David A. Rosenberg Chief Economist & Strategist research@gluskinsheff.

com

November 23, 2012 Economic Commentary

MARKET MUSINGS & DATA DECIPHERING

Turkey with Dave
I am pleased to share this free edition of Turkey with Dave containing selected excerpts from some of my popular recent reports IN THIS ISSUE A look back at what Rosie predicted a year ago (not too shabby!)

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With this being Thanksgiving in the United States and such a slow market day here in Canada, I decided to dust off the year-ahead outlook piece I published around this time in 2011

How to fix the fiscal mess — a 10 point plan Back to school

I realized as I was putting my 10-point fiscal plan down on paper that there is an over-riding theme here in terms of what is really hindering the progress of the U.S. economy. It comes down to one word and one number: Education and 40 …

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Frugality on the part of the global consumer (living within our means. 6. and a consistent focus on reliable dividend growth and dividend yield would seem to be in order yet again. elections and regime changes) Changes in inflationary/deflationary expectations Changes in growth expectations Changes in asset allocation preference (fund-flows/de-risking) I realize there is still weeks to go. I realize there is still weeks to go. 7. Education. but … most of the calls actually came to fruition Investment Mission Statement We believe that the dominant focus in 2012 will still be on capital preservation and income orientation.A. One has to do with the degree of success we had in our “2012 Year-ahead” in terms of the themes we highlighted at the time. Enjoy the feast! Dave A LOOK BACK AT WHAT ROSIE PREDICTED A YEAR AGO (NOT TOO SHABBY!) With this being Thanksgiving in the United States and such a slow market day here in Canada. and I’m not one to pat myself on the back. And the third piece is all about the real deficit and how to address it. whether that be in fixed income (bonds and creditrelated strategies). retirement with dignity) 2. Austerity on the part of sovereigns (spending cuts/tax reform) Nationalism (an umbrella for protectionism and isolationism: mean reversion for globalization) Political movement along the ideological and fiscal spectrum (from gridlock to change) Geopolitical change (wars. Page 2 of 9 . hybrids or alternative strategies such as long/short. So in the spirit of Thanksgiving. 2012 — TURKEY WITH DAVE Dear Readers. 3. we decided to share them with you. and I’m not one to pat myself on the back. back on the road towards fiscal stability. but … most of the calls actually came to fruition. We were inundated with feedback (mostly positive) on three pieces we published in the past couple of BWDs. 8.S. I decided to dust off the year-ahead outlook piece I published around this time in 2011. 5. Next is our ten-point budget plan to put the U.November 23. We see the range of outcomes in the financial markets and the economy to be unusually wide at the current time. Here are the bullet points on ‘Behavioural Change’ and the 2012 Investment Mission Statement below: Eight Areas of Behavioural Change to Watch for in 2012 1. 4.

Promote oil and gas development (leasing on public lands. another deflationary force. three-quarters of the net $10 trillion in the nation’s debt will be due to the spiralling costs of Medicare and Medicaid. 2012 Outlook: A Year of Transition. 9. This will perversely distort the incentive system. 3. which in turn creates jobs. It is not good enough to say the Bush tax cuts were always meant to be temporary — anything that has been around for a decade is pretty well deemed to be permanent. As such. at a time when the U. This is the way to make the tax system more progressive and more efficient. A full-scale war on health care costs. and especially since life expectancy is no longer 60 (try 75) as it was when the program was initiated in 1935. According to the WSJ. 8. 2012 — TURKEY WITH DAVE But one conclusion we should agree on is the need to maintain defensive strategies and minimize volatility and downside risks as well as to focus on where the secular fundamentals are positive. Frugality has also reared its head again as it pertains to the broad retail sector. Changes at the Margin HOW TO FIX THE FISCAL MESS — A 10 POINT PLAN 1. 6. Generating more taxpayers is a better policy than raising tax rates on the most successful entrepreneurs. This will perversely distort the incentive system 5.S. by the way. A national sales tax. . Simplify and clarify financial regulation (as Roger Ferguson put it in the WSJ. it is time to raise the eligible retirement age. 2. Means-test entitlement programs. where earnings have a strong semblance of visibility and predictability. “be careful not to create a one size-fits-all regulatory environment that could lead to instability”). This will help make the overall revenue neutral and help build incentives to invest. particularly in fixed income and in equity sectors that spin off a reliable cash flow primarily in noncyclical parts of the market. Reduce corporate tax rates. Incentives to contain costs are essential Page 3 of 9 Do not raise top marginal tax rates on income and capital. Do not raise top marginal tax rates on income and capital. Better to tax conspicuous consumption than incomes (Canada has done both this and entitlement reform. As for Social Security. especially considering that life expectancy is rising by just under one year every decade. Broaden the tax base. Deflation has re-emerged as the dominant trend — not inflation — as the deleveraging cycle that is ongoing in the United States has now engulfed much of Europe. Raise contribution rates. Reforms to immigration that allow foreign students to live and work after graduation. This will help ease the skills shortage besetting small manufacturers. encourage more shale gas development).November 23. again with progressivity a primary goal too. Limit deductions. 4. it is absolutely imperative to remain focused on high-quality investments with preservation of capital attributes. It can be done). and to use the inherent market volatility that is part and parcel of every post-bubble deleveraging cycle to one’s advantage by becoming ever more tactical and opportunistic in long-short “relative value” strategies. encourage more pipeline expansion. 7. unemployment rate remains stubbornly stuck above 9%.

