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

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January 4, 2011 Economic Commentary

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave
WHILE YOU WERE SLEEPING Equity markets remain firm across the board today while the relative safety of government bonds loses their allure — Asia just hit a new 2 ½ year high today. Consistent with the pro-cyclical sentiment at the current time, the U.S. dollar is slipping as it dips below the 50-day moving average and admittedly the chart of the DXY looks pretty sick at this juncture, which in turn is adding some impetus to the commodity upturn (copper just made a new high for the fourth day in a row and oil is now at a 27-month high — though gold is consolidating near its record highs). The big winner has been the Asian FX complex — the Korean won has firmed to a seven-week high today. The overseas data so far today have been sparse but mixed with the U.K. PMI coming in strong in December (best in 16 years!) but French consumer confidence dropping unexpectedly. German unemployment also rose 3k to 3.15 million versus consensus estimates of down 15k, though inclement weather is the culprit no matter where we look across research reports for the surprising weakness. The equity markets have indeed started off the year with a bang and there is a risk that talk of the fabled “January effect” lures more buyers into stocks. This is still very much a sentiment game. After all, all the Fed had to do was “jawbone” the market into believing that the Fed was going to not only abandon any steps to shrink its balance sheet but to actually expand it further last fall to generate a renewed uptrend in valuation. But keep in mind that we heard all this claptrap this time last year about what the market does for the year if the first week of January is a positive one. The NYSE actually rose smartly in the first six sessions to kick off 2010 and that told you nothing of the meat-grinder we were going to endure right through to the end of the summer. Not until the government handed out more steroids to Mr. Market in the late summer and fall did equities change course and head back up from the low end of what was at the time a year-long trading band. In terms of themes for 2011, we think that there are wide swaths of the fixedincome market that offer good value at current pricing levels. Although REITs look expensive, it does look as though fundamentals are showing improvement (see Signs of Life in Office Market on page A2 of today’s WSJ — occupancy rates and rents are rising for the first time in nearly three years). Sentiment in equities is way overdone, but the barbell between hard assets and incomegenerating securities still seems to have merit. Volatility or the cost of insuring against a market correction is about as cheap as it can be right now.

IN THIS ISSUE
• While you were sleeping:

equity markets remain firm across the board, U.S. dollar slipping, overseas data has been sparse and mixed
• Oh, Canada! The market

clearly favours the country with the more sound national balance sheet and more solid long-term economic prospects
• Markets lining up behind

Bernanke? Look for what happened in the past four months to have been nothing more than a bad case of misplaced optimism
• ISM – the good and the

not-so-good: the headline numbers seem impressive but still below the peak posted last April
• A December to remember:

half of the gains in the S&P 500 for 2010 can be attributed to the run-up in December
• Getting a grip: the U.S.

economy has its share of structural problems that will come home to roost at some point abound

• Signs of exuberance • What was the real

surprise of the year? That we would close 2010 with the yield on the 10-year U.S. Treasury note anywhere near 3.3%.
• Is the sun rising in Japan?

Please see important disclosures at the end of this document.

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Gluskin Sheff 07 08 09 10 OH. With exploration budgets expanding sharply. we remain of the view that this market is overvalued. the real play within the space may be in oil and mining services. (However.) The Korean Kospi index just made a new all-time high today. M&A will be a major theme (up 12% last year to $895 billion according to Dealogic). though we maintain that the stock market is hugely overbought from here. Page 2 of 15 . overbought and overextended at the current time. With all this cash. The key is to buy low and sell high. so the yield theme is intact (255 companies raised their payouts last year compared to 157 in 2009). Stock buybacks have risen now for five quarters in a row and that may also end up being a source for the cash hoard going forward. the TSX closed the year with a 21% gain in USD terms.S. we are not convinced that buying high and trying to sell higher is going to work over the near-term in such a frothy market.January 4. See the chart below. outpacing the 13% gain in the S&P 500 by 800 basis points. Second. This will likely add more fodder to cyclical sentiment. 2011 – BREAKFAST WITH DAVE Commodities are in a secular bull market but have moved a tad too parabolic right now and speculative interest has picked up dramatically of late. the loonie managed to cross above “par” against the greenback on December 28 for the first time in eight months. and as such could help establish a firmer floor under the equity market. but that we will be entertaining the notion of becoming more constructive when corrective phases set in that serve up more compelling valuation metrics. CANADA! First off. CHART 1: THIS IS PRETTY CONSTRUCTIVE SIGN FOR THE BULLS — KOSPI HIT A NEW HIGH South Korea: Korea Index 2400 2000 1600 1200 800 400 0 96 97 98 99 00 01 02 03 04 05 06 Source: Wall Street Journal/Financial Times /Haver Analytics Source: Haver Analytics. which in turn means that financials with a high concentration in the merger space may not be bad places to be. in common-currency terms. The largest S&P 500 companies are sitting on 10% more cash than a year ago at over $900 billion and that means more dividend payouts. This marks seven of the past eight years in which the Canadian stock market outperformed the U.

