NAVIGATING THE NEW NORMAL David A.

Rosenberg October 2012

TM

WHAT, ME WORRY?

Yes, I am more worried than I look!

Note: Source: The Atlantic, April 2012

LETS PLAY RISK

The staff also reported on potential risks to financial stability, including those owing to the developments in Europe and to the current environment of low interest rates.
The staff viewed the uncertainty around the forecast for economic activity as elevated and the risks skewed to the downside, largely reflecting concerns about the situation in Europe and the possibility of a more severe tightening in U.S. fiscal policy than anticipated. In addition, participants still saw significant downside risks to the outlook for economic growth. Prominent among these risks were a possible intensification of strains in the euro zone, with potential spillovers to U.S. financial markets and institutions and thus to the broader U.S. economy; a larger-than-expected U.S. fiscal tightening; and the possibility of a further slowdown in global economic growth. However, participants also observed that significant risks related to the euro-area banking and fiscal crisis remained, and that a number of important issues would have to be resolved in order to achieve further progress toward a comprehensive solution to the crisis. Moreover, while the sovereign and banking crisis in Europe had eased some recently, members still saw strains in global financial conditions as posing significant downside risks to the economic outlook. The possibility of a larger-than-expected fiscal tightening in the United States and slower global growth were also seen as downside risks. The Minutes from the September 12 - 13, 2012 Federal Open Market Committee Meeting, released on October 4, 2012
3

U.S. GOVERNMENT SPENDING $1.50 FOR EVERY $1.00 IN REVENUE

United States: Net Outlays/Net Receipts
(ratio)
1.80

Deficit
1.70 1.60 1.50 1.40 1.30 1.20 1.10
1.00

Unheard of outside of WWII

55 0.90

58

61

64

67

70

73

76

79

82

85

88

91

94

97

00

03

06

09

12

Surplus
0.80

Note: Shaded bar and represents the OMB estimate Source: Office of Management and Budget, U.S. Treasury

CENTRAL BANKS RADICALLY EXPANDED THEIR BALANCE SHEETS

U.S., U.K., ECB, and Japan Central Bank Assets as Percent of Combined GDP
(percent)
26.0% 24.0% 22.0% 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% Unprecedented!

2006
Note: Source: Haver Analytics

2007

2008

2009

2010

2011

2012
6

CALL IT THE WILE E. COYOTE ECONOMY

A SUB-PAR U.S. ECONOMIC RECOVERY

United States: 12 Quarters After A Recession Ends
Real GDP per capita
(annualized percent change)
5% 4.5% 5% 4% 4% 3% 3% 2% 2% 1% 1%
0%

Nominal GDP per capita

(annualized percent change)
10% 9.2%
9%

8.2%

3.7% 3.3% 3.3% 3.0%

8% 7% 6% 5%
1.7%

7.6%

6.3%

5.0% 3.8% 4.0%

3.1%

1.7%

4%

1.4%

3% 2% 1%
0%

61 Q1

70 Q4

75 Q1

82 Q4

91 Q1

01 Q4

Avg.

Current

61 Q1

70 Q4

75 Q1

82 Q4

91 Q1

01 Q4

Avg.

Current

Last Quarter of Recession

Last Quarter of Recession

Note: Source: Bureau of Economic Analysis, Bureau of Labour Statistics

NOT A TYPICAL CYCLE

United States
Real Estate Deflation
(home price index, 1890 = 100)
200.0 190.0 180.0 170.0 160.0

Household Credit Contraction

(year-over-year percent change)

20.0

16.0

12.0

150.0
140.0 130.0 120.0 110.0 100.0
Note: Source: Robert Shiller, Federal Reserve Board, Haver Analytics
Down 43%!

