April — the
number of discouraged workers has ballooned 50% in the past year — the
unemployment rate would be sitting at 10.4% right now (if the participation
rate was unchanged from April’s level).
• As a sign of how far the economy has slowed from its springtime peak, the
employment/population ratio dipped from 58.8% in April to 58.7% in May,
to 58.5% in June, to 58.4% in July — the lowest it has been since the turn of
the year. Moreover, two-thirds of the private sector job creation this year
took place in March and April, when the economy was hitting its peak.
• We had mentioned that one of the bright spots in the data was the pickup
on factory payrolls, but again this was more the result of seasonal
adjustment wizardry than anything else. Somehow, a 16k drop in the
automotive industry in the raw data managed to swing to a +21k print on a
seasonally adjusted basis and this likely reflected the one-off lack of plant
idling this year at GM.
• The workweek did edge up, but it is still an anaemic 34.2 hours and this
reflects the ability of businesses to adapt their labour force needs more At the rate the economy is
than anything else. The fact that they chose this route rather than add creating jobs; we will not
bodies, and shedding full-time workers, is a sign that companies lack a get back to the previous
commitment right now. The fact that they cut their reliance on the temp peak in employment until
agency market for the first time in 10 months is another indication that the 2017
aggregate demand for labour contracted last month.
• At the rate the economy is creating jobs — 654,000 so far this year — we
will not get back to the previous peak in employment until 2017. Just to get
back to the 8% unemployment rate that the White House had forecasted we
would require job creation of at least 2.5 million. At the rate we are going,
that will take longer than two years to accomplish.
• Let’s not lose sight of the fact that initial jobless claims kicked off the
month of August by jumping 19k, to 479k, the highest level since last
August. If we see this number back up to over 500k, then for sure we will
see less denial over double-dip risks.

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TAKE MR. BOND VERY SERIOUSLY

The yield on the 10-year note hit its nearby peak on April 5, at 4.01%, and has Let’s not forget, the bond
since plunged nearly 120 basis points. market is the tail that wags
the stock market’s dog — it
Declines of this magnitude very often presage the onset of bear markets and leads
recessions. Typically, equities and then economists are late to the game. Nothing
we are seeing is any different from the past, at least on this score.

What is key to note is that the bond market is the tail that wags the stock
market’s dog — it leads.

The 10-year note yield peaked on May 2, 1990 at 9.09%. By December 12,
1990, the yield was all the way down to 7.91%. The S&P 500 peaked on July
16, 1990, the same month the recession started. So Mr. Bond led both by over
two months — the 120 basis point slide in yields by December provided
ratification (though there were still some, including Alan Greenspan at the time,
who still believed a recession had been averted).

The yield on the 10-year T-note peaked at 6.79% on January 20, 2000 — the
stock market peaked less than eight months later on September 1. By
November 28, 2000, the yield had plunged to 5.59% — down 120 basis points
(as is the case today), again providing ratification that we were not heading into
some routine soft patch. Indeed, the recession started in March 2001, so the
bond market again played the role of the real leading economic indicator, not
the stock market.

Then in the most recent cycle, the 10-year T-note yield reached its high on June
12, 2007 at 5.26% — by November 21, it was all the way down to 4.00%. The
S&P 500 peaked on October 9, 2007, three months after the peak in the bond
yield. Yet again, a 120 basis point slide was the smoking gun for the economic
downturn — it was called the ‘hard landing’ then, though the plethora of
economists decided to look the other way; and today it is called the ‘double dip’
and once again this view is met with widespread ridicule from the economics
intelligentsia.

DEFLATION NOW A MAINSTREAM VIEW?

We could go on and on about how early we were on the deflation call — this was
central to our debate with Jim Grant at the Grants conference back in April when
deflation was considered by many to be a controversial and completely out-of-
the-mainstream view. Not to mention that back then the yield on the 10-year
note was nearly 4% and a growing chorus of economists were calling for 5%+.