Think about that for a moment. which tells you that. What the markets are telling you is that Canada.” And in the Year of the Rabbit. when adjusted for the gap in the “cost of carry”.. the little brother to the north. is a much safer place to park your money from a fiscal balance sheet standpoint. let’s not get into that). comparable levels. Though it does at least make the quarterly data-flow appear to be more buoyant than they actually are and will be able to fool investors for as long as the stimulus doesn’t wear out. “anything that can’t last forever. Page 3 of 15 . is a much safer place to park your money from a fiscal balance sheet standpoint 2 1 0 -1 90 95 Source: Haver Analytics Source: Haver Analytics. the little brother to the north. long bond yields (percentage points) 3 What the markets are telling you is that Canada. 2011 – BREAKFAST WITH DAVE Third. but the market has clearly discriminated which country has the more sound national balance sheet and more solid long-term economic prospects. Both countries are rated AAA by the major credit agencies.S. the 10-year Canada yield trades at a 21 basis points discount to the U. won’t.S.S.. The U.S.A. (Who has the bigger army. Dipping into Social Security so that people can have more pocket money to buy more gasoline imported from the Mideast and more electronic gadgets manufactured in emerging Asia hardly represents a very impressive long-term growth plan (like the 5-year ones they have in China). Canadian long bond yields minus U. The other part is a more responsible fiscal policy.January 4. this may well end up being applied to the rabbits that reside in Ben Bernanke’s hat . CHART 2: CANADIAN BOND YIELDS LOWER THAN U. But as Herb Stein famously said. bond yields at the longest maturity are arguably 125 basis points lower in Canada than they are in the U.S.S. Gluskin Sheff 00 05 10 Moreover. government continues to pursue a profligate spend-and-borrow fiscal strategy that is not going to end up doing much more than mortgage economic growth from future generations. there may not be that many more that he will be able to pull out. the fact that the Canadian dollar is appreciating is only one part due to commodities. 10-year note and the long Canada bond is now around 90 basis points below U. by definition. This is unprecedented and comes despite a policy rate that is 75 basis points higher in Canada.

maybe stabilize” just prior to the collapse. This is how the story ends. completely serviceable. (Check out the picture of Mr.” This is from Ben Bernanke. Sorry — 0. Bernanke decked out in a superman costume with cape and all on page R1 of yesterday’s WSJ. 2011 – BREAKFAST WITH DAVE Canada is experiencing very similar modest rates of economic growth like the U. but these are only models and what they don’t include are intangibles ― such as a comparatively intelligent and affordable set of fiscal and monetary policies. top federal rates on profits are 35% in the U. but for now.A.January 4.5% from 18%. and Japan. not for following the herd and joining the bandwagon. this is a time for maintaining resolve.S. as far as we know. The headline seems impressive but is still below the 60. And “they” are Fannie and Freddie. as they have for some time. This is about on par with “the troubles in the subprime sector on the broader housing market will likely be limited” and of course “what I think what is more likely is that house prices will slow. MARKETS LINING UP BEHIND BERNANKE? “They will make it through the storm. At the national level.6. For those of us with memories of how liquidity-induced bubbles end. Page 4 of 15 . ISM ― THE GOOD AND THE NOT-SO-GOOD Well. This was bang-on the consensus estimate but the “whispered” number was far higher following last week’s regional data (especially the ripping Chicago-land data). Household debt in Canada is clearly problematic. By way of comparison.0 from 56. Our models say the Canadian dollar is overvalued. Yikes!) Look for what happened in the past four months to have been nothing more than a bad case of misplaced optimism. and 25% on average in Europe. but not on the back of quantitative easing and not at the risk of blowing a hole through the government balance sheet. We of course do not want to appear disparaging. and is on track to slip to 15% by 2012.4 peak posted last April (which is why it is absolutely incredible that today’s WSJ would run with the headline on page A2 Factory Activity Surged in December.S. There was a nice compliment on Canada’s efforts to stimulate the private sector without resorting to beggar-thy-neighbour monetary policies in the op-ed section of yesterday’s WSJ (Canada's Competitive Edge ― page A16). but this is the chief monetary official that the markets have lined up behind and put their faith in over the past four months. the ISM did manage to rise in December to 57.4 point advance is hardly a “surge”). These words were literally uttered a mere two months before Fannie Mae and Freddie Mac collapsed and were effectively nationalized. Canada is the only G7 country with a credible federal government plan to balance the books over the next five years and at the same time promote domestic competitiveness via a schedule of sliding top marginal corporate tax rates. which just fell to 16.