8.0

4.0

0.0
Debt deleveraging

-4.0
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
58 63 68 73 78 83 88 93 98 03 08
10

UNPRECEDENTED FIVE-YEAR CONTRACTION IN U.S. HOUSEHOLD NET WORTH

United States: Household Net Worth
(five-year percent change at an annual rate)
16 14 12 10 8 6 4 2 0 -2 -4 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11
11 Note: Source: Federal Reserve Board

STILL MORE TO GO BEFORE THE HOUSEHOLD BALANCE SHEET IS REPAIRED

United States
(percent)

Household Debt-to-Asset Ratio

23 22 21

Household Debt-to-Income Ratio

140 130 120 110 100 90

20
19 18 17 16 15 14 13 12 11 '72 '77 '82 '87 '92 '97 '02 '07 '12
Note: Source: Federal Reserve Board Pre-bubble average

80
Pre-bubble average

70 60 '72 '77 '82 '87 '92 '97 '02 '07 '12

12

MCKINSEY ON FINANCE: PERSPECTIVE ON CORPORATE FINANCE & STRATEGY

Findings from McKinsey & Company:
While we cannot say for certain whether these sectors will deleverage, we do know that nearly every significant financial crisis in the post-World War II period was followed by a lengthy and painful period of deleveraging. These episodes lasted on average six to seven years, with total debt as a percentage of GDP declining by roughly 25 percent. GDP contracted in the initial years of deleveraging but rebounded in the later years. If history is a guide, therefore, we would expect a significant period of deleveraging to come, which will dampen GDP growth.

13

LIFE AFTER THE CREDIT COLLAPSE -- FAT TAIL RISK

Distribution of Outcomes before the Credit Collapse

Distribution of Outcomes after the Credit Collapse

14

RANGE OF OUTCOMES IS EXTREMELY WIDE

United States: Range of FOMC September 2012 Forecasts
(percent)

Real GDP Growth Rate

4.5 4.1

Unemployment Rate
8.5
8.3 8.0 8.0

8.0

3.5

3.5

7.5

7.5

7.0

7.0

2.7 2.5 2.3 2.0

6.5

6.3

6.0

5.5 1.6 1.5

2012 2013 2014

5.0
2012 2013 2014

Note: Source: Federal Reserve Board

15

WHAT HAVE WE LEARNED IN 2,604 YEARS?

The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance.
Cicero - 55 BC

16

THE WORLD IS AWASH IN DEBT

OECD: Gross General Government Debt-to-GDP Ratio
(percent of nominal GDP)
115 106 105 98 102

95

91

85 74 74 74 73 75

80

76

75 69 64

70

72

73

75

70

70

72

73

65

55 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
17 Notes: Shaded bars represent OECD estimates Source: OECD

18

SAFE-HAVENS DWINDLING IN NUMBER

AAA-RATED COUNTRIES
(AAA countries government debt as percentage of total government debt)

60% 50% 40% 30% 20% 10% 0% '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12

Note: Source: Standard & Poors, Bank for International Settlements

19

TOO MUCH DEBT AT ALL LEVELS

Domestic Debt Outstanding as a % of adjusted GDP (Q1 2012)
800 700 600 500 400 300
200

100 0

Note: Source: Haver Analytics * Q1 data are not available, using the last available data

20

IS THIS REALLY THE END?

Note: Source: The Economist, November 26, 2011 21

INTEREST RATES DIVERGE IN THE EUROZONE TO THE PRE-EMU LEVELS

10-Year Government Bond Yield
(percent)
25

20

19.2

15

10

8.7
5.8

5.0

4.9 2.4 2.2 1.7

1.3 Germany
22

0 Greece
Notes: Source: Bloomberg

Portugal

Spain

Ireland

Italy

Belgium

France

Netherlands

SOME EVIDENCE OF ECONOMIC DIVERGENCE

Unemployment Rate
(percent; Q2 2012)
25 24.7 22.6

20
15.2 15

14.7

10.5 10

9.6

8.6 6.8 5.3 5.1

0 Spain Greece* Portugal Ireland Italy France Finland Belgium Germany Netherland
23 Note: Source: Haver Analytics * Q2 data is not available, using the last available data

MORE EVIDENCE OF ECONOMIC DIVERGENCE

Year-over-Year GDP Growth Rate
(percent; Q2 2012)
3 2

1
0 -1 -2 -3 -4 -5 -6 -7

1.0 0.3 0.2

-0.3

-0.6 -1.3

-2.6

-3.2

-6.3 Germany France Finland Belgium Netherland Spain Italy Portugal Greece
24

Notes: Source: Haver Analytics, Gluskin Sheff

EUROPE HEADING BACK TO RECESSION

Euro Area
(year-over-year percent change)

