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David A. RosenbergJune 17, 2009
 Chief Economist & Strategist Economics Commentarydrosenberg@gluskinsheff.com+ 1 416 681 8919
 
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 1984and 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 highestlevel of personalized client service. For more information or to subscribe to Gluskin Sheff economic reports
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visit www.gluskinsheff.com
 
MARKET MUSINGS & DATA DECIPHERING
Breakfast with Dave
GREEN SHOOTS TURNING BROWNISH
Well, we can forget about calling for an end to the recession. Three of theingredients are still contracting:1.
 
Industrial production is still contracting — down 1.1% in May and thiscame on top of a downwardly revised -0.7% print in April (was -0.5%).This was the SEVENTH decline in a row and left the level of production atan 11-year low (July 1998, believe it or not). Even outside of the autoindustry (-7.9%), output was still down 0.7% last month and it is now verydifficult to discern any improvement at all since the credit collapsestarted to subside in March. Every major industry posted a decline in May— so much for the ISM (then again, it is only a diffusion index). Oh yes, itis early days yet but we do have the NY Empire index and it fell back to-9.41 in June from -4.55 in May — and this is a proxy for tech spending.It’s a sign that we could see a setback for ISM this time around — thoughwe will await the Philly Fed survey before making any definitive statement.2.
 
Employment fell in May — indeed, the 345k slide in May was worse than the depths posted in each of the last two recessions. Strange way for arecession to end. As for jobless claims, it is not enough that they havefallen from their near-depression highs — they have to break well below500k before payrolls stop declining, and only then will it be safe to call for the end of the recession.3.
 
Real organic personal income — one of the key ingredients (sorry, but theECRI, which was predicting an ongoing boom in July 2007, doesn’t go into the NBER definition). Never mind ‘real’, in nominal terms, average weeklyearnings fell 0.2% in May for the second time in the last three months. Yes, yes, the housing start number was a good number, especially the single-family result (+7.5% to 401k units at an annual rate — the third increase in arow); as well as the 7.9% MoM bounce in single-family permits. Still, it is difficult to really say anything except that perhaps the single-family sector has foundbottom — after all, natural demographic demand for single-family homes iscloser to 500k than 400k, the level at which starts are still hovering around.The report also lost part of its luster from the previously released NAHB index,which slipped back to 15 in June after two months of gains.When multi-unit construction is added in, what we see is that total housing starts came in at 532k at an annual rate, which by today’s standards mayqualify for a ‘green shoot’, but in reality was the third worst rally ever in the 50-year history of the data series. Still, lumber futures managed to buck the overalldown trend in commodity prices and closed at a nine-month high, and thehomebuilding stocks outperformed.
IN THIS ISSUE
• With industrial productionstill contracting,employment falling andnominal wagescontracting, we can forgetabout calling an end to the recession• Demand for newly-issuedcorporate paper has beenextremely strong; makehay while the sun shines• Could the Dow Transportsbe signaling a sell signal?• Consumer spending onbasic TV servicesexpected to rise; all partof the cocooning wavecoming our way in thefrugal future• But for overall spending,frugality is a killer — justask Best Buy• Is booming money supplyreally inflationary? Notwhen we are in a liquidity trap
 
