Economics Commentary
drosenberg@gluskinsheff.com
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\u2022 Signs of credit market
improvement are still
mixed

\u2022 Retail investors caught
the bounce \u2014 equity
mutual funds posted a
$12.3bln net inflow in
April

It really is a whole new investing world when a Chinese manufacturing diffusion
index can generate a gigantic melt-up in equity prices across the globe. But that
is indeed what is happening. Even in the face of GM\u2019s imminent bankruptcy
filing, the news that China\u2019s purchasing managers\u2019 index came in at 53.1 in May
from 53.5 in April (the CLSA comparable was 51.2 from 50.1) was enough to
kick the MSCI Global index up 1.4% to its highest level since last November
(markets had been led to believe for the past few weeks that a sub-50 reading
was quite possible).

Emerging markets advanced 2.6% and now up 55% from the lows. Russian
equities soared 5.8%, helped out by the rising oil price (page A2 of today\u2019s WSJ
contains a healthy dose of scepticism over the longevity of the oil price rally
given lingering weakness in global crude demand). Asian equities climbed 2.9%,
led by a 4.0% surge in the Hang Seng index to 18,888 (now how lucky is that?).
But gains were broad based right across the continent, with Japan up 1.6%, the
Kospi rising 1.4% and the Shanghai index rallying 3.4%. European marts are up
2.7% (up now in five of the last six sessions) and again, practically every country
is flashing green.

Bonds are selling off, as one would expect, with the yield on the 10-year note up
6bps this morning to 3.53% as risk appetite gets whetted even further. This is
further ratified in the commodity complex where oil has firmed $2.00/bbl to
$68.29/bbl, copper has soared 3.5% and gold has risen nearly 1.0% to around
$988/bbl as it closes in on the cycle highs.

The dollar continues to lose ground, hitting its low-water mark for the year, and
the flip side is big rallies in Asian FX (led by the Korean won and Taiwan dollar),
the Euro (five-month high), Sterling (eight-month high), the Russian Ruble (six-
month high) and the commodity currencies (notably the Aussie and Kiwi). CDS
spreads, which gauge corporate bond risk in Europe also have come in 14bps to
710bps.

better than advertised, at 40.7 in May from 36.8 in April (consensus was 40.5). The U.K. comparable improved to 45.4 from 43.1 in April too \u2013 best result in a year. And not only that, but UK home prices as measured by the Hometrack survey were flat in May \u2013 first time in 20 months that it did not show a decline.

It also looks as though Treasury Secretary Geithner managed to soothe Chinese
concerns over the U.S. fiscal situation \u2014 by most accounts we have seen
regarding his trip to Beijing. And the data show that foreign central bank
support for the Treasury market remains intact \u2014 custodial bond holdings at the
Fed rose 3.3% in May to $69 billion, the third most on record. This has helped
ease fears that the U.S.A. would be facing a credit outlook downgrade in the
near future (as the U.K. experienced last week).

for the session and 4.1% for the month. Over the last three months, it is up 20.4%, which is the best performance in such a short span since November 1998. For the S&P 500, it advanced 5.3% in May and 25% in the last three months, which is a feat last achieved in August 1938.

up 11.2% \u2014 the best performance since June 2000 and the fifth highest monthly
gain in recent history (data back to 1984). The TSX has now risen three-months
in a row, a feat last accomplished back in the spring of 2007. The monthly
pattern is +7.4% in March, +7.0% in April and 11.2% in May and that is the best
three-month performance ever. But note that in the past, when the TSX is up
10% or more, which only happened 5 times going back to 1984, the index
usually takes a breather and is flat as a beaver-tail three months later.

(see below), but on Thursday the Treasury is expected to announce the size of the 3, 10 and 30-year auctions for the following week (likely to be a $65 billion package).

some time that for there to be proof that the March lows wereth e lows, the
market would have to successfully retest those lows as it did in March 2003
(though the July 2002 test did fail). With this in mind, it is encouraging to see
that the folks at S&P are in general agreement with this premise, and Sam
Stovall, who is the Chief Investment Strategist for the agency, found that typical
retests usually see the stock market correct 7.0% from the interim post-trough
highs; but the decline is closer to 14% on average after a \u201cmega downturn\u201d of
the likes we saw from October 2007-March 2009. That would put 800 on the
S&P 500 as the proverbial line in the sand. See What About the Valley After the

are in some form of economic depression because the policy response is so
far more pronounced than it was in the 1930s. While there is an element of
truth to that from a Fed policy standpoint, fiscal policy has so far been wholly
ineffective and in fact, as California now takes a sharp knife to its social
programs, historians may well look back at this as a classic policy error. Then
again, the laws are such that state governments are not allowed to run
operating deficits. See Deep Cuts Threaten to Reshape California on page 15
of the Sunday New York Times (front section).

Indeed, U.S. retail gasoline prices have spiked 45 cents in the last month to
$2.50/gallon \u2014 the equivalent of a $60 billion annualized pay cut (which
basically offsets the reduction low-and middle-income workers are seeing
come off their paychecks in terms of reduced withholding taxes).

of Canada policy statement on Thursday and May employment on Friday. We
would advise against being long the Canadian dollar ahead of the BoC
statement because there is little chance that it won\u2019t be addressed. The loonie
has rallied 15% in less than three months, double the increase in the commodity
price index that matters most for the central bank (while oil, gold and copper
have soared, wood products and natural gas \u2013 which represent 10% of
Canada\u2019s export base \u2013 have actually fallen). In other words, half of the
Canadian dollar\u2019s rally has been de facto monetary restraint on the overall
(fragile) economy and as such is unwelcome and troublesome. In the U.S.A.,
there is a ton of data, from ISM today to nonfarm payrolls on Friday, and we will
hear twice from Fed Chairman Bernanke too, with his Wednesday 10 a.m.
testimony to the House Budget Committee likely to be a key event. The BoE and
ECB also meet on Thursday.