Real GDP
4 3 2 1 0

Employment level
2.0 1.5 1.0 0.5 0.0

-1

-0.5
-2 -3 -4 -5 -6
'07 '08 '09 '10 '11 '12

-1.0 -1.5 -2.0 -2.5 '07 '08 '09 '10 '11 '12

Note: Source: Statistical Office of the European Communities

25

 AND LIKELY TO REMAIN THAT WAY FOR SOME TIME

Euro Area: Leading Indicator
(year-over-year percent change)
6

-2

-4

-6 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
26 Note: Source: OECD, Haver Analytics

THERE IS NO DECOUPLING
Real GDP Growth
(year-over-year percent change)
6.0
r = 0.84

4.0

United States (USD)

2.0
European Union (Euro)

0.0

-2.0

-4.0

-6.0 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
27 Note: Source: Eurostat, BEA, Haver Analytics

EUROPEAN RECESSION ALREADY CAUSING ASIAN EXPORTS TO DECLINE

Exports
(year-over-year percent change)

China
60 50 40 30 20

Korea
50 40 30 20 10

10 0 0 -10 -20 -30 -40

'07 '08 '09 '10 '11 '12

-10 -20 -30 -40

'07 '08 '09 '10 '11 '12

Note: Source: China Customs, Korea Custom Services, Haver Analytics

28

TRADE SHOCK LIKELY TO HIT HOME SOON

United States
Exports of Goods and Services (left axis, year-over-year percent change) ISM New Export Orders (right axis, level, 50+ = increasing)
22.5 correlation = 0.81 15.0
60
65

7.5

55

0.0

50

-7.5

45

-15.0
Exports growth (lagged by four months)
ISM New Export Orders Index

40

-22.5 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09

35

Note: Source: Census Bureau, Institute for Supply Management

29

BERNANKE ON THE FISCAL CLIFF

I think its important to say that if no action were to be taken by the fiscal authorities, the size of the fiscal cliff is such that there is, I think, absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy.

Note: Source: FOMC Press Briefing on April 25, 2012

30

THE FISCAL CLIFF

Change in Primary Fiscal Balance to GDP Ratio
(percentage points)
4%
Net Fiscal Drag

Record Drag!

2%

-1%

-3%

-5%
Net Fiscal Stimulus

-7% 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13
Notes: 2013 is based on CBO estimates of the fiscal balance Source: CBO, Haver Analytics 31

A CHALLENGING ENVIRONMENT FOR THE FEDERAL GOVERNMENT

United States: Government Finances (percent)
Interest Payments as a Share of Total Revenue
21 19 17

Debt as a share of GDP

115
105 95

85
75 65

15
13 11 9 7 5 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 '20

55
45 35

25
'70 '75 '80 '85 '90 '95 '00 '05 '10 '15 '20

Notes: Shaded bars and dotted lines represent estimates (interest payments/total revenue estimates by Gluskin Sheff and debt/GDP estimates by the OMB) Source: OECD, U.S. Office of Management and Budget (OMB)

32

CORE CAPEX ORDERS WAVE A RED FLAG; CORE RETAIL SALES ARE ON A DOWNWARD PATH
United States
Core Capex Orders*
(year-over-year percent change of the three-month average)
30 20 10 0
2

Core Retail Sales**

10

(year-over-year percent change)

8
6 4

-10
0

-20 -30 -40 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11

-2 -4 -6 '06 '07 '08 '09 '10 '11 '12

Note: * Nondefense capital goods ex aircraft **Retail sales ex auto, gasoline and building materials Shaded regions represent periods of U.S. recession Source: Census Bureau

33

Note: Source: Time Magazine (June 13, 2005)

34

HOUSING RECOVERY IN PERSPECTIVE

United States: Housing Starts
(thousands)