By the time Bernanke gave his hand-holding speech on August 26. Wouldn’t it be nice to know what trades are going to be made? What about injuries? Or unexpected Jeter-like slumps by future Hall of Famers? But what is fascinating in the markets is that so many people can be right despite all their assumptions and lines of reasoning being totally off base.9 from 57. which is impressive. A DECEMBER TO REMEMBER We get asked all the time what our “target” is for the major averages for the coming year. the S&P 500 was down 6.. but what wasn’t was the move down in employment to a 9-month low of 55. What actually are the assumptions that drive the forecasts for the end of December in any given year? It’s like asking what team I think is going to win the World Series next October.1% for the year (and 14% from the nearby highs). but this goes to show how dramatic this back-end loaded performance was to close off the year. and that actually compares to 78% in October and 94% in April.5 from 69. Order backlogs stayed below 50 (at 47) for the fourth month in a row. double-dip risks would intensify and the market would roll over.78%. What is fascinating in the markets is that so many people can be right despite all their assumptions and lines of reasoning being totally off base Page 5 of 15 . which is okay but not great. which was highly evident in the sagging employment component. To think that through November. the entire year came down to an 18-week 20% rebound. 2011 – BREAKFAST WITH DAVE Only 61% of industries reported growth. and despite the surge in copper (to record highs).5 and well off the 78. That was the case in 2010 ― go back to the consensus in Barron’s a year ago and you will see that the bullish prognosticators at the time were optimistic because of visions of a sustainable V-shaped recovery taking hold. As if that is meaningful. and once the government ran out of steroids. There wasn’t much there for the inflation-ists.87% ― not bad.5 from 57. which was based on the premise that once all the stimulus started to fade.4 nearby peak last April when the commodity complex was far lower than it is today. Supplier delivery delays eased to 55.. the entire advance for 2010 was 12. the ISM prices-paid index barely rose at all ― to 72. which included all the good monetary and election news. Both production and orders moved back above the 60 level.7 from 57. Nor did we think that the government would enact another budget-busting stimulus program just weeks after a mid-term election seemingly fought on fiscal probity. Export orders also receded for the second month in a row to 54. Since that day.0. Fully half of the gains came in December ― the stock market bounced 6. Indeed. We were rather cautious in our market view.5 in November (only half of the respondents reported higher payrolls last month).53% in the month. That spells profit margin squeeze . companies maintain a tight control over their payroll cost. crude and cotton. This is exactly what happened from April right through to the end of August.2. the market rocketed ahead by 20%. the market was up 5. We underappreciated the prospect of Ben Bernanke reversing course and not only forgoing the expected “exit policy” but embarking on another round of central bank balance sheet expansion with the specific aim of driving asset prices higher. of course. unless.January 4.