Skills bolster productivity. and that was in the aftermath of the horrible downturn in the early 1980s. Education. close to two percentage points lower than in the States. Canada does not have the former and has a higher homeownership rate than is the case state-side. their productivity will be hampered by the fact that they had been out of the labour market for so long. The United States scores 14th in the globe in terms of education rankings in mathematics. All the focus is on the fiscal cliff. America now ranks 7th in terms of competitiveness. A greater shift in resources towards education and R&D. 2012 — TURKEY WITH DAVE — no more of this fee-for-service. the share of the workforce that has a college degree has stalled out at around 33%. after decades of increase. This is criminal.8% unemployment rate. 10. which is all about spending. It comes down to one word and one number. and not enough on GDI (Gross Domestic Income). You can’t work on the deficit and not work on this — only 20% of the budget is discretionary. sciences and reading. economy. And 40% is the share of the unemployed that has been without work for at least a half year — before the Great Recession.S. But not enough on a long-term strategy to generate national income growth on a sustained basis. the harder it will be to redeploy them into the workforce. the highest this number ever reached was 26%. and Canada has the latter and still manages to have an economy where consumers still comprise the largest share of GDP (and vibrant enough to be attracting the likes of Target which is poised to test the Canadian frozen waters). which is the true measure of a country’s standard-of-living. Fair enough. Education means skills. The longer these folks are idle. This will do a far better job in stimulating sustainable job creation than maintaining a system that mobilizes finite taxation resources to the housing market. It would take at least as much political courage to phase out mortgage interest deductibility as it would to implement a national VAT. Far too much emphasis is on GDP.A. which is the true measure of a country’s standard-of-living Page 4 of 9 . BACK TO SCHOOL I realized yesterday as I was putting my 10-point fiscal plan down on paper that there is an over-riding theme here in terms of what is really hindering the progress of the U. is now down to 10th in terms of global innovation. And after four years of relative decline. The 13 countries ahead of America have an average unemployment rate of around 6%. And the greater the skills. the higher the wages. And if and when they do find a job. Productivity is a key ingredient for economic success. This educated share of the workforce has a 3.S. after all. The U. Imagine then if we could get that A greater shift in resources towards education and R&D. which is all about spending. This will do a far better job in stimulating sustainable job creation than maintaining a system that mobilizes finite taxation resources to the housing market Far too much emphasis is on GDP. Here are the embarrassing statistics. For whatever reason. and not enough on GDI (Gross Domestic Income). 40. Why the 40? Because 40% of small businesses right now are saying they have job openings they can’t fill because of unqualified applicants (this has doubled in just the past three years).November 23.

bell captains. The rest of society has to grapple with an unemployment rate of over 9%. These two sectors now account for a record 21% of the U. The war on credit appears to have been won with banks ready and willing to lend.8% share. But in manufacturing. We actually have more than double the number of busboys. If this is the information age. This explains why this goes down as the mother of all wage-less recoveries. As a share of total public expenditures. bell captains. Perhaps a very big part of the solution is how to boost the denominator in those ratios. and the principal cause of that is a widening and troublesome deficit in education services. 2012 — TURKEY WITH DAVE share up and have everyone with that jobless rate. and according to all the small-service business surveys. So much focus is on the fiscal deficit when the real deficit is in the labour market — the true unemployment rate (U6) is close to 15%. but look at where the jobs in America are being created — an evergrowing share in leisure/hospitality and retail. No doubt there are In over 30 years. and since better education equates to higher incomes. educational outlays have fallen to 25. This file is not receiving enough attention.S. Not only that. because the average hourly wage in the leisure/hospitality sector is $13.S. barmaids and cashiers than we have in industries that actually make things. it’s not because the demand for people with the necessary skills isn’t there. Full stop. then I’m sad to report that information services represent a mere 2% share of total U. and in retail it is $16. Instead of mobilizing more resources into education. And this is the highest paid part of the labour market — 40% above the national average and about double the pay in the leisure and hotel sectors. the government sector has actually been withdrawing its relative support in this critical part of human capital stock. But manufacturing is just 9% of the employment pie and has not been 21% — where the leisure and retail sectors are today — in over 30 years. this is where the government should be directing its efforts. We have a country where there are more real estate agents than there are engineers — now how did that ever happen? We all talk about deficits and debts relative to income. barmaids and cashiers than we have in industries that actually make things The war on unemployment can only be won with additional resources being directed towards the education sector Page 5 of 9 . as an example. versus the peak of 30% a decade ago. We actually have more than double the number of busboys. in my view. since better education equates to stepped-up productivity growth. How can the government help the private sector generate the income that in turn can help defray the costs of public sector initiatives? Since better education equates to lower rates of unemployment. employment pie and that share is rising over time. The war on housing appears to have been won as well with housing starts and household formation rates on the rise. Professional and technical services account for 6% of the jobs pie and this is the second highest income group. since better education equates to improved skill sets that are in demand. We just don’t have enough of these folks. the average wage is $23 an hour. employment.November 23. They simply do not have the skills set that employers need in this fast-changing tech-driven world. But the war on the fiscal front is inextricably linked to the war on unemployment and that war on unemployment can only be won with additional resources being directed towards the education sector.