The economy and the stock market were so hot by then that the Fed was on the
precipice of shrinking its balance sheet, everyone was debating when the first
tightening was going to come and the White House was busy gloating about the
success of the fiscal boosts (to the point where Larry Summers boasted that
“the economy appears to be moving towards escape velocity” — two weeks
before the stock market peaked). Talk about the proverbial kiss of death.

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August 9, 2010 – BREAKFAST WITH DAVE

The yield on the 2-year note is at a record low of 0.5% — down 5bps last week —
and the 10-year note is at a 15-month low of 2.82% after last week’s 9bp rally. Look at what the bond
We had said for some time that while it was a financial panic that led to the market is doing for the
downdraft in yields back to these levels in late 2008 and early 2009, the next economy; it is driving
time we revisit these levels in the near future it would be an “economic event” mortgage rates and AAA-
as opposed to a “financial event.” And, here we are (note, this huge bond rally rated corporate bonds down
has taken place even with the U.S. dollar sinking to a 15-year low against the
Japanese yen — so much for a weaker greenback triggering higher yields).

Look at what the bond market is doing for the economy; it is driving mortgage
rates down to new all-time lows of 4.5%. The rally in Treasuries, which for some
reason so many market pundits resist, has also played a crucial role in
revitalizing the corporate financial backdrop. The 100 basis point decline in
AAA-rated company bonds in the past 12 months, to a 40-year low of 4.72%,
didn’t happen all on its own. The downdraft in government bond yields — a
welcome downdraft — has played a vital part in dramatically cutting into debt-
service expense across the business sector. The yield on the 5-year TIPS is
close to zero, which is another indication that inflation concerns right now have
been completely swept under the rug. Globally, we also saw the 10-year JGB
yield dip below 1% while the German bund retreated 16 bps back to 2.5%.

And, over the weekend, the same media types that four months ago were
lamenting over inflation are now filled with deflation commentary — check out
these articles from the weekend press:

• Time to Print, Print, Print (page 15 of Barron’s)

• A Lover of Treasurys Bets on Deflation (page B1 of the weekend WSJ)
• How to Beat Deflation (page B7 of the weekend WSJ)
• Japanese-style Inflation Fears Bode Well for U.S. Bonds (page 15 of the
weekend FT)
• Afraid of Deflation? Try Some Medicine (Page 6 of the Sunday NYT business
section)
• Fed Must Beware of Public’s Deflationary Mindset (page C1 of Monday’s
Wall Street Journal)

As contrarians, we much preferred it when the crowd was still crowing about
inflation and there was dearth of deflation talk. Now it has become
commonplace and that indeed has us concerned that much of the deflation view
is priced in to the market (consider that the Fed funds futures contract has
pushed out the date of the expected first Fed tightening to August of next year).

We are not yet prepared to abandon our long-standing deflation views but we
are nervous that this is now becoming a mainstream forecast and let’s face it,
yields across the Treasury curve have rallied to levels that virtually nobody saw
coming this year.

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When you look at the variety of “top 10 surprise lists” that were published at the
start of 2010, who was saying back then that the best-returning security would If there is a part of the curve
be the 30-year zero coupon bond? Were there any strategists back then that has lagged behind, not
forecasting that heading into the eighth month of the year that bonds would be yet hit new lows in yield, and
outperforming stocks? that represents true inflation
expectations, it is the long
Then again, if there is a part of the curve that has lagged behind, not yet hit new bond
lows in yield, and that represents true inflation expectations, it is the long bond
at 4.00%. There is probably more juice here than anywhere else along the
maturity spectrum if the economy continues to weaken and along with that, the
forces of deflation gather steam. As an aside, it was interesting to see gold
trade back up to a three-week high of $1,200/oz even as the CRB index closed
the week with a 1.1% loss (biggest decline since June 29). This goes to show
that it is also an effective hedge against deflation (as was the case in the 1930s
when the sterling price of gold doubled).