000 versus zero back then. our long-standing bond-bullion barbell worked out very well. while initial claims are the lowest since July 2008. and L. Eight cities are now down or perilously close to new cycle lows. and this last happened in February 2009 (when investors were actually paying attention to what was happening in the housing market). 2006: NSA: 500k (SA: 339k) 2. would be equivalent to a 75% slide in the stock market! Page 6 of 15 . Also note that first time claimants on State’s rolls increased by 118k. economy has its share of structural problems that will come home to roost at some point: 1. Deflating home prices ― in fact.7 million today versus 127. Stubbornly high unemployment rate (at 9. there is still nothing organic about the macro economic backdrop. the real sustainable recovery was more than a year away. not far off the recession high of 10.A. In “wealth effect” terms. 2007: NSA: 508k (SA: 352k) Dec 30. 2009: NSA: 557k (SA: 454k) Dec 27.January 4. economy has surpassed our expectations and Q4 growth looks set to cross above a 3% annual rate. as for that ballyhooed slide in initial jobless claims. not only did Case-Shiller home prices decline 1. Cleveland. compares with 3. So.1 million back in 2008. a rally of Maccabeus proportions) was in 1991. so there were other ways to generate profits than merely through equities. Despite what the stock market was telling us back then. a rally of Maccabeus proportions) was in 1991 Dec 26. once again. Then let’s compare initial claims on a non-seasonally adjusted of 522k for this past week . As an aside. although that is still the asset class that seems to dominate everyone’s attention. 2011 – BREAKFAST WITH DAVE However. gold was up 30%. and this compares with: • • • • The last time we enjoyed such a Santa rally (or in Bernanke’s case. including some big markets like Miami. as far as 2010 is concerned. While we were not bullish enough on the stock market. but the U. the stock market resurgence to close out the year was remarkable.3% MoM in October. While the U.8%.. 2008: NSA: 717k (SA: 514k) Dec 29. at 4.. Continuing claims today. This was certainly a December to remember.1 million. GETTING A GRIP The stock market is clearly being fuelled by ongoing dramatic government actions. Even so. The last time we enjoyed such a Santa rally (or in Bernanke’s case. and the high-yield bond market was up a good 15%.400 back then (thanks to Rich Yamarone for that little ditty).S. Oh yes. Investors are focused on not fighting the tape. extended benefits today are at 819. and emergency claims at 3.1%).S. but all 20 cities showed a sequential decline. the high seasonal factor divisor contributed to a 388k headline despite an increase of 25k in raw unadjusted terms. home prices may have another 28% downside from here (and to think we thought the Dallas Fed research team was bearish at down 23%).S. we would like to remind investors that silver was up nearly 90% last year. and the next Fed tightening cycle was more than two years away. there was a nifty op-ed piece by Peter Schiff on page A19 of the December 30 WSJ that laid out the reason why (hint: Bob Farrell’s first rule) U. this masks just how soft the overall jobless situation really is.

it’s not a given that we are going to see all the stimulus at the federal level come to the fore either ― the new Congress will see to that (the front page of the NYT also went with GOP Newcomers Set Out to Undo Obama Victories as well as Congress Targets Spending on the front page of yesterday’s WSJ). already north of $3 a gallon. Looking at the near record net speculative long positions on the New York Mercantile Exchange. exports and the policy tightening in inflation-bound emerging Asia will negatively influence another 25% of the pie.S. speculative longs in copper have also reached five year highs). 23 states have boosted taxes in the past year. The looming showdown in Congress over the stopgap bill that keeps the government running until March. The Fed has now successfully convinced investors that it will defend the S&P 500 vigorously at the low end of the range Page 7 of 15 . The biggest myth being promulgated today is that the economy must be doing better because state/local government revenues are on the rise. So forget about any 2011 improvement from the foreign trade front. soaring budget deficits and the loss of federal stimulus money. Slowing global growth. steep expenditure cuts will very likely be part and parcel to any deal resolving the looming debt ceiling issue. Eight have raised income taxes ― you may want to see the December 26 NYT editorial titled The Looming Crisis in the State. Now that would pretty well take care of that payroll tax cut . And yesterday’s NYT ran with a front page article titled Cuomo Plans 1-Year Freeze On State Pay. And stimulus freaks may have to contend with a GOP-led House that is pushing for spending to return to 2008 levels. incoming governors face the deepest fiscal crisis in decades and expectations that they will remain true to campaign pledges to slash spending and taxes.January 4.. and then some. Governors Warn of Tough Times. Remember that it was this investment-related action in 2008 that ultimately caused the price to head into reverse as the physical demand growth went into reverse (as an aside. Surging energy prices ― oil prices have broken above $90/bbl and we seem to recall that when this happened in 2007. user fees and service cutbacks. as far as light sweet crude is concerned. Ditto for the December 27 front page WSJ article titled Strapped Cities Hit Nonprofits with Fees. 5. It was edifying. Yesterday’s USA Today ran with an article quoting some energy experts predicting that gasoline prices. as flagged by the decline in the Chinese stock market. And. This is a major macro theme for 2011 ― the fiscal squeeze at the lower level of government.. The dramatic fiscal squeeze in Europe is also going to affect 25% of U. We wonder how many economists. giddy over the recent tax stimulus. Make no mistake. may yet test $4 a gallon before long. To wit: “With sagging economies. 2011 – BREAKFAST WITH DAVE 3. 6. an unexpected recession followed four months later. Huge state/local government budget gaps ($65 billion this year) will be closed with tax hikes.” It remains to be seen how this 12% share of GDP and 15% share of employment end up wreaking havoc on newly minted near-4% economic growth forecasts for 2011. which promises to come to a head by April. 4. Have a look at GOP Sets Up a Huge Target for Budget Ax on the front page of today’s NYT — the new Congress is not the old Congress and is seeking $100 billion of cuts in government spending this year. We also recommend a read of the article on page 2 of today’s FT — Republicans Ready for Battle on Debt Ceiling. it is abundantly clear that this runup in oil prices is not merely related to physical demand. have entertained the notion how dramatic spending restraint in their forecast as far as the widespread consensus 2011 macro forecast is concerned. May we also suggest a read of page A3 of yesterday’s WSJ ― Forget Pep Talks. Dude! That’s not the economy! It’s called tax increases. In fact.