June 17, 2009
– BREAKFAST WITH DAVE
 
Page 2 of 7
But the market for residential real estate, where the unsold inventory is close to12 months’ supply when properly measured, remains in a very deep deflationaryfunk, with specific reference to the high-end where there will be multiple sellersby boomers seeking to downsize and fewer trade-up buyers since theirdemographic is much smaller and not to mention the fact that the new secular theme is ‘getting small’ and living below our means.Finally, for all the talk about reflation or inflation, somebody forgot to tell the PPI,which rose just 0.2% MoM in May (consensus was around +0.6%) and thisdragged the YoY down to a 50-year deflation low of -5.0%. The core was off 0.1% MoM too. Even better, the core intermediate PPI deflated 0.2% and hasdeclined now for eight months in a row, which is epic — this metric leads coreCPI inflation so this was quite bond bullish. While the core crude PPI did bounceback 6.7% MoM on the back of the commodity rebound, it is still down 37% on a YoY basis and the fundamental trend is still … down. As the Feds’ Beige Booknotified us last week, both WAGES and PRICES are either flat or falling in mostareas of the United States. In other words, deflation, fully two years into theFed’s great easing experiment, remains the predominant macro risk. Policy-induced reflation remains at best a consensus forecast; at worst, a false hope.As an aside, Martin Wolf writes a brilliant exposé today on how this currenteconomic downturn is tracking the 1930s — and it is not that far off despite all the gobs of policy stimulus and booming money supply. See page 9 — the titlesays it all:
How Today’s Global Recession Tracks the Great Depression
. This iswhy it is so irresponsible to be drawing inferences (the fabled ECRI comes tomind) from relationships that held in the post-WWII manufacturing inventorydownturns because what we have on our hands is a deleveraging cycle and they take years, not months, to play out, and metrics such as unsold homeinventories, the savings rate, cash/asset ratios on commercial bank balancesheets, labour turnover, debt/assets and debt/net worth in the householdsector matter far more than the ISM or other little ‘rules of thumb’ that so manypundits rely on instead of recognizing that this is a different animal altogether.At least we have a template from Rogoff and Reinhart (quoted in the article) thatshows that these types of balance sheet recessions lasts two years, the bearmarket lasts three years, unemployment rises for four years and home prices donot bottom for six years.So even if we manage to post a fractionally positive GDP number in 3Q it willvery likely mean as much as the one we managed to experience — and was notsustainable which is the key — in last year’s second quarter. That too wasinitially met with a certain degree of euphoria, pundit calls that the lows (Marchat that time) were turned in, and a brief but ill-fated rally in the so-called ‘earlycyclicals’. The only difference between now and then is that the stock marketbounced off a deeper oversold low.
For all the talkabout reflation orinflation, someoneforgot to tell the PPI — the YoY rate isfalling 5.0%
 
June 17, 2009
– BREAKFAST WITH DAVE
 
Page 3 of 7
There seems to be this universal belief that policymakers “get it” and that thecountercyclical policies that extended the economic malaise will simply not berepeated this time around. As for the folks that lay claim to this — while theyfocus on the Fed’s efforts to save the RV industry with its balance sheet — are they also watching the belt-tightening moves by the fiscally-challenged stategovernments who are now raising taxes at the worst possible time in thebusiness cycle. For the latest, see
Plan to Raise Income Tax in Pennsylvania
onpage A14 of the New York Times (the state intends to boost its income tax rateby 16% in the next three years).
MAKE HAY WHILE THE SUN SHINES
There is no doubt that in contrast to the Treasury auctions, the demand fornewly-issued paper in the corporate market for debt and equity has beenextremely strong. Issuers are well advised to tap the sentiment now because there is no guarantee in an extended sub-par economic cycle that the window isgoing to remain open. Moody’s sure seems skeptical — see
Moody’s Warns onFunding Problems
on page 21 of the FT. The rating agency found that $615billion of corporate paper globally is set to mature in the coming 12 months.Also, as many as 46% of speculative-grade companies are less than 20% below their debt covenants (up from 20% a year ago); the comparable figure forinvestment-grade is 17% (triple the 6% share a year ago).
DOW TRANSPORTS — SELL SIGNAL?
It’s the irony of ironies that when so much was made of the fact that the S&P500 kissed its 200-day moving average a short two-weeks ago that the eventwould mark the end of the bear market rally. Then again, Mr. Market is amalevolent beast and full of surprises in both directions.Guess what? The Dow Transports never did confirm this wonderful 40%+ rallyfrom the lows, which just ended. As Chart 1 shows, the rally in this criticaleconomic-sensitive barometer posted a most unimpressive rally from itsoversold March lows, and put in a classic double top. The peak was turned inback on May 6 when nobody was looking, and after yesterday’s 1.0% drubbing, the Transports are now down 6.5% from the nearby high (and down 10.0% for the year). The Dow Utilities index, by way of comparison, is holding incomparatively well and the ratio to the Dow Transports looks consistent with afurther down-move in 10-year Treasury note yields, to a 3.00 - 3.25% zone —adding some much-needed confirmation to this positive reversal we are seeing in the bond market.
The Dow Transportsnever did confirmthis wonderful40%+ rally from thelows
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