Moreover, we can take solace in the widespread acclaim that Jan Hatzius at
Goldman Sachs is now receiving for being the prominent pessimist on Wall
Street. The front section of the Saturday NYT (page A3) says: “A prominent
pessimist, chief economist for Goldman Sachs, lowered his forecast of
economic growth for 2011 to 1.9%, from 2.5%.”

What a country! You are labelled a “prominent pessimist” with a 1.9% growth
forecast. This guy would be a hero through much of Europe not to mention To be sure, there is growing
Japan. In the U.S.A., he is labelled a “pessimist.” Well, having worked on Wall chatter that the Fed is once
Street for close to seven years and having been early on the 2008-09 recession again going to come to the
call, we know what being pessimistic (more like realistic, but who knew back rescue
then when securitization was a license to print money) is all about. So, we take
some solace at least that even though there is “talk” now about deflation, it
really has not comprised anyone’s official forecast, and that “double dip” risks
continue to be readily dismissed.

When Jan Hatzius, who by the way is a first-rate economist, cuts that 1.9% to
something closer to 0% for 2011 GDP growth, we will know that the degree of
pessimism has reached its climax. In our view, what the NYT dubs a
“pessimistic” growth forecast is really the best-case scenario for the economy in
the coming year.

To be sure, there is growing chatter that the Fed is once again going to come to
the rescue and Barron’s hints strongly at a coming $2 trillion quantitative easing
program. The rumour mill is filled with talk of how the Administration is cooking
up a new scheme, through the channels of Fannie and Freddie, to forgive part of
the mortgage loans for distressed homeowners who are “upside down” (ie,
negative net equity in their home) — a huge fiscal expansion that could bypass
Congressional approval.

Atlanta Fed President Lockhart summed it all up in a sermon he delivered back

on June 30:

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August 9, 2010 – BREAKFAST WITH DAVE

“To sum up, I don't see inflation as much of a current worry. If anything, there is
a small risk of deflation that must be monitored. Limited inflation allows focused In the U.S., if the private
attention to recovery and growth, which I'd like to turn to now. sector requires stimulation
from the public sector, then
Here’s a key point about these contributors to recovery — each could be the economy must still be in
transitory. The economy has not yet arrived at a state where healthy and a recessionary state
sustainable final demand is underpinning growth.

I make this point not to predict a reversal of the progress made but just as a
cautionary reminder to avoid counting chickens too early. There are sectors
that remain in a very depressed condition — housing, for example.

So, to pull this together, a recovery of the national economy is proceeding but
not yet with solid and sustainable underpinnings. Inflation appears restrained.
The outlook from here is beset by somewhat more than normal uncertainty.”

These are very disturbing conclusions. Twice he mentions the fact that without
policy stimulus, there are no sustainable underpinnings to the fragile economic
recovery. No wonder the Nation Bureau of Economic Research (NBER) has yet
to declare the downturn to be over — if the private sector requires stimulation
from the public sector, then the economy must still be in a recessionary
state. It’s no different than taking some aspirin to break the fever, but you only
know if you are no longer sick when your temperature is normal when you are off
the medication. Mr. Lockhart goes much further and intimates that not only is
public policy needed to stimulate economic activity, but that it is required to
sustain growth.

Friends, when the private sector needs the public sector for growth to be
sustained — not just stimulated, which is par for the course in fighting
recessions in a classic post-war Keynesian fashion — then you know that we
actually have on our hands is a depression. Let’s not keep our head in the sand
and stay in denial mode. When you have a Federal Reserve official lamenting
about how the economy still to this date has no “sustainable underpinnings”
after the central bank has taken rates to zero, tripled the size of its balance
sheet and the government has bailed out banks and homeowners and
embarked on an array of spending incentives that has taken the deficit to a
record 10% of GDP (outside of WWII) then you know that we have a totally
different experience on our hands.

Nearly half of the 14.6 million unemployed have been out of work for over six
months (according to the NYT, “a level not seen since the Depression”); and 1.4
million have been jobless for more than 99 weeks, at which point jobless
benefits run out. Professor Robert Gordon, one of the gurus at the NBER, told
the NYT that “[t]he situation is devastating. We are legitimately beginning to
draw analogies to the Great Depression, in the sense that there is a growing
hopelessness among job seekers.”