S. Can the Fed and Others Exit Neatly? Well. one would have thought that given the fiscal goodies announced that it would have been this component that would have shot up . the Question Is. In the past.9 from 73. We actually saw an economist interviewed on CNBC last week who said he was dismissing the adverse consumer confidence report because it didn’t line up with the other pieces of December data. As for the markets. at current valuation levels..8. is this “intervention” or is this “manipulation”? We can see why the bears have become extinct and the shorts are running scared ― the government has somehow managed to convince investors that bear markets or even corrections are now unconstitutional. The current complacency is palpable. In the past.. the good news appears to be fully priced in and then some.January 4. The prospect of intense spending restraint under the new and more hawkish Congress. The pitfalls have been ignored. After all. This question in the title could have been asked a year ago ― and it is so evident that once the ‘exit strategy’ was about to be implemented. a healthy organically-driven economy was associated with minimum levels of 90 on this barometer. personal bankruptcy filing jumped 9% in 2010. The Conference Board reported that consumer confidence fell to 52. but that there is no limit for asset prices on the upside that would cause the central bank to take the punch bowl away. the markets puked. a healthy organically-driven U.5 in December from 54. 2011 – BREAKFAST WITH DAVE From our lens.60 for every tax dollar it is taking in from the revenue base. In fact. lingering consumer strains were underscored by the fact that U. Now. it is not one that requires the federal government spending $1.3 in November and below the consensus forecast of 55. economy was associated with minimum levels of 90 on the “expectations” component of the Conference Board Consumer Confidence report … … A level we have not seen since the economy approached the Great Recession in the latter months of 2007 Page 8 of 15 .S. This then begs the question. The “expectations” component sagged to 71. what exactly is a “healthy organically–driven” economy? As Doug Cliggott has recently pointed out. So we know what happened. hmmmm. in part because the Fed has now successfully convinced investors that it will defend the S&P 500 vigorously at the low end of the range. a level we have not seen since the economy approached the Great Recession in the latter months of 2007. the limited chance of a QE3 monetary program. QE2 happened. the realization that much of the growth we will see in 2011 will have been borrowed from 2012 and President Obama’s sudden move to the center (evidenced by his choice of William Daley as his new Chief of Staff) which has greatly enhanced his re-election prospects will all make the market action beyond this quarter very interesting indeed. you know that there is nothing but air underneath this economy when you have people like Paul Krugman clamouring for even more stimulus (see his op-ed Deep Hole Economics on page A19 of yesterday’s NYT). you know that there is not much being fundamentally driven when you see this article on page R1 of yesterday’s WSJ ― Meet the Supporting Cast: Markets Continued to Benefit From Intervention in 2010.6.