Short-term View
800

Long-term View
2,800

750

2,400

700

2,000

650

1,600

600

1,200

550

800

500 Jan/10 Jul/10 Jan/11 Jul/11 Note: Source: Census Bureau, Haver Analytics

400

Jan/12

Jul/12

'59

'69

'79

'89

'99

'09

35

DITTO
United States: New Home Sales
(thousands)

Short-term View
380

Long-term View
1,400

360

1,200

340

1,000

320

800

300

600

280

400

260 Aug/10 Feb/11 Aug/11 Note: Source: Census Bureau, Haver Analytics

200

Feb/12

'62

'72

'82

'92

'02

'12

36

HOUSING DOWN TO A 2% SHARE OF GDP

United States: Housing Share of GDP
(year-over-year percent change)
8

2 '47 '52 '57 '62 '67 '72 '77 '82 '87 '92 '97 '02 '07 '12
Note: Shaded regions represent periods of U.S. recession Source: Bureau of Economic Analysis

37

THE (SLIDING) EVOLUTION OF THE FED'S GDP FORECAST

United States: Federal Reserve GDP Forecast
(percent)
4.3

2012
4.1 4.0

2013
4.5 4.2 4.0
3.5

3.9

3.8

3.9

3.9

3.3

3.5 3.3

2.8

2.7 2.5

2.7

3.0

3.0

2.9 2.75

2.3

2.2 1.85

2.5

2.5

1.8
Note: Source: Bloomberg

2.0

38

HELICOPTER BEN BERNANKE .

39

UNPRECEDENTED MONETARY EXPANSION

United States
Fed Funds Rate
(percent)
5.5 5.0 4.5 4.0 3.5 3.0 2.5
2.5

Fed Balance Sheet Total Assets

($ trillion)
3.0

2.0

2.0
1.5 1.0

1.5

1.0

0.5
0.0 05 06 07 08 09 10 11 12
Note: Source: Federal Reserve Board

0.5 05 06 07 08 09 10 11 12
40

RATES ON HOLD FOR ANOTHER THREE YEARS

FOMC meeting June 22, 2011 The Committee continues to anticipate that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate for an extended period. FOMC meeting August 9, 2011 The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. FOMC meeting January 25, 2012 In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. FOMC meeting September 13, 2012 In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.
Note: Source: Minutes from FOMC meetings 41

WHAT CORRELATES WITH BOND YIELDS

United States
(correlation: percent)

88% 75% 64% 64% 58%

40%

39% 25%

Fed Policy
Note: Source: Haver Analytics

Core CPI Inflation

CPI Inflation

Core PPI Inflation

PPI Inflation

Budget Deficits

CRB Index

Oil Prices

42

BOND YIELDS FOLLOW FED POLICY

United States
(percent)

20
18 16 14 12 10 8 6 10-year Treasury Note Yield r = 89% Fed Fund Rate

4
2 0 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10

Note: Source: Federal Reserve Board

43

A SUPER STEEP U.S. YIELD CURVE: HOW WILL IT FLATTEN?

United States: Treasury Yield Curve
(percent)

Today (October 2012)

3.5
3.0

Average for Past 30 Years

8.0

A Year Ago
7.5

2.5 2.0 1.5 1.0 0.5 0.0 Fed Funds Rate 2Y 5Y 10Y 20Y

Today
7.0

+270bps
6.5

+160bps

Historical Avg

?
6.0

5.5

5.0

30Y

Fed Funds Rate

2Y

5Y

10Y

20Y

30Y

Note: Source: Federal Reserve Board

44

Note: Source: Wall Street Journal, January 3, 2011

45

WHAT THE FED HAS DONE BEYOND INTEREST RATES MULTIPLE QEs
QE1 (December 2008 to March 2010):
$1.25 trillion of mortgage-backed securities $300 billion of long-term Treasuries $200 billion of Agency debt QE2 (November 2010 to June 2011): $600 billion of longer-term Treasury securities Operation Twist (September 2011 to present):

The Fed bought over $500 billion of long-term Treasury securities and sold an equal amount of short-term Treasury securities
QE3 (September 2012 to ??): The Fed will purchase additional Agency mortgage-backed securities at a pace of $40 billion per month, until it is satisfied with the economys progress.
Note: Source: Federal Reserve Board 46

HE SAID WHAT??

