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

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December 15, 2009 Economic Commentary


Latkes with Dave
WHILE YOU WERE SLEEPING Data overnight were certainly not of the bond-friendly variety with France’s inflation rate joining China and swinging into positive territory for the first time in seven months (+0.5% YoY and an expected 0.2% MoM rise). Of course, much of this reflects depressed year-ago bases, which are exaggerating the swing. Core CPI in France actually FELL 0.1% MoM and is running at a tepid 1.7% YoY rate. U.K. headline inflation also ticked up 0.3% MoM (consensus was at +0.2%) and this took the YoY rate to 1.9% in November from 1.5%. European auto sales continue to respond to government incentives and popped 27% YoY in November — again flattered by depressed November 2008 levels. This is a rapid acceleration from the +11.2% pace in October and +6.3% in September. So if momentum is your game, then the automotive sector across the pond has its motor running. The German ZEW investor sentiment did dip to 50.4 in December from 51.1 in November but this is being treated as a green shoot as it did not drop to 50 as was widely expected (though it is down now for three months in a now … now in this era of “good news only”, that was a tidbit that was really tough to find). In terms of market action, the U.S. dollar is firm and the commodity currencies are selling off in the aftermath of comments from the Reserve Bank of Australia (from the policy meeting minutes) which have investors believing that the rate hike in the Land of Oz may be over and done with (or that at least a pause is in order). The greenback is also now trading at over a two-month high against the Euro even though it is the ECB that has been more vociferous over an exit strategy. Then again, while the U.S.A. does have Illinois and California, it does not have Spain, Portugal, Ireland and Greece to worry about in terms of default risks. Bonds are trading quite jittery as inflation expectations are creeping in just as the supply schedule is looking more ominous. Equities are lower too with the U.S. stock market opening on a down note (U.S. futures were in the red and the S&P 500 is coming off a four-day winning streak that took it to a new 14-month high yesterday). Asian equities were off 0.8% overnight with declines right across the board (talk about a region that is more than fully priced at the current time — trading at 22x forward earnings). Commodities are trading lower today along with the firmer dollar — the DXY index just poked its nose above the 100-day moving average on the upside; gold is testing the 50-day moving average to the downside; oil has already sliced through its 50 and 100-day moving averages and a test of the 200-day moving average would imply $65/bbl. IN THIS ISSUE • While you were sleeping — economic data across the globe were certainly not of the bond-friendly variety • U.S. money velocity and the S&P 500 — there is a very tight relationship between the two • Can the U.S. yield curve steepen even more? • We don’t have a big inflation view, but in case inflation were to stage a comeback, we have highlighted some ways to play that scenario • Post-Christmas sales may disappoint — according to a consumer survey, only 35% of consumers plan to shop after the holiday season • GDP is not everything — the data is revised massively in the future and is not the best barometer of economic health • Why inflation expectations may be creeping higher • Speculation runs amok — just take a look at the latest Commitment of Traders report • The Empire strikes out — New York Empire State manufacturing index plunged in December • Light trucks exert heavy impact on U.S. producer prices

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 15, 2009 – LATKES WITH DAVE

U.S. MONEY VELOCITY AND THE S&P 500 Chart 1 maps out the S&P 500 with money velocity (GDP/M1 ratio). There is a 90% correlation between the two. It is one thing to have the Fed pump liquidity into the system but it is quite another for the liquidity to be re-leveraged into credit and recycled into the economy. The Fed’s easing program is over two years old and the rampant Fed balance sheet expansion 15 months old, and still to this day, what the commercial banks have done (to Obama’s wrath) with all that liquidity is to keep it as cash on their balance sheet to the tune of $1.2 trillion. We’re not sure why Obama is as rankled as he is because the banks are in fact lending out a good chunk of that Fedinduced liquidity — right back to Uncle Sam (the banks now own a record $1.3 trillion of government securities). Back to the chart — there is obviously a close connection between money turnover and the stock market. But we can get periodic divergences as we did in the first leg of the rally in 2003. But the carry-through from 2004 to 2007 hinged critically on that multi-year acceleration in money velocity. If we don’t see the banks begin to extend credit in 2010, it is hard to see the 2009 bounce from oversold lows as being sustained in the coming year. CHART 1: VELOCITY OF MONEY AND THE STOCK MARKET ARE HIGHLY CORRELATED
United States: Total Nonfederal Debt to Nonfederal GDP Ratio (percent)
10.5 r = 0.90 10.0 9.5 9.0 8.5 8.0 7.5 7.0 600 6.5 6.0 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 400 S&P 500 (level: right hand scale) 1000 1200 Money Velocity (Nominal GDP to M1: ratio: left hand scale) 1600

If U.S. banks don’t begin to extend credit in 2010, it is hard to see the 2009 equity market bounce from oversold lows as being sustained in the coming year