only a fool would say that that this overextended market can’t become even more extended in coming months Page 9 of 15 . We should add that Tom Lauricella of the WSJ also called it for what it was in his article on page R1 of Monday’s WSJ ― Meet the Supporting Cast. Nor did we believe the market would have responded so aggressively. 2011 – BREAKFAST WITH DAVE This is not the onset of the secular bull market that began in 1982 when the Fed was still conducting monetary policy in a traditional way and when the government was getting out of the way instead of permeating practically every facet of the economy and capital market in order to influence asset values.” At this point. At least if there is any honest reporting out there. what we are seeing unfold should be highly troublesome.January 4. it is from Mark Gongloff at the WSJ. though admittedly along the way we had more bailout action in Europe and then the last-minute fiscal giveaways as the year drew to a close. For any supporter of free markets.. we never thought that the Fed would allow its balance sheet to get so bloated and for the government to run up such a debt tab all in the name of trying to reignite a bull market in risk assets. The title on page R2 of yesterday’s WSJ does pose the question: “Can Markets Star Without Help?” This is what bubbles are made of ― decisions made on the actions or inactions of central banks as opposed to economic fundamentals While we are still not drinking the Kool Aid that the Fed has spiked in its punch bowl. In a mere 12 words . The market has become euphoric in a junior way to what we saw unfold in late 1999 and early 2000.” Indeed. we were one of the few that recognized just how fragile this recovery was. but we did not think that Bernanke was going to do such an about-face regarding his exit strategy. we remind ourselves of Bob Farrell’s Rule Four: “Exponential rapidly rising or falling markets usually go further than you think” This market has already gone much further than we had thought possible but then again. Decisions made on the actions or inactions of central banks as opposed to economic fundamentals. “The story of 2010 shows how government support continued to prop up financial markets. although the headline of his article on the front cover of yesterday’s paper (Investors’ Forecast: Sunny With Chance of Overheating) didn’t quite talk to us as much as this little ditty did: “The big concern at the dawn of 2010 was the economy’s budding comeback would take a nosedive ― concerns that were borne out over the summer but were put to rest as the economy rebounded in the final months of the year with the help of the Federal Reserve. Irrational may even be a more appropriate term because there really seems to have been very little in the month of December to have warranted a run-up in the market that on average takes over a year to achieve even in secular bull phases. This is what bubbles are made of..

2011 – BREAKFAST WITH DAVE Well. There is no such thing as a free lunch and yet it has been a meal of government-fed steroids that Mr. not 17x. he announced this at a Jackson Hole speech in late August before a meeting of his central bank brethren ever took hold. while we are still not drinking the Kool Aid that the Fed has spiked in its punch bowl. Investors Intelligence bullish sentiment is back to where it was at the all-time market highs of October 2007. Then again. But this is a highly speculative market and it is amazing now how analysts. Given the new congressional oversight and new FOMC voting membership. GDP and S&P 500 price targets for 2011. the last three quarters of 2011 are going to be very interesting. economists and strategists have been so quick to raise their earnings.5x. So something tells us that beyond Q1. giving a tax cut is like giving someone a free parking pass ― just try to take it away! Of course. But again. in the second quarter. Market has been feasting on since late summer. is back to where it was last April. though now that it is back in positive terrain it has re-emerged as a source of jubilation). This will be something the market will be mulling over in the second quarter ― the Fed is at the end of its rope. that will only steal growth away from 2012. the share of the time that the P/E multiple was higher than 16x was less than 30%) ― yet somehow this is now considered to be a normal level despite all the future uncertainties surrounding how the Fed and the Federal government can ever extricate themselves from this unbelievable volume of monetary and fiscal largesse. the time to buy the market is when the VIX is at 40x. it is unlikely that Ben Bernanke will receive the backing he got in order to implement QE2 ― remember. we know that in the United States. only a fool would say that this overextended market can’t become even more extended in coming months. and a showdown over the debt ceiling is a clear risk in coming months ― again. We now have Wall Street houses laying claim to fair-value multiples being as high as 16x (going back seven decades to the time the tech bubble began in the 1990s. Remember what happened next. Page 10 of 15 . we can look forward to an acrimonious relationship between the House Republicans and the Administration.January 4. All we can say is that there will be a day when the piper gets paid. Looking back at the past. In the meantime. At stake could be a good dose of spending restraint as ‘pay-go’ rules make a sudden reappearance after being neglected by the lame duckers late last year. There is always the reality of the payroll tax cut coming to an end in December and how that will crimp personal income in 2011. there is always the prospect of a Q4 corporate spending binge as the bonus depreciation allowance expires. SIGNS OF EXUBERANCE ABOUND • • Equity mutual funds and ETF’s took in $24 billion in December ― when bonds were attracting inflows like this last year. at 17. This is the exact reverse image to what we were seeing in the summer (when we were told to ignore the ECRI leading economic indicator. the vast majority believed the fixed-income market was in some sort of bubble The VIX index.