We do think that these policies can bring interest rates down, not just treasury rates but a whole range of rates including mortgage rates and rates for corporate bonds and other types of important interest rates. It also affects stock prices. It affects other prices, home prices, for example.
So looking at all the different channels of effect, we think it does have an impact on the economy. It will have impact on the labor market but again, the way I would describe it is a meaningful effect, a significant effect, but not a panacea, not a solution for the whole issue.
Ben Bernanke, at the Post-FOMC Meeting Press Conference, September 13, 2012.

47

IS THE FED PUSHING ON A STRING?

United States
(ratio)

St Louis M1 Money Multiplier

1.7

Velocity of Money: Nominal GDP to M2

2.00 1.95 1.90 1.85

1.5

1.3

1.80 1.75

1.1

1.70
0.9

1.65 1.60

0.7 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12

1.55 '03 '04 '05 '06 '07 '08 '09 '10 '11
48

Note: Source: Federal Reserve Bank of St. Louis, Macroeconomic Advisers, Federal Reserve Board

FED LIQUIDITY BOTTLED UP ON BALANCE SHEETS

United States
($ billions)

Nonfinancial Corps Cash and Cash Equivalents

1500 1400

All Commercial Banks Cash Assets

1750 1500 1250 1000 750 500 250

1300
1200 1100 1000 900 800 700

600
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
Note: Source: Federal Reserve Board

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11
49

INCOME MATTERS MORE THAN WEALTH EFFECT ON SPENDING

United States
(year-over-year percent change)

Disposable Personal Income

10.0 correlation = 0.75 8.0 6.0 4.0

Household Net Worth*

20.0 correlation = 0.57 15.0 10.0 5.0 0.0

2.0 -5.0 0.0 -10.0 -2.0 -4.0 -6.0 -15.0

Real PCE Real Disposable Income

-20.0 -25.0 '65

Real PCE Real HH Net Worth

'70 '75 '80 '85 '90 '95 '00 '05 '10

'60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '60 Note: * Nominal net worth deflated by the CPI index Source: Bureau of Labor Statistics, Bureau of Economic Analysis, Federal Reserve Board

50

A RISK-ON, RISK-OFF MARKET

United States: S&P 500 Index
(index)
1,600

QE 1
1,500 1,400 1,300 1,200
1,100

QE 2

Operation Twist and QE3

1,000 900 800 700 600

Jan/09 Apr/09 Jul/09 Oct/09 Jan/10 Apr/10 Jul/10 Oct/10 Jan/11 Apr/11 Jul/11 Oct/11 Jan/12 Apr/12 Jul/12 Oct/12
Note: Source: Wall Street Journal, Haver Analytics 51

2010-12 IS A MICROCOSM OF THIS INTENSE ROLLER COASTER RIDE

United States: S&P 500 Composite Index
(percent change, since January 2010)
22.1% 16.9%
14.0%

15.2% 10.3%

16.9% 13.1% 8.5%

5.5% 3.3% 3.0%

6.4%

6.9%

-2.9%

-4.7% -7.6%
-8.7%

-3.9%

-8.9%

-8.5%

-7.0%

-6.4%

-7.2%
-9.6% -9.9%

-18.8%

Note: Source: Haver Analytics

52

BEARISH FUNDAMENTALS BUT BULLISH MARKETS

Note: Source: Barrons (September 3, 2012)

53

REVENUE AND PROFIT GROWTH ALMOST VANISHED

United States
(year-over-year percent change)

S&P 500 Sales Per Share

20 15 10 5 0 -5

Corporate Profits*
70 60
50

40 30 20 10

-10

0 -10 -20 -30

-15 -20 -25

Note: * Corporate profits after tax with inventory valuation adjustment and capital consumption adjustment Source: Standard & Poors, Bureau of Economic Analysis, Gluskin Sheff

54

THE FEDS INFLATION REACTION FUNCTION HAS CHANGED

United States: