David A. Rosenberg November 30, 2009
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
MARKET MUSINGS & DATA DECIPHERING
Breakfast with Dave
WHILE YOU WERE SLEEPING
IN THIS ISSUE
The markets are assessing what areas of the global banking system are most
exposed to the Dubai situation, and have very quickly come to the conclusion that • While you were sleeping; it
it is Europe (where equities are down a further 1.0% so far today). Asia is seems that Europe is
emerging relatively unscathed with Japan up 264 points, or 2.9%, to 9,345 and deemed as being more
Hong Kong recovering 687 points, or 3.2%, to 21,821. In fact, most of Asia was exposed to the Dubai
situation than Asia —
up 2.0% or more today.
European bourses are
down nearly 1% today
Bonds are relatively flat and the DXY index is back down 15bps to 74.71 as it goes while Asian markets are
back to challenge the nearby lows — flight-to-safety trades are being limited by the up more than 2%
central bank of the UAE stating that it will back any losses caused by Dubai
• U.S. Black Friday/Post-
World’s possible default. Thanksgiving retail sales
disappoint — despite all
U.S. BLACK FRIDAY/POST-THANKSGIVING SALES DISSAPOINT the promotions and
Despite all the promotional activity and gimmicks, the best the National Retail gimmicks, the best retail
Federation could give us was a paltry +0.5% YoY post-Thanksgiving sales pace sales could muster was a
paltry 0.5% YoY increase
(November 26-29). Considering that this is off an alleged “end-of-world” level
of a year ago, what does a flat trend from then make this year if not something • Keep an eye on the credit
very similar. (Don’t tell that to Mr. Market who has visions of a V-shaped markets again — real
rates, have collapsed
recovery this Christmas). This +0.5% pace was with the number of shoppers
34bps since the end of
rising to 195 million from 172 million a year ago, so that says something October; Baa corporate
about this secular trend towards ‘frugality’ (more below) and unfortunately, spreads are 13bps wider
shopper traffic does not go into GDP (see More Shoppers Hit Stores, But from the nearby lows and
Spend Less on page B1 of the WSJ). high-yield spreads have
widened out 25bps
What consumers paid for in the bags does go into GDP; however, and online • Memories of Dubai — the
surveys show that the average consumer spent $343.31 (including online sales) current Dubai situation is
versus $372.57 when shoppers were reportedly comatose this time last year. This a reminder that there is
still so much debt that is
8% slide (worse than the 3% slide per capita that was being projected … at least so
still being supported by
far) is symptomatic of a deflationary state insofar as it pertains to the items that go questionable collateral
into the CPI (gold, copper and crude not included).
• More on the depression —
we currently have a
The Cincinnati PMI just came out and bounced to 51.3 in November from 44.6 in
situation that is not
October and this may lead some to hyperventilate over today’s Chicago PMI report consistent with a plain-
and tomorrow’s ISM index — but a three-point pop in this diffusion index in October vanilla recession but with
coincided with a 0.1% dip in manufacturing activity during the month, so it’s a depression
questionable as to how useful it is since it has a large company bias and it is small
companies that are currently in cutback mode (and they account for 65% of the
jobs pie). This is why the National Federation of Independent Business optimism
index at this stage may be a more accurate barometer of what is really going on in
the economy and it has far lagged behind the ISM recovery.
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
November 30, 2009 – BREAKFAST WITH DAVE
As an aside, Black Friday and the first post-Thanksgiving weekend sales can
often be misleading. Look at what happened last year when sales were greeted Because of seasonal
with a sigh of relief because they were only down 1.0% YoY at first to only finish adjustment vagaries in
off the holiday season down close to 6.0% YoY. There is also a sense that job various economic data, (ie,
market conditions are improving because jobless claims fell to 466k last week, initial jobless claims,
but the truth be told, without the benefit of an aggressive seasonal adjustment employment) treat the
factor, claims really came in at 544k on a raw basis. Look for seasonal data very judiciously
adjustment vagaries to give a similar illusion towards an employment recovery
this Friday — treat the data very judiciously.
KEEP AN EYE ON THE CREDIT MARKETS AGAIN
What we find most interesting is that despite Warren Buffett’s foray, the transports
have not managed to make a new high since November 17 and that is despite the
benefit from lower energy costs (even more importantly, the S&P financials have
failed to make a new high in six weeks). Real rates, as proxied by the yield on 10-
year TIPS, have collapsed to 1.16% from 1.50% at the end of October breaking
below the March 2009 low and now back to where it was in March 2008 when the
recession was just getting going (and real rates tend to lead real GDP). Baa
corporate spreads are 13bps wider from the nearby lows and high-yield spreads
have widened out 25bps. Nothing major but keep an eye on the credit markets.