the most since September 2008 when people still thought we were in a soft landing.January 4..2% increase in the fourth quarter. The trigger for the article ― banking sector Commercial and Industrial (C&I) loans eked out a 0. The front page of the December 30 WSJ ran with this as the lead article ― Banks Open Loan Spigot. the last time we saw retail inflows like this into equities was last March . the vast majority believed the fixed-income market was in some sort of bubble. This is what passes for exuberant news these days. consumer loans and residential mortgage credit from the banks have declined now in each of the past two weeks. just ahead of a 17% correction.2% in the first half of December on the NYSE. particularly the QQQ’s (Nasdaq stocks). according to Moody’s. But that does not mean the stock market can’t go up ― instead of extending credit to the Cleaver family.. Since July. Indeed. the banks are seemingly using the newly minted reserves from the Fed to engage in a little bit of old fashioned speculation in the market place as the chart below on “trading assets” at the commercial banks would suggest. as Bob Farrell has been busy pointing out. and by 2. Rest assured that this is the only place you will find this information (save. margin debt has exploded by 16% to $274 billion. perhaps. And despite the Fed’s latest QE move to entice banks to lend. which was to be avoided (have a look at Stock Funds Draw Investor Cash on page C11 of the December 30 WSJ). cash on their balance sheets continues to exceed $1 trillion. The number of short-selling positions slid 2. total net new credit creation is still non-existent and the money multiplier is actually contracting. another leg up in price!! As an aside. Market leadership is narrowing. As Kelly Evans asserted last week. it may just have been a slow news day. it can only mean one thing. It’s not a case of don’t fight the Fed as much as don’t fight the Wall Street prop desks! • • • • • • Page 11 of 15 .8% on the Nasdaq. But since we are now talking about the stock market garnering this much attention. 2011 – BREAKFAST WITH DAVE • The non-commercial accounts on the CME have recently opened up a considerable net speculative long position in equities. for John Williams). Equity mutual funds and ETF’s took in $24 billion in December (TrimTabs data) ― when bonds were attracting inflows like this last year. The bears are running scared. the AAII investor sentiment poll has been above its historical norm now for 17 weeks running ― the longest stretch in six years. Then again.) Let’s just add here that there is no sign at all that lending is rising to the household sector. a quarter in which business credit does not contract (it doesn’t have to expand ― just don’t go down and you reserve the right to have a front page story written about it.

it is up 100 basis points from the SeptemberOctober lows. 2011 – BREAKFAST WITH DAVE CHART 3: BANKS TRADING ASSETS HAS SURGED BY $64 BILLION IN THE LAST MONTH United States: Trading Assets for all commercial banks (billions) 500 450 400 350 300 250 09 Source: Federal Reserve Board /Haver Analytics Source: Haver Analytics. Page 12 of 15 . but the consensus for the 10-year note a year ago was that it would be in a 4-5% range.3%. was remotely constructive on the fixed-income market (Van Hoisington and Gary Shilling aside). Gluskin Sheff 07 08 09 10 WHAT WAS THE REAL SURPRISE OF THE YEAR? That we would close 2010 with the yield on the U.S. Moreover. except for us.S. we have the Treasury market delivering a decent 5. despite the rough going in the last few weeks of the year in particular. recession Source: Haver Analytics.January 4. 10-year Treasury note anywhere near 3. millions) 100 75 50 25 0 -25 -50 99 00 01 02 03 04 05 06 Source: New York Stock Exchange /Haver Analytics Shaded region represent periods of U. To be sure. Nobody.3% total return last year. Gluskin Sheff 10 CHART 4: MARGIN DEBT UP 24% IN PAST YEAR United States: Debit balances in margin accounts at Broker/Dealers (% change – year to year.