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In this light, maybe the fact that there is some growing acknowledgment of
deflation risks and that a cut to a GDP growth forecast by a “prominent Maybe it’s time to abandon
pessimist” to +1.9% is perhaps just the beginning stage of ‘acceptance’ as all the fiscal quick fixes that
opposed to our view being totally priced in at the current time. Though after have little multiplier impact
reading Welcome to the Recovery on the op-ed page of last Tuesday’s NYT by
at tremendous taxpayer
cost
Timothy Geithner, there does seem to be “denial” at the highest level of
policymaking in Washington (Frank Rich in his excellent op-ed piece in the
Sunday NYT rather appropriately called Mr. Geithner “tragically tone-deaf”).

Meanwhile, in the same edition we saw Alan Greenspan state that the economy
was in a “quasi recession” — hopefully Mr. Geithner realizes that President
Obama’s approval rating is down to a record low of 41% and it’s not about how
he is handling the war on terror as much as to what is happening to the labour
market.

As for policy prescriptions, maybe it’s time to abandon all the fiscal quick fixes
that have little multiplier impact at tremendous taxpayer cost. With 6.6 million
unemployed now for at least six months and discouraged workers dropping out
of the labour market at an alarming rate, perhaps we need more in the way of
creative supply-side measures to bolster business investment and durable
employment growth. For more on this file, have a look at the column on op-ed of
the Saturday NYT (The Economy Needs a Bit of Ingenuity — page A15).

And Bill Gross couldn’t have put it any better either — to the Sunday NYT. To wit:
“In the new-normal world, there are structural problems, which require
structural solutions.”

A WEAK CONSUMER OUTLOOK

It looks like July was another soft month even with the incentive- and fleet-led It looks like July was
rebound in auto sales (that still left them below consensus expectations, by the another soft month even
way). Call it deflationary growth but auto incentives were up an average of 2.5% with the incentive- and fleet-
YoY in July (according to Edmunds.com). led rebound in auto sales in
the U.S.
Moreover, almost 70% of retailers missed their sales targets last month, and
July was the fourth month in a row in which sales came in below plan (+2.9%
versus +3.1% expected last month). Keep in mind that the +2.9% YoY trend is
being “flattered” by the depressed base in the comparable year-ago period when
sales plunged 5.1% in July 2009. And, we see from the RBC outlook survey that
62% of families are either going to cut their back-to-school budgets this year or
actually spend nothing at all. Another 29% intend to spend the same while only
9% of the respondents indicated a willingness to loosen their purse strings and
spend more than they did in 2009.

At least the ECRI weekly leading index improved last week, to -10.3 from -10.7,
but the damage has already been done and recession risks based on this index
hovers around 2-in-3 odds.

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What seems obvious is that left to its own devices, households are concentrating
on boosting savings (that was loud and clear in the Q2 GDP data) and paying down After taking a dive during
debt — while June’s $1.3 billion net reduction in consumer credit was light vis-à-vis the depths of the European
expectations, credit card debt was pared by $4.5 billion, which was the 21st debt mess in the spring and
consecutive decline.
early summer, we have seen
the likes of oil, copper, zinc,
GREENSPAN WEIGHS IN ON TAXES tin and nickel all soar to
multi-month highs
One of the sources of uncertainty out there is the tax picture for 2010 — this is
now turning into a heated debate, even among Democrats. So far, Geithner is
not biting. And, it would seem as though he and the White House received a
shot in the arm from Alan Greenspan who was quoted in the Saturday NYT (see
Greenspan Calls for Repeal of All the Bush Tax Cuts on page B1) as saying: “I’m
in favor of tax cuts, but not with borrowed money.” He added that while the
repeal is “risky” as far as affecting the economy, he stressed that “the choice of
not doing it is far riskier. It is the difference between bad and worse ...”

