Dave Rosenberg 12/07/2009 by etfdesk


									David A. Rosenberg                                              December 7, 2009
Chief Economist & Strategist                                    Economic Commentary
+ 1 416 681 8919


Breakfast with Dave
                                                                                                                   IN THIS ISSUE
Equity markets are mixed to lower to start off the week: Europe is off 0.5% at
this moment and the Hang Seng index is off 0.8% to 22,324. The Nikkei,                                             • While you were sleeping —
however, has all of a sudden emerged as a global outperformer, gaining 145                                           global equity markets are
                                                                                                                     mixed; bonds rallying
points, or +1.5%, to close at 10,167. Both the Shanghai and the Korean Kospi                                         across the globe U.S.
also eked out 0.5% gains apiece. Bonds are rallying across the globe following                                       dollar remains firm
Friday’s post-payroll slaughter.
                                                                                                                   • We list 10 reasons why we
                                                                                                                     believe that the sweet
The U.S. dollar remains firm; the DXY index just crossed above its 50-day moving                                     spot is over with regard to
average. The commodity complex, including gold, is now in reverse, albeit for only                                   the market
the short-term as all the speculative long positions we have been discussing in this
                                                                                                                   • Outside reversal — in the
space for the past month get cleared out.
                                                                                                                     last two trading days, both
                                                                                                                     the S&P 500 and the Dow
We have Bernanke speaking today, the Bank of Canada policy meeting tomorrow,                                         could not hold on to their
retail sales data to close out the week and a ton of bond supply to hit the market                                   intra-day highs
(see below).
                                                                                                                   • Was the drop in the U.S.
                                                                                                                     jobless rate a big deal?
On the economic data front today, it’s pretty sparse but what there was, was not                                     We don’t think so
very pretty — German factory orders unexpectedly declined by 2.1% in October —
                                                                                                                   • A 1-in-35 event —
the consensus was looking for a 0.8% advance (and the YoY trend is firmly                                            according to the U.S.
ensconced in negative terrain, at -8.5%).                                                                            Bureau of Labor Statistics,
                                                                                                                     the service sector added
THE SWEET SPOT IS OVER                                                                                               58k jobs in November;
Below are 10 reasons why we believe this:                                                                            however, the ADP report
                                                                                                                     showed an 81k decline
1.    For the time being, the equity market is going to have to contend with                                       • The case for a further
      more chatter of the Fed’s exit strategy.                                                                       near-term job market
2.    The market also faces a new reality. While employment stabilizing                                              improvement; the
      (maybe) is a good thing, it means the era of declining unit labour costs                                       question is going to be
      and margin expansion is behind us.                                                                             how the equity market
                                                                                                                     deals with this reality
3.    Market leadership is beginning to fade as seen by the receding advance-
      decline line on the big board.                                                                               • November U.S. retail sales
4.    Market complacency is a worry with the VIX index back down to 21.25.
      The good news is that insurance against a correction is priced about as                                      • A word on U.S. bonds
      low as it can go. Protection is cheap.
                                                                                                                   • From the sublime to the
5.    The WSJ (page C1) reports that not only have individual investors been                                         ridiculous
      selling into this last leg of the rally (then again, the S&P 500 has really
      done nothing for over six weeks), but pension funds have been                                                • Now how brilliant is that?
      rebalancing too.                                                                                             • Long live the green
6.    Volume has declined markedly and has surpassed 4.7 billion shares on                                           shoots!
      the NYSE just once in the past three weeks.                                                                  • U.S. commercial real
                                                                                                                     estate in disarray

Please see important disclosures at the end of this document.

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms. Founded in 1984 and focused primarily on high net
worth private clients, we are dedicated to meeting the needs of our clients by delivering strong, risk-adjusted returns together with the highest
level of personalized client service. For more information or to subscribe to Gluskin Sheff economic reports, visit www.gluskinsheff.com
December 7, 2009 – BREAKFAST WITH DAVE

7.   With the correlation between a weak greenback and a positive stock               In the U.S., it was fascinating
     market above 90% over the past eight months (versus zero over the past
     30 years), a countertrend rally in the U.S. dollar would likely coincide with
                                                                                      to see the stock market’s
     sputtering equity prices.                                                        reaction to the employment
                                                                                      data on Friday; the markets
8.   The Dow transports/utilities ratio has turned in a classic triple-top and        couldn’t handle the good
     this is a signpost to get defensive.
                                                                                      economic news
9.   The latest Investors Intelligence poll shows the bull camp at 50%; the
     bear share at a mere 16.7%. In other words, there are three bulls for
     every bear. This is negative from a contrary perspective (another sign of
10. Corporate bond yields have stopped narrowing over the past three
    months and have actually recently shown modest signs of an upward bias.