CHART 1: REAL INTEREST RATES MELT DOWN AGAIN
United States: 10-year Treasury Inflation Indexed Note Yield
(percent)
3.2
2.8
2.4
2.0
1.6
1.2
0.8
08 09
Source: Haver Analytics, Gluskin Sheff
The ECRI leading economic index that led the green shoots in the data during the
spring has slowed now for six weeks in a row, to stand at a two-month low.
Meanwhile, Market Vane bullishness on equities has risen to 54%, the highest
since May 2008 when investors were bracing for a post-recession recovery and
right where it was when the fun began in November 2007. Complacency reigns.
Page 2 of 10
November 30, 2009 – BREAKFAST WITH DAVE
THE WEEK AHEAD
It is a busy week ahead with ISM, auto sales, chain-store sales, the Fed’s beige Memories are indeed
book, nonfarm payrolls, plus the ECB meeting on Thursday and Bernanke heading short, especially when it
to the Hill to defend his reappointment in front of the Senate. The Reserve Bank comes to trauma
of Australia meets tomorrow and there is growing market chatter of another
Australian rate hike coming.
MEMORIES OF DUBAI
Memories are indeed short, particularly as it pertains to trauma. So, perhaps
it is not surprising that the investment community appears to be have been
oblivious to the long list of serious risks still lurking in the global economy and
capital markets.
Perhaps the most obvious one is that there is still so much debt that is still
being supported by questionable collateral as well the cash flows required to
service them. The current Dubai debacle is just one example but is
particularly iconic insofar as the ‘Las Vegas of the Middle East’, as it had come
to be known, is such an oxymoron (indoor ski area and all).
And it’s not just Dubai World. In the past week, we have seen Russia and
Switzerland intervene in the foreign exchange markets, with Japan probably Given the situation in
not far behind. Mexico was just downgraded to BBB and the EU is trying to Dubai, along with Mexico’s
figure out what to do with Greece. In addition, Vietnam devalued its currency
downgrade, Russia and
Switzerland’s FX
(the Dong) and dramatically raised interest rates in a classic beggar-thy-
intervention and Vietnam’s
neighbor policy that conjures the memory of the Thai Baht devaluation of mid-
currency devaluation …
1997, which at the time did not make front page news, but inevitably was the
launching pad for the Asian meltdown. One must wonder how China will fit
into all this, with a dramatically undervalued exchange rate, a property market
heading further into a bubble, and a banking sector that is now being forced to
improve its depleted capital ratios.
So the odds increasingly favour that the head-first dive into risk assets over
the past eight months was just a bear market rally that could end in tears.
We went into this latest round of turbulence with tremendous complacency in the
marketplace (I really sensed it during the two-hour stint on CNBC’s Squawk Box
last Tuesday) — rallies were still light-volume in nature (only two sessions in the
past three weeks with NYSE volume north of a billion shares), the VIX index had
just receded to its low for the year, at 20.5 (down 60% since March!), the bull/bear
share of the sentiment surveys hit late-2007 levels, and with the trailing P/E ratio
… the odds increasingly
for the S&P 500 sat at 27x and the forward P/E on $65 of earnings of 17x. There favour that the head-first
is no margin for error in an overvalued equity market — one that is priced for nearly dive into risk assets over
5% GDP growth. Remember, it was in the fourth quarter of 1987, a quarter that the past eight months was
saw 7% GDP growth and a 55% earnings trend, that the S&P 500 cratered 30%. just a bear market rally
So, it’s not just about the economic backdrop, it’s what is being priced in — that is that could end in tears
the lesson. For a highly overvalued market, it does not take much — like an off-
the-cuff remark from the Treasury Secretary on the Meet the Press — to entice a
massive round of profit-taking.
Page 3 of 10
November 30, 2009 – BREAKFAST WITH DAVE
While the equity market this year has been busy repricing an era of minimal
risk and maximum growth, what was lost in the violent up-move from the The range of possible
March lows was that the credit-related issues left over from the bubble that macroeconomic and
burst in 2007 are far from resolved (as the Lex column aptly put it in today’s market outcomes in the
FT, “Dubai is a reminder the world is not out of the woods”). aftermath of a credit
collapse is usually very
Moody’s credit card delinquency rate in the U.S. rose 15bps in October, to 6.12% wide
and is well above the 4.96% rate this time last year. And, Freddie Mac’s mortgage
series shows that delinquency rates here rose 21bps last month, to 3.54% and
has jumped by more than a percentage point since the spring (not sure that
classifies a ‘green shoot’). Moreover, according to the Federal Deposit Insurance
Corporation (FDIC), the number of “problem” banks has swelled to 552 (with
nearly $350 billion in assets), as of Q3 — a 33% increase from the end of the
second quarter (not to mention the fact that 124 banks have already failed this
year versus 25 for all of last year). The insurance agency is now stuck with an
$8.2 billion deficit (and at a time when the FHA has broken well below its
capitalization rate of 2%) — the first time this has happened since 1992.
Indeed, the range of possible macroeconomic and market outcomes in the
aftermath of a credit collapse is usually very wide — resolutions rarely occur as
quickly as the equity market has discounted over the past eight months, along
with many other risky assets. Just go to the Federal Open Market Committee
(FOMC) minutes and see the wide divergence of views over the macro outlook,
and this is coming from 17 of the nation’s top policymakers who also
ostensibly keep in touch with each other. The range on 2010 GDP estimates
is: 2.0% to 4.0%; for 2011, 2.5% to 4.6%, and 2.8% to 5.0% for 2012. These
two percentage points are huge for a $14 trillion economy — we’re talking
about differences that amount to $300 billion!
CHART 2: RANGE OF POSSIBLE OUTCOMES EXTREMELY WIDE
United States: The Federal Open Market Committee’s Range Forecast
Real GDP (ann. % change) Unemployment Rate (%) Inflation* (ann. % change)
5.5 11 3.0
Min 5.0 Min Min
10.2
5.0 2.4
Max 4.6 Max Max 2.3
10 2.5
4.5 2.0
4.0
2.0
4.0 8.7
9 8.6
3.5 1.5
2.8 8 1.1
3.0 7.6
2.5 7.2 1.0
2.5 0.6
2.0 7
0.5
2.0 0.2
6.1
1.5 6 0.0
2010 2011 2012 2010 2011 2012 2010 2011 2012
*Looking at PCE price index
Source: Federal Open Market Committee, Gluskin Sheff
Page 4 of 10
November 30, 2009 – BREAKFAST WITH DAVE
The range on the unemployment rate forecast for 2010 is 8.6% to 10.2%; for Buying call options on
2011 it is 7.2% to 8.7%; and for 2012, the band is 6.1% to 7.6%. These volatility has rarely looked
ranges are massive. as attractive as is the case
today if this Dubai
And, for the inflation rate, the range for 2010 is 1.1% to 2.0%; 0.6% to 2.4% situation turns into
for 2011, and for 2012, the range is 0.2% to 2.3%. So consider that at the something similar to what
Fed, there is one official that sees the potential for a return to full employment happened in Thailand,
by 2012; and another that sees the prospect of deflation. These views are Russia or Argentina in the
worlds apart and attest to our assertion that the band around any particular past
forecast in a post-bubble credit collapse is huge.
Buying call options on volatility has rarely looked as attractive as is the case
today if this Dubai situation turns into something even fractionally similar to
what happened in places like Thailand, Russia or Argentina. Once the
complacency is shaken out of the market, which in our view would be a good
thing, it is going to give those who have been skeptical over this “liquidity-
induced” rally a chance to take out our rulers and sharpen our pencils.
MORE ON THE DEPRESSION
Last week, we received some classic guffaws when we responded to whether
or not the recession has ended with this: “We’re not convinced, but even if it is
statistically over, the depression is ongoing”.
We were reprimanded by former Fed Governor Mishkin for breeding “fear”.
The eyes were rolling among the Squawk Box crew and we were told to tell
that to Mr. Market, who has rallied more than 60% from the March lows
(“artificial” lows, we were told off camera). After all, Mr. Market is so adept at
calling the economy – like the peak in late 2007, literally weeks ahead of what
the polite economics crowd dubs “The Great Recession”; or how adept Mr.
Market was in calling the 2001 tech wreck; or the three failed attempts at
predicting recovery over the past two years. Mr. Market’s ability at calling the
economy, is shall we say, a tad spotty.
In fact, even with the massive amount of stimulus in modern history, all the
economy could do was muster up a 2.8% annualized growth rate in Q3. If that
number stands, it will go down as just about the poorest bounce off a
recessionary environment on record. History, by the way, shows that 80% of
the time, the opening quarter of the recovery ends up being a pretty good
predictor over the extent of the economic pickup we see in the year that
follows. So, that near 5% GDP growth backdrop being projected by Mr. Market
right now looks to be more than just a tad dubious.