A NICE RUN FOR THE COMMODITY COMPLEX

After taking a dive during the depths of the European debt mess in the spring
and early summer, we have seen the likes of oil, copper, zinc, tin and nickel all
soar to multi-month highs. This has occurred even with the pace of U.S.
economic activity sputtering, and has partly reflected confidence that Chinese
growth will remain close to double-digits and that most of the policy tightening
there is now behind us.

Recall that back in 2008, the commodity complex rolled over eight months after
the U.S. recession began — the problem for the oils and metals was when the
financial crisis morphed into a Chinese economic downturn. This is what we
have to keep an eye on, and the one metric that has us a bit concerned is the
news that China’s PMI dropped to a 17-month low in July (to a sub-50
contractionary reading of 49.4 we may add — down from 50.4 in June and the
fourth decline in as many months).

PROFIT UPDATE
What do you know? Of the 443 companies that have reported thus far, 75%
have beaten their forecasts. That number changes about as often as double-
digit GDP growth does in China.

Overall operating EPS is on track to show a 38% YoY gain (+46% on a reported
basis) — well above the 27% that the consensus was expecting when Q2
earnings season began. But the market now needs top-line performance too,
especially with profit margins back to cycle highs — and 38% of companies have
disappointed on this score (Revenue at Viacom Remains the Same, but Profit
Rises on Cost-Cutting as per page B4 of the NYT).

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Sales in Q2 are running at just +5.5% YoY or basically 1/7th the pace of overall
profit. The consensus for 2010 operating EPS is around $96 with margins hitting To the frustration of many a
fresh highs — revenues are seen rising 6.3% in 2011, which would imply a pace bull, we are sure, Main
that is at least double nominal GDP growth (they both tend to rise in tandem); Street investors continue to
though profit growth of 16% would be more than five times stronger than nominal
ignore Wall Street
strategists by shunning the
GDP growth, which points to profit margins hitting cycle highs — highs that in the
ever-volatile equity market
past coincided with booming economic growth years. Margins tend to be mean-
for safety and income at a
reverting and as the FT points out, if we were to apply a 3% nominal GDP growth
reasonable price
estimate for next year with profit margins heading back to the long-run norm, we
would be talking about corporate earnings coming in closer to $71 per share. This
then means that we are possibly talking about a forward P/E multiple of 16x as
opposed to the “cheap” 11.5x that everyone bandies about just because it is the
“consensus view” — the same consensus that typically overstates earnings by an
average of 20% at turning points in the economy.

Also keep in mind that consensus “reported” EPS forecasts for next year have
been marked down to $75.50 from around $77. In the 1980s, and much of the
1990s, outside really of that financial debacle in 1992, “operating” and
“reported” EPS tracked each other quite closely. It was really 1997 and onward
that Wall Street began to advertise “operating” earnings as the profit measure to
focus on — you know, the earnings measure that excludes mistakes (because
ostensibly they are “one offs”). But as our old pal Rich Bernstein pointed out
time and again, it is “reported” earnings — the tried, tested and true GAAP
results — that investors should be paying for, not the earnings that smoothes
over the “bad stuff”. So even here, supposedly heading into the third year of a
recovery, the consensus has a $20 EPS gap between these two series, which is
unusual. But if we are going to deploy “as reported” earnings, then even using
the consensus view we get a 15x forward multiple. That may not be exorbitant,
but it is still overpaying for whatever expansion we are likely going to see from
the income statement through the end of 2011.

INCOME THEME INTACT

To the frustration of many a bull, we are sure, Main Street investors continue to
ignore Wall Street strategists by shunning the ever-volatile equity market for
safety and income at a reasonable price. The ICI data just came out for the July
28th week and showed a net outflow of $3.9 billion dollars from equity funds
while bond funds attracted $7.1 billion of fresh money on top of $7.9 billion the
week before. Hybrid funds, which also deliver an income stream, posted net
inflows of $69 million too, in addition to $370 million the previous week. As an
aside, remember how everyone always laments about how America has lost
control of its bond market because over half of outstanding Treasuries are
“owned” by foreign investors. Well, a new page has been turned in this story
because U.S. residents, in their deliberate attempt to add income-generating
securities to their asset mix, now comprise 50.2% of the Treasury market — up
from 44.3% two years ago. This demographic drive for income is increasingly
emerging as a secular theme as households move to correct their dramatic
under-exposure to the fixed-income market (remember, the first of the 78 million
boomer population hits retirement age this year).