Meanwhile. the Japanese equity market has a lot of catching up to do in relation to its G7 counterparts. Wild stuff. Sentiment towards bonds is so depressed that even fixed-income strategists want to switch coverage. valuations look pretty compelling too.January 4. Sentiment towards bonds is so depressed that even fixedincome strategists want to switch coverage Page 13 of 15 . The December 29 WSJ ran with Fixed-Income Pro Favors Stocks. trades at 2. Back on the week of November 16. whereas the U. at least to us. it may not hurt to know that the last time the net speculative short position was this high was back on June 15 of last year. to see this title show up in the Current Yield column in Barron’s: Fear Inflation? TIPS for 2011. So it comes as little surprise. In stark contrast to equities. Japan trades at book.2x book and nearly 2x for Europe as well as non-Japan Asia. In any event. 2011 – BREAKFAST WITH DAVE Once again. the surprise will be the same in 2011 as it was in 2010 — deflation is the primary risk.852 contracts) and in the 10-year note (138.968 contracts). And inflation is back on everyone’s radar screen just as it was a year ago when the core rate of inflation was nearly triple what it is today. the consensus sees little prospect for lower bond yields in 2011 and even former bulls have turned bearish.134 contracts ― talk about a massive swing. it is already priced in. we had a pretty nice short squeeze that allowed the 10-year yield to decline a nice 35 basis points within a month’s time. which means that whatever bad news there is. As Leslie Norton points out in Barron’s (page M7 ― In Love With Japan Yet Again). there was a net speculative long position of 57. IS THE SUN RISING IN JAPAN? The yen is no longer acting as a pervasive vice on profits and the Japanese corporate sector is about to enjoy a five percentage point cut in the top marginal rate to 35%. the latest Commitment of Traders report show that the speculators have established a huge net short position both in the long bond (8.S. In our view.A.

We assemble concentrated portfolios our top ten holdings typically represent between 25% to 45% of a portfolio. In this PERFORMANCE way. Equity Portfolio in 1991 (its inception Our success has often been linked to our long history of investing in underfollowed and under-appreciated small and mid cap companies both in Canada and the U.8 million 2 usd on September 30. risk-adjusted investment returns together with the highest level of personalized client service. equities that we sell short. Please contact Gluskin Sheff for information specific to your situation. our Gluskin Sheff became a publicly traded Portfolio Managers have been with the corporation on the Toronto Stock Firm for a minimum of ten years and we Exchange (symbol: GS) in May 2006 and have attracted “best in class” talent at all remains 49% owned by its senior levels. we are dedicated to the prudent stewardship of our clients’ wealth through the delivery of strong. please contact questions@gluskinsheff. Growth and For corporate bonds.6 million usd for the S&P 500 Total Return Index over the same period. Alternative and Fixed Income) and investment styles (Value. Our investment interests are directly aligned with those of our clients.com Unless otherwise noted. 2 We have strong and stable portfolio management. Firm is $3 million. shareholder-minded management and a share price below our estimate of intrinsic We offer a diverse platform of investment value. Aside from recent additions. Our investment interests are directly aligned with those of our clients. research and client service teams. equities. as Gluskin Sheff’s management and employees are collectively the largest client of the Firm’s investment portfolios.January 4.1 million2 on September 30. $1 million invested in our Canadian Equity Portfolio in 1991 (its inception date) would have grown to $9. 2010 versus $5. public company accountability and governance with a private company We have a strong history of insightful commitment to innovation and service. and yields which The minimum investment required to are attractive relative to the assessed establish a client relationship with the credit risks involved.S.S. and are presented net of fees and expenses. we look for issuers 1 with a margin of safety for the payment Income). 2010 versus $5. Not all investment strategies are available to non-Canadian investors. 2011 – BREAKFAST WITH DAVE Gluskin Sheff at a Glance Gluskin Sheff + Associates Inc. we look for companies Gluskin Sheff’s management and with a history of long-term growth and employees are collectively the largest stability. Equity Portfolio in 1986 (its inception date) would have grown to $11. the Firm managed assets of $5. Equity portfolios. Page 14 of 15 . clients benefit from the ideas in $1 million invested in our Canadian which we have the highest conviction. Returns are based on the composite of segregated Value and U. INVESTMENT STRATEGY & T EAM date) would have grown to $9. all values are in Canadian dollars.1 million on September 30. bottom-up security selection based on fundamental analysis. Our performance results are those management and employees.9 million for the S&P/TSX Total Return Index over the same period. For further information. Notes: PORTFOLIO CONSTRUCTION In terms of asset mix and portfolio construction. 2010 versus $9. 1. We have of the team in place. client of the Firm’s investment portfolios. as applicable.8 billion.9 million for the S&P/TSX Total Return Index over the same period.S. We look for the opposite in strategies (Canadian and U. 2010. of interest and principal. OVERVIEW As of September 30. Founded in 1984 and focused primarily on high net worth private clients. is one of Canada’s pre-eminent wealth management firms. 2. a proven track record. as For long equities. $1 million usd invested in our U.S. we offer a unique marriage between our bottom-up security-specific fundamental analysis and our top-down macroeconomic view.

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