In the U.S., it was fascinating to see the stock market’s reaction to the
employment data on Friday. The markets couldn’t handle the good economic
news very well considering that we closed the S&P 500 at 1,106 versus the intra-
day high of 1,119; and the Dow finished at 10,389 compared to its intra-day high
of 10,516. Indeed, this was the second outside reversal session in a row, and
leadership is beginning to falter. The Nasdaq just can’t seem to crack the 2,200
threshold despite the strength in the semiconductor group, which has emerged as
a leader (and Apple, can you believe it, just lost its 50-day trendline!). What
explains this behaviour?

1.   Classic buy the rumour, sell the fact.
2.   The market had already priced in the jobs recovery long ago.
3.   Investors had become accustomed to treating negative employment
     positively because of what it meant for costs and margins.
4.   By giving the greenback a lift, the stronger than expected jobs data took away
     the dollar “carry trade” (the key reason why gold was knocked down …
5.   Fed tightening expectations have crept back into the marketplace.

In our opinion, the answer is no. This was the eighth time we have seen the
unemployment rate go down in a month since it bottomed back in October                Since the U.S. jobless rate
2006. Nothing moves in a straight line. The peak still lies ahead of us.              bottomed back in October
                                                                                      2006, we have seen it go
In the prior cycle, the unemployment rate bottomed on April 2000, at 3.8% and         down eight times in a given
peaked at 6.3% on June 2003. During that time, we saw the jobless rate fall five      month; the peak still lies
times. In the early 1990s cycle, the unemployment rate actually fell no fewer
                                                                                      ahead of us
than six times. Declaring victory because of a one-month wiggle can be
dangerous. Especially since a key reason why the jobless rate dipped was
because the ranks of discouraged workers who exited the labour force due to
grim job prospects jumped 60,000 to 357,000 last month.

                                                                                                          Page 2 of 9
December 7, 2009 – BREAKFAST WITH DAVE

As for the -11k print on Friday’s headline payroll report, unadjusted, the number
was +80k, which therefore goes down as the third softest November reading in         It’s remarkable nobody talks
the past 18 years. November is normally a month where between 300k and               about this; the big surprise in
500k workers find a job before the seasonal adjustment kicks in. Something to        the payroll data was the
keep in mind.                                                                        service sector component; it
                                                                                     rose 58k, but we know from
A 1-IN-35 EVENT                                                                      the ADP report that service
                                                                                     sector employment fell 81k
It’s remarkable nobody talks about this. The big surprise in the payroll data was
the service sector component; it rose 58k. But we know from the ADP report
that service sector employment fell 81k, which was fractionally worse than the
79k decline in October. Such a discrepancy has occurred less than 3% of the
time in the past, and each time, the following month after the big gap, there was
a convergence ... with headline nonfarm payrolls swinging 100k lower on
average, which would imply a 111k decline when December’s figure comes out.

Also take note that the +58k print in the service sector payroll was completely at
odds with the 41.6 reading in the ISM non-manufacturing employment index in
November — a figure that in the past was consistent with a -192k tally in service
sector payrolls and never before aligned with a positive number. Go back to the
2001 recession, and the worst ISM non-manufacturing jobs subindex was 43.9
(right after 9/11) and here we published a figure that was more than two points
shy of that!

So as we wonder how the headline number could only be -11k on Friday, there
were some very lumpy increases in some very non-cyclical segments of the

• Administration/waste management +87k
• Health/education +40k
• Government +7k

The rest of the economy shed 145 jobs and the declines were spread across
nearly 60% of the industrial base from retail, to transports, to manufacturing, to
construction. For some reason, we didn’t see this dichotomy mentioned
anywhere in the weekend press.

The Canadian employment data, while robust on the surface, also had its own          The Canadian employment,
peculiarities — like half the gain being in education (more teachers in              but beneath the surface, it
November?); wages declining (even with a lower unemployment rate?); and the          also had its own peculiarities
workweek contracting (more bodies, fewer hours — reverse of what we saw
stateside). We would have to think that Mr. Carney is going to look through this
spurious piece of Household employment this week, especially since GDP
growth is already coming in well below official forecasts.