November 23. especially with regard to defense. But that education has to be funded somehow with tax revenues. In many cases. But broadening the tax base and introducing a tax on consumption is far more efficient and does not lead to as much resource misallocation — incredibly. not to mention housing (mortgage interest deductibility AND tax-free capital gains!). Tax is not some dirty three-letter word if the proceeds are going into a productive endeavour that will more than pay for itself over time. Last but not least — education needs a revolution from kindergarten on up. so withdrawing support for these drivers is actually self-defeating. but education and training are essential drivers of the future income growth that will be needed to fund these other critical initiatives. A large part of solving the education dilemma lies in restructuring the institutions along with investing in them. universities focus so much on research in the sciences that teaching is a secondary role for many professors. Credit in the form of student loans and parent-funded debt has dramatically inflated the cost of post-secondary education while accommodating an everpoorer student experience. so withdrawing support for these drivers is actually self-defeating A sales tax to fund education and redress the skills shortage is my prescription for future durable economic growth Page 6 of 9 . at the expense of education which has to compete with other essential areas like health care and social security for precious and finite taxpayer resources. the United States is the only advanced country without a national sales tax system. needs a whole new measure of support from parents. We need the student body to be more broadly energized and motivated by their educational experience. A sales tax to fund education and redress the skills shortage is my prescription for future durable economic growth. We have choices in this country and the one that has been made for some time now is to subsidize consumption (which is over 70% of GDP). 2012 — TURKEY WITH DAVE competing pressures on the public purse. It makes no sense. the number of non-teaching employees exceeded the number of teachers beginning in 2006. Public elementary and secondary education. We need to reboot to a true education culture and replace the dysfunctional systems that were developed during the post-Vietnam War era and the credit bubble. particularly in urban areas. On college campuses. higher-paying jobs will end up swamping the short-term negative impact on household spending from having to pay a national sales tax on your next iGadget. To sum it all up: I said yesterday that the trail towards greater economic growth can be blazed with more emphasis on high-quality education. teachers and government — both state & local and national. Education and training are essential drivers of the future income growth that will be needed to fund these other critical initiatives. Tinkering with top marginal rates creates disincentives to save and invest so this is not the way to go. The income that will be created via the stepped-up pace in higher-skill. pensions and healthcare.

visible organic growth.). Minimize volatility via alternative strategies such as long/short equity strategies. preferreds and bonds Canadian and U.November 23. Retail. assets in geopolitically safe regions and a focus on dividend growth Gold exploration companies whose assets have high grades.I. 2012 Source: Gluskin Sheff Page 7 of 9 . should be able to significantly outperform gold bullion.S. Focus on those firms that benefit from the secular trend surrounding the portability of data and increased consumer usage of smartphones/tablets. Telecom.P. Gold equities have seen tremendous multiple compression over the past few years and those that can generate growth in production and reserves. preferred shares Energy infrastructure Utilities Technology firms Income Orientation Mobility/ Connectivity and IT Infrastructure Cellular carriers/Tower companies Gold Mining Stocks Mid. significant resource expansion potential and that are located in regions with relatively low geopolitical risk Other Invest in hard “strategic” assets. Identify and invest in firms that benefit from cloudbased strategies that allow customers to be more efficient and realize cost savings. Being and staying ahead of the robust demographic (baby-boomers aging) shift towards income oriented investments. SECTOR/ASSET CLASS Dollar/Discount stores Home improvement/ Gardening Tobacco/Beverages/Movies Non-Cyclical Focus on special situations that are not correlated with the economic cycle. Safety and Income at a Reasonable Price (S. Asian consumers Food products Updated: November 12. Insurance Income-producing equities. Buy high-quality corporate and government bonds in non-cyclical sectors. while holding the line on costs. Focus on burgeoning middle class in emerging markets.and large-cap producers with low cost structures. 2012 — TURKEY WITH DAVE OVERVIEW OF THEMES AND STRATEGIES THEME Frugality STRATEGY Identify where people spend their money and time in an economic downturn. Focus on reliable dividend growth and dividend yield. Defense-aerospace Healthcare Capital Preservation Credit of Canadian Banks.R. simple metallurgy.

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