Source: Haver Analytics, Gluskin Sheff

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December 15, 2009 – LATKES WITH DAVE

CAN THE YIELD CURVE STEEPEN EVEN MORE? We do have the steepest U.S. yield curve in three decades on our hands, but that is not to say that it cannot get even steeper. For one, the Fed is going to come out again this week, in all likelihood, and state for the record that it will be keeping rates near zero for an “extended period” of time. This should help anchor the front end of the yield curve. As for the back end of the curve, if last week’s bad case of indigestion was any sign in terms of the poor showings at the Treasury auctions, there is a risk that we end the year with more of the same. There apparently is going to be a whopping $118 billion of new Treasury supply to hit the market in the last week of December, this at a time when liquidity conditions are not exactly going to be that robust. HOW TO PLAY INFLATION? There is no sense in being dogmatic. But just in case inflation were to stage a comeback, this is how one would prepare for it:
• Precious metals (while gold grabs the spotlight, silver has surged 52% this

We do have the steepest U.S. yield curve in three decades on our hands, but that is not to say that it cannot get even steeper

year and has far outpaced the 27% runup in gold; and the gold/silver ratio, while down from a peak of 84 to 66, is still above the average of 54 over the past three decades).

We don’t have a big inflation view, but you never score brownie points by being dogmatic

• An even steeper U.S. yield curve! • TIPS (or real return bonds) — the 5-year TIPS breakevens right now point to an

inflation expectation of just over 1.7%, whereas consumer expectations are closer to 2.6%.

• Short-term duration corporate bonds (and go out the credit curve). • Commodity currencies — Canadian Loonie, New Zealand Kiwi, Aussie dollar,

Brazilian Real, and Norwegian Kroner.

• Basic material stocks (including energy) as well as consumer staples (tobacco,


We don’t have a big inflation view, but you never score brownie points by being dogmatic. If (when?) the massive amounts of fiscal and monetary stimulus ever do show through in final inflation (this will hinge on a renewed expansion in household balance sheets and a fresh credit-creation cycle), these are the areas that would likely garner the most investor interest.

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December 15, 2009 – LATKES WITH DAVE

UTILITIES VERSUS FINANCIALS As Chart 2 illustrates, why buy U.S. financial stocks when you can pick up a record yield spread in the utilities sector. CHART 2: A BIGGER PAYOUT IN THE UTILITY SECTOR THAN IN THE FINANCIAL SECTOR
United States: Dividend Yield: S&P Utilities relative to Financials* (ratio)
2.9 2.7 2.5 2.3 2.1 1.9 1.7 1.5 1.3 1.1 0.9 0.7 59 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 As of Q4 2009, Dividend Yields: Utilities = 4.10 and Financials = 1.51

*Prior to 1974, using Financial Money Centers as a proxy for financials. After 2001, using GICS classification for utilities and financials Source: Haver Analytics, Gluskin Sheff

POST-CHRISTMAS SALES MAY DISAPPOINT A survey by America’s Research Group over the weekend showed that only 35% of consumers intend to do any shopping the week after Christmas. This is down from 38% a year ago and below the typical range of 48-55% over the past decade. Moreover, and this is bound to depress January sales data, the share of shoppers buying gift cards dropped to 49% this year from 53% at this time in 2008. A mere 24% said they shopped this year with a credit card — the new era of cash-and-carry has arrived. Apparel spending seems to have been the biggest casualty in this new holiday frugality — people would rather play Rock Band it seems than wear a new outfit. GDP ISN’T EVERYTHING We mentioned yesterday that there is an outside chance that we could see Q4 real GDP approach a 4-5% range at an annual rate, well above current consensus expectations. A good chunk of that is in inventories, not final demand, but so be it. The point we are trying to make is that GDP is not only revised massively in the future but it is not the best barometer of economic health, notwithstanding all the attention it receives. Let’s not forget that Japan has had nearly 60-positive GDP quarters since its bubble burst in the early 1990s. You want to know what is really happening beneath the veneer of the data? Go have a look at the front page of today’s NYT (Poll Reveals Depth and Trauma of Joblessness in U.S.). More than half the ranks of the unemployed have been forced to borrow money from friends or relatives since losing their jobs.

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December 15, 2009 – LATKES WITH DAVE

WHY INFLATION EXPECTATIONS MAY BE CREEPING HIGHER It could have more to do with government mandated cost-push inflation than anything related to consumer demand-pull inflation. But we did see in today’s Investor’s Business Daily an article, which stated that governments have enacted 297 protectionist trade measures in the past year. (Amazingly, it was just over a year ago when the G-20 meeting was held in Washington when it was agreed that no such anti-trade measures would be taken.) The number of ‘planned measures’ has risen by 50 (!) in just the past three months — the pipeline keeps growing. This is why gold is a buy on pullbacks … like the one we have on our hands right now. SPECULATION RUNS AMOK We just sifted through the latest Commitment of Traders report from the Commodity Futures Trading Commission (looking at both futures and options) for the week of December 8th:
• S&P 500: net speculative longs of 151,006 contracts. • VIX: net speculative shorts of 18,872 contracts. • Gold: net speculative longs of 264,775 contracts (still near a record high). • Silver: net speculative longs of 43,069 contracts. • Copper: net speculative longs of 12,626 contracts (new high for the cycle). • Oil: net speculative longs of 141,550 contracts.

Just as the Nasdaq finally manages to pierce the 2,200 mark, we get this piece of downbeat techrelated news in the form of the New York Fed’s Empire State Manufacturing survey

All this has occurred even with the U.S. dollar bouncing back and the net speculative short positions on the dollar reverting to net longs in late November and now standing at 13,854 contracts. And, the commodity complex is hanging in even with the Baltic Dry Index rolling over again. THE EMPIRE STRIKES OUT! Just as the Nasdaq finally manages to pierce the 2,200 mark, we get this piece of downbeat tech-related news in the form of the New York Fed’s Empire State Manufacturing survey — this index (one proxy for the ISM index) plunged to +2.55 in December from +23.5 in November and the second decline in a row. This takes the index down to its lowest level since last July. And the details were as soft as the headline:
• Orders fell to 2.20 in December from 16.66 in November and down from the

30.82 peak level we saw back in October. At 2.20, this is the lowest level in orders since June.

• Shipments also slowed in December, actually halting, to 6.30 from 12.97 in

November and 35.08 in October. Like orders, shipments are at their lowest level in six months. inventories, at -18.42 in December versus -17.11 in November. We have not seen a positive inventory reading since August 2008. the NY region. Prices paid rose 9.2 points to 19.74 in December — highest level since September. Prices received dipped to a 4 month low of -9.21 in December from 2.63 in November.
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• The manufacturing sector in the NY region continues to reduce their

• There is some margin compression going on in the manufacturing sector in

December 15, 2009 – LATKES WITH DAVE

• The employment indicators also swung back to negative terrain. The number

of employees fell to -5.23 from 1.32 in November and way off the 10.39 level we saw back in September. And the workweek also swung from +5.26 in November to -5.26 in December.

Chart 3 below shows what this data could mean for the Nasdaq near-term. CHART 3: WHAT THE EMPIRE MANUFACTURING INDEX COULD MEAN FOR THE NASDAQ NEAR TERM
United States (percent)
40 Empire State Manufacturing Diffusion Index (net percent: left hand scale) 3,000 r = 0.71 2,800 2,600 2,400 10 2,200 0 Nasdaq Composite (right hand scale) 2,000 1,800 -20 1,600 1,400 1,200 05 06 07 08 09






Source: Haver Analytics, Gluskin Sheff

LIGHT TRUCKS EXERT HEAVY PPI IMPACT The U.S. producer price index (PPI) offered up a huge upside surprise today — the headline came in at +1.8% (market was at +0.9% MoM) and the core (excluding the effects of food and energy) was +0.6% (market was at +0.2% MoM). The story was almost exclusively in light trucks where prices soared 4.2% — outside of that, the core PPI was a tame +0.2%. Remember that light truck prices sank 5.2% in October and that was the only reason why the core PPI was down 0.6% that month. Best to look at the broad trends — total PPI negative 0.7% at an annual rate on a three-month basis, +0.7% on a six-month basis, and +1.2% on a YoY basis. Not much of an inflation story here, to tell you the truth. The pipeline measures were well behaved too — the core intermediate PPI was +0.3%, but that followed a 0.2% decline in October and the YoY trend is ensconced in negative terrain, at -1.2%. And the core crude PPI — the very back end of the production process — posted a 0.8% decline, the first falloff in eight months. So in a nutshell, less inflation here than really meets the eye.

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December 15, 2009 – LATKES WITH DAVE

STRONG PRODUCTION NUMBER OUT OF THE U.S.A. The one thing we can take away from the November industrial production (IP) data is the limitations of the ISM index. The diffusion index jumped to 55.7 in October from 52.6 and IP was flat; then we see ISM roll over in November, to 53.6, and IP spikes 0.8% MoM. The gains were broadly based too — mining +2.1%, automotive +1.8%, machinery +0.6%, computers/electronics +0.4%, materials +1.3%, even construction supplies were +1.6% (government infrastructure kicking in?). With October and November results in, industrial production is running at a 5.4% annual rate for Q4. As I’ve been saying since last week, watch consensus GDP expectations continue to ratchet up. Problem for equities is that this was priced in before the economists figured it out (ahem) and bond yields are ratcheting up.

The one thing we can take away from the November U.S. industrial production report is the limitations of the ISM index

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December 15, 2009 – LATKES WITH DAVE

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December 15, 2009 – LATKES WITH DAVE

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