                                                                                                         Page 3 of 9
December 7, 2009 – BREAKFAST WITH DAVE

There is a case to be made that we will go through a continuation of the good           How will the equity markets
news on the job front, and the question is going to be how the equity market            deal with the new normal of
deals with the new normal of no more job destruction and no more cost                   no more job destruction and
containment. Pricing power better come back along with what could be a                  no more cost containment?
temporary — underline temporary — jobs spurt due to:

1.   A skew from the seasonal adjustment factors caused by the massive
     losses from November 2008 to May 2009.
2.   Obama hiring 1.5 million people during Q1 to conduct the census (it will
     last into April).
3.   We are about to see the President (tomorrow, in fact) announce a slate of
     job creation measures including tax credits for new hiring and additional
     infrastructure spending as well as more financial aid to state and local
4.   Based on what the automakers are saying, we should be seeing a 10%
     sequential rise in motor vehicle production in the first quarter as well.
5.   The November employment report showed there to be upward revisions, a
     hefty gain in temp agency employment and a healthy increase in the
     workweek — all leading indicators and the first time we have seen such a
     trio in three years.

That said, we think that once we get beyond the census effect post first-quarter,
employment is likely to weaken again and we continue to see new highs ahead
for the jobless rate. Economists who continue to use the experiences of the
post-WWII recession, which was a mere correction in GDP in what was a secular
credit expansion, are doomed to failure, as so many were heading into the
collapse of late-2007, 2008 and early 2009.

According to Retail Metrics, same store sales edged up 0.7% YoY in November,
which was well below an already downwardly revised +2.2% estimate. And this             The job picture may look
                                                                                        better, but the spending
is off a -7.3% trend in November 2008, so sales were more than 6% lower than
                                                                                        picture sure doesn’t
they were in November 2007 in the face of all the stimulus. Moreover, despite
all the promotional activity, 75% of retailers could not hit their sales targets last
month. The job picture may look better, but the spending picture sure doesn’t.

This is what Ken Perkins, president of Retail Metrics, had to say about the sales

“This doesn’t bode well for the next three weeks. I think we will see more
promotions than planned. Shoppers are focused on deals and necessities and
retailers are going to have to make it worth their while”.

                                                                                                           Page 4 of 9
December 7, 2009 – BREAKFAST WITH DAVE

What we mentioned above is certainly not the sort of deflationary backdrop that
                                                                                         The U.S. bond jitters could
will cause bond yields to rise materially despite the near-term negative technical
                                                                                         be with us for a short while,
backdrop. There is certainly no sign at all that foreign central banks are
                                                                                         but we doubt a sustained
abandoning the U.S. Treasury market (see China Holds Steady on Treasurys on
                                                                                         backup in yields is going to
page A14 of the WSJ). And the renewed Fed rate hike expectations that have               be likely
come back into the market seem to be a tad premature from our lens (the
futures market is now pricing in 74% odds that the Fed begins to hike rates by
June, up from 42% before the November payroll report came out).

The Treasury market is going to contend with some massive supply in the
coming week — totalling $135 billion: $30 billion in three-month Treasury bills
and $31 billion of six-month bills today; $40 billion of three-year Treasury notes
on Tuesday; $21 billion in a 10-year re-opener on Wednesday; $13 billion in a
30-year re-opener on Thursday. We also have Bernanke on tap today and retail
sales to close out the week. The bond jitters could be with us still for a short
while, but to repeat, we doubt a sustained backup in yields is going to be likely.

The “Streetwise” column in the current edition of Barron’s (It’s Still Too Early to
Worry Too Much) runs with a series of assertions otherwise dubbed “common
misperceptions” — one of them being that the U.S. consumer is really not 70%+
of the economy because “only a quarter of it is truly discretionary.”

We’ll get back to this in a second, but the fact of the matter is that much of what
appears to be non-cyclical is in fact, cyclical (like elective surgery in health care;   Even if it is true that
veal chops in the food category, etc). Second, even if this assertion is correct that    consumer discretionary
‘only’ 25% of consumer spending is economic-sensitive, it begs the question as to        spending is just 25% of total
why that is important in anyone’s analysis. Is 25% small? If it is, then what is         expenditure, that would still
going to be the driver for the economy going forward; government spending? If            make it the largest cyclical
25% is small, then how is it that on average consumer spending manages to                component of the economy
generate 300 basis points of growth for the economy coming out of recessions —
because they are buying more soap and toothpaste with the other 75%? Maybe
that 25% (and that number is not correct but it doesn’t matter in any event) is a
huge swing factor in recessions and expansions for overall GDP growth. Once
again, this is a classic failure to assess the economic shifts at the margin.