Page 5 of 10
November 30, 2009 – BREAKFAST WITH DAVE
CHART 3: REAL GDP GROWTH IN THE FIRST QUARTER OF AN ECONOMIC
EXPANSION/RECOVERY
United States: Real GDP
(quarter-over-quarter percent change at an annual rate)
20
18 17.2
16
14
11.5
12
9.7
10
7.7 7.6
8 7.3
6 5.1
4.6
4 3.5
3.1 2.8
2.7
2
0
1950 Q1 54 Q3 58 Q3 61 Q2 71 Q1 75 Q2 80 Q4 83 Q1 91 Q2 02 Q1 Average Current *
Quarter #1 of the Economic Expansion/Recovery
*As of Q3 2009
Source: Haver Analytics, Gluskin Sheff
CHART 4: HOW THE ECONOMY PERFORMS ONE YEAR INTO AN
ECONOMIC EXPANSION/RECOVERY
United States: Real GDP
(four quarter annual average growth rate)
12
10.4
10
8.5
8.1
8
7.0
6.7
6.2
6 5.6
4 3.5
3.0
2 1.4 1.5
0
1950 Q1 54 Q3 58 Q3 61 Q2 71 Q1 75 Q2 80 Q4 83 Q1 91 Q2 02 Q1 Average
Quarter #1 of the Economic Expansion/Recovery
Source: Haver Analytics, Gluskin Sheff
Page 6 of 10
November 30, 2009 – BREAKFAST WITH DAVE
Now, as for calling this a ‘depression’, it is an attempt at providing a reality Currently, we have a
check to Wall Street research forecasts of a robust recovery. Practically situation that is not
everyone thought the worst was over in 1930 but all we were in at that time consistent with a plain-
was the classic phase 2 of the triple-waterfall — the “reflex rally” that comes vanilla recession but with
on the heels of the “initial sharp down” to only then be followed by the long a depression because
and drawn out decline to the fundamental low. The Great Depression didn’t depressions are
even receive that label until 1934 and by then we were well over a year past associated with credit
the lows in both real GDP and the stock market. contraction and asset
deflation
But it was a treacherous environment for the rest of the decade and despite
seven years of huge stimulus — and resource-misallocation distortions from
the FDR New Deal — the unemployment rate still finished off the 1930s at
15%; the CPI was still deflating at a 2% annual rate; nominal GDP had still yet
to re-attain its 1929 peak; and the next secular bull market in equities did not
commence for another 15 years. Income strategies worked best even after
the S&P 500 hit bottom; and gold doubled in Sterling terms. Equity rallies
came … and they went. Volatility reigned. What goes around comes around.
Currently, we have a situation that is not consistent with a plain-vanilla recession
but with a depression because depressions are associated with credit contraction
and asset deflation. It is more than just about a mathematical contraction in GDP.
In recessions, social change does not occur. In depressions, they do. Hence the
fact that in Halloween, the reason why sales-related items were so tepid was
because 30% of families made their own costumes.
Frugality does not emerge as secular theme in a garden-variety recession but it
does in a depression. More than a year after Lehman’s collapse, and nine
months after the depths of the economic slide, we continue to see headlines like Frugality does not emerge
this (Stores Are Swamped by Thrifty Shoppers) make it to the front page of the
as secular theme in a
garden-variety recession
weekend Financial Times. If the U.S. consumer was about to embark on his/her
but it does in a depression
old spending patterns of the past then take it from us, stores like Old Navy
would not have opened their doors at 3:00 a.m. on Friday (three hours after Toys
R Us opened).
As we said, we are undergoing a social change — and change that is secular in
nature, not merely cyclical.
In a recession, we do not typically see:
• 15.7 million American households, or a third of those with a mortgage, have
negative net equity (see page A16 — Housing Weighs on the Economy — of the
Saturday NYT).
• 17.5%, or 1 in 6 Americans, are either unemployed or underemployed.
• A mere 3.2% of respondents to the latest Conference Board’s Consumer
Confidence Survey believe jobs are plentiful — this is amazing considering that
we have a 0% funds rate, a $1.4 trillion budget deficit, a super-weak
exchange rate, and a $2.2 trillion Fed balance sheet. What should be done
for an encore?
Page 7 of 10
November 30, 2009 – BREAKFAST WITH DAVE
• 1 in 7 Americans with a mortgage are now either in arrears or in the
foreclosure process. In a recession, you don’t see, already two years after the
recession began, articles like this make it to the front page of the Sunday NYT
— U.S. to Pressure Mortgage Firms For Loan Relief: Official Faults Banks —
Karl Marx would be proud.
• Small business failures are up 44% year-over-year as was the case in Q3 this
far into a Fed easing cycle.
• 1 in 8 Americans are now on food stamps and there are 239 counties where
at least 25% of the population is on the program (again, see the front page of
the Sunday NYT).
• A 35% slide in home prices; a 50% plunge in commercial real estate values; and
a 20% mall vacancy rate nationwide (see page M6 of Barron’s) — between 250
and 300 million square feet of retail space has to vanish just to bring the
vacancy rate down to 12%. Some food for thought for those that think we are
about to embark on anything close to a normal economic recovery.
Page 8 of 10
November 30, 2009 – BREAKFAST WITH DAVE
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