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August 9, 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 June 30, 2010, the Firm managed We have strong and stable portfolio
assets of $5.5 billion.
1
management, research and client service
teams. Aside from recent additions, our Our investment
Gluskin Sheff became a publicly traded
Portfolio Managers have been with the interests are directly
corporation on the Toronto Stock
Firm for a minimum of ten years and we
Exchange (symbol: GS) in May 2006 and aligned with those of
have attracted “best in class” talent at all
remains 54% owned by its senior our clients, as Gluskin
levels. Our performance results are those
management and employees. We have Sheff’s management and
of the team in place.
public company accountability and employees are
governance with a private company We have a strong history of insightful collectively the largest
commitment to innovation and service. bottom-up security selection based on client of the Firm’s
fundamental analysis.
Our investment interests are directly investment portfolios.
aligned with those of our clients, as For long equities, we look for companies
Gluskin Sheff’s management and with a history of long-term growth and
employees are collectively the largest stability, a proven track record,
$1 million invested in our
client of the Firm’s investment portfolios. shareholder-minded management and a
Canadian Value Portfolio
share price below our estimate of intrinsic
We offer a diverse platform of investment in 1991 (its inception
value. We look for the opposite in
strategies (Canadian and U.S. equities, date) would have grown to
equities that we sell short.
Alternative and Fixed Income) and $11.7 million2 on March
investment styles (Value, Growth and For corporate bonds, we look for issuers
2 31, 2010 versus $5.7
Income). with a margin of safety for the payment
million for the S&P/TSX
of interest and principal, and yields which
The minimum investment required to Total Return Index over
are attractive relative to the assessed
establish a client relationship with the the same period.
credit risks involved.
Firm is $3 million for Canadian investors
and $5 million for U.S. & International We assemble concentrated portfolios —
investors. our top ten holdings typically represent
between 25% to 45% of a portfolio. In this
PERFORMANCE way, clients benefit from the ideas in
$1 million invested in our Canadian Value which we have the highest conviction.
Portfolio in 1991 (its inception date)
Our success has often been linked to our
would have grown to $11.7 million on
2

long history of investing in under-followed

March 31, 2010 versus $5.7 million for the
and under-appreciated small and mid cap
S&P/TSX Total Return Index over the
companies both in Canada and the U.S.
same period.
$1 million usd invested in our U.S. PORTFOLIO CONSTRUCTION
Equity Portfolio in 1986 (its inception In terms of asset mix and portfolio For further information,
date) would have grown to $8.7 million construction, we offer a unique marriage please contact
usd on March 31, 2010 versus $6.9
3
between our bottom-up security-specific questions@gluskinsheff.com
million usd for the S&P 500 Total fundamental analysis and our top-down
Return Index over the same period.
macroeconomic view.
Notes:
Unless otherwise noted, all values are in Canadian dollars.
1. Preliminary unaudited estimate.
2. Not all investment strategies are available to non-Canadian investors. Please contact Gluskin Sheff for information specific to your situation.
3. Returns are based on the composite of segregated Value and U.S. Equity portfolios, as applicable, and are presented net of fees and expenses.
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August 9, 2010 – BREAKFAST WITH DAVE

IMPORTANT DISCLOSURES
Copyright 2010 Gluskin Sheff + Associates Inc. (“Gluskin Sheff”). All rights and, in some cases, investors may lose their entire principal investment.
reserved. This report is prepared for the use of Gluskin Sheff clients and Past performance is not necessarily a guide to future performance. Levels
subscribers to this report and may not be redistributed, retransmitted or and basis for taxation may change.
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 Foreign currency rates of exchange may adversely affect the value, price or
simultaneously to internal and client websites and other portals by Gluskin income of any security or financial instrument mentioned in this report.
Sheff and are not publicly available materials. Any unauthorized use or Investors in such securities and instruments effectively assume currency
disclosure is prohibited. risk.