Even if consumer discretionary spending is just 25% of the total expenditure pie
(and hence 17.5% of GDP), that would still make it the largest cyclical
component of the economy — almost double capital spending and exports, just
as an example, and almost eight times larger than housing and commercial

                                                                                                             Page 5 of 9
December 7, 2009 – BREAKFAST WITH DAVE

What does resonate with us are the workings of strategists from yesteryear,          It seems to us that most
when deep thinking took center court over data mining, and what we are               strategists and economists
referring to here is the works of Bob Farrell, the dean of Merrill Lynch research    are still operating under the
for roughly five decades. Back in August 2001, Bob published a report titled         assumption that the
Change May be Secular and opened with this paragraph:                                recession we just endured
                                                                                     was, although deep, a
“Change of a long term or secular nature is usually gradual enough that it is        familiar garden-variety, when
obscured by the noise caused by short-term volatility. By the time secular           in fact the new secular
trends are even acknowledged by the majority, they are generally obvious and         paradigm is one of credit
mature. In the early stages of a new secular paradigm, most are conditioned to       contraction and thrift
hear only the short-term noise they have been conditioned to respond to by the
prior existing secular condition. Moreover, in a shift in secular or long-term
significance, the markets will be adapting to a new set of rules, while most
market participants will still be playing by the old rules.”

It seems to us that most strategists and economists are operating under the
assumption that we are still in a secular credit expansion that began after WWII
and that the recession we just endured was deep but still had a familiar garden-
variety feel to it, when in fact, the new secular paradigm is one of credit
contraction and thrift. It is extremely difficult to shoehorn the trends of the
previous paradigm into the current reality and many mainstream market pundits
are resorting to torturing the statistics in order to do exactly that.

To say that discretionary consumer spending is only 25% obscures the point — in
much the same way as the legion of economists tried to convince investors not
to worry about housing as it fell off the cliff in 2006/2007 because it was “only”
5% of GDP. How did that level of ‘analyses’ benefit anyone?

All that is being said in reference to the consumer discretionary share of
spending being 25% (we won’t quibble with that number today but it is not
accurate) is that there are segments of consumer spending that have high
income elasticities and other segments that have low income
elasticities. Okay. That’s nice. However, the bottom line is that real organic
personal income has continued to deflate to new cycle lows and this process is
exerting ongoing downward pressure on discretionary spending (even in some of
the more economic-sensitive “staples” categories) and this is why the
government is being compelled to step in with tax rebates, cash-for-clunkers and
housing credits. In addition to weak personal income growth, there is also a
dramatic decline in credit at the household level that is ongoing, and without the
life support from Uncle Sam’s extreme generosity, consumer spending would be
under even more severe downward pressure.

                                                                                     According to the FDIC, there
The Federal Deposit Insurance Corporate (FDIC) ate six banks to close out the        are now 130 bank failures in
week, including AmTrust, the fourth largest failure of the year. This brings the     the U.S., which is more the
total this year to 130 — this is more than the total in the previous 16 years        total of the last 16 years
combined! Nice to see that the credit crunch is behind us.

                                                                                                        Page 6 of 9
December 7, 2009 – BREAKFAST WITH DAVE

As an aside, we also saw the latest ECRI leading index come out on Friday and
the smoothed level dropped to an 11-week low, of 23.4%. Could it be that             The U.S. government is
growth is peaking now?                                                               becoming increasingly
                                                                                     creative in its quest to raise
GEOPOLITICAL RISKS ARE HARDLY OFF THE TABLE                                          money to fund all of its fiscal
Without going into too much detail, we advise everyone to read the article on        interventions
page 27 of the Economist (An Iranian Nuclear Bomb, or the Bombing of
Iran?). This may be one reason why the recent giveback in gold and oil is going
to provide a very nice re-entry point for the commodity bulls.

The U.S. office vacancy rate has surged to 16.5% as of Q3 — a five-year high and
up 280 basis points from a year go. So far, landlords have only trimmed their
rents by 4.3% and we would be looking for some serious downward adjustments in
the coming 12 months. The commercial default rate now stands at a 16-year high
of 3.4% and is very likely heading into a 5.0-6.0% range over the next two years.

If you drive a car, I’ll tax the street,
If you try to sit, I’ll tax your seat,
If you get too cold, I’ll tax the heat,
If you take a walk, I’ll tax your feet.

The U.S. government is becoming increasingly creative in its quest to raise
money to fund all of its fiscal interventions — a new ‘Botax’ is coming (taxing
elective surgeries — nifty article on this on page A4 of the Friday WSJ). There is
also a move afoot in Congress to tax financial transactions (under the guise of
“speculation” — that evil activity). And guess what? The long-awaited repeal of
the estate tax? Well, we can forget that too (again, a good take on this in
Friday’s WSJ). And you can forget about the punitive Alternative Minimum Tax
ever being touched as well.

                                                                                                          Page 7 of 9
December 7, 2009 – BREAKFAST WITH DAVE

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Alternative and Fixed Income) and           safety for the payment of interest and                                                              $15.5 million2 on
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          1                                                                                                                                     September 30, 2009
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The minimum investment required to                               We assemble concentrated portfolios                                            S&P/TSX Total Return
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