Gluskin Sheff may own, buy, or sell, on behalf of its clients, securities of Materials prepared by Gluskin Sheff research personnel are based on public
issuers that may be discussed in or impacted by this report. As a result, information. Facts and views presented in this material have not been
readers should be aware that Gluskin Sheff may have a conflict of interest reviewed by, and may not reflect information known to, professionals in
that could affect the objectivity of this report. This report should not be other business areas of Gluskin Sheff. To the extent this report discusses
regarded by recipients as a substitute for the exercise of their own judgment any legal proceeding or issues, it has not been prepared as nor is it
and readers are encouraged to seek independent, third-party research on intended to express any legal conclusion, opinion or advice. Investors
any companies covered in or impacted by this report. 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
Individuals identified as economists do not function as research analysts of legal proceedings in which any Gluskin Sheff entity and/or its directors,
under U.S. law and reports prepared by them are not research reports under officers and employees may be plaintiffs, defendants, co-defendants or co-
applicable U.S. rules and regulations. Macroeconomic analysis is plaintiffs with or involving companies mentioned in this report is based on
considered investment research for purposes of distribution in the U.K. public information. Facts and views presented in this material that relate to
under the rules of the Financial Services Authority. any such proceedings have not been reviewed by, discussed with, and may
not reflect information known to, professionals in other business areas of
Neither the information nor any opinion expressed constitutes an offer or an Gluskin Sheff in connection with the legal proceedings or matters relevant
invitation to make an offer, to buy or sell any securities or other financial to such proceedings.
instrument or any derivative related to such securities or instruments (e.g.,
options, futures, warrants, and contracts for differences). This report is not Any information relating to the tax status of financial instruments discussed
intended to provide personal investment advice and it does not take into herein is not intended to provide tax advice or to be used by anyone to
account the specific investment objectives, financial situation and the provide tax advice. Investors are urged to seek tax advice based on their
particular needs of any specific person. Investors should seek financial particular circumstances from an independent tax professional.
advice regarding the appropriateness of investing in financial instruments
and implementing investment strategies discussed or recommended in this The information herein (other than disclosure information relating to Gluskin
report and should understand that statements regarding future prospects Sheff and its affiliates) was obtained from various sources and Gluskin
may not be realized. Any decision to purchase or subscribe for securities in Sheff does not guarantee its accuracy. This report may contain links to
any offering must be based solely on existing public information on such third-party websites. Gluskin Sheff is not responsible for the content of any
security or the information in the prospectus or other offering document third-party website or any linked content contained in a third-party website.
issued in connection with such offering, and not on this report. 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
Securities and other financial instruments discussed in this report, or this report does not imply any endorsement by or any affiliation with Gluskin
recommended by Gluskin Sheff, are not insured by the Federal Deposit Sheff.
Insurance Corporation and are not deposits or other obligations of any
insured depository institution. Investments in general and, derivatives, in All opinions, projections and estimates constitute the judgment of the
particular, involve numerous risks, including, among others, market risk, author as of the date of the report and are subject to change without notice.
counterparty default risk and liquidity risk. No security, financial instrument Prices also are subject to change without notice. Gluskin Sheff is under no
or derivative is suitable for all investors. In some cases, securities and obligation to update this report and readers should therefore assume that
other financial instruments may be difficult to value or sell and reliable Gluskin Sheff will not update any fact, circumstance or opinion contained in
information about the value or risks related to the security or financial this report.
instrument may be difficult to obtain. Investors should note that income
Neither Gluskin Sheff nor any director, officer or employee of Gluskin Sheff
from such securities and other financial instruments, if any, may fluctuate
accepts any liability whatsoever for any direct, indirect or consequential
and that price or value of such securities and instruments may rise or fall
damages or losses arising from any use of this report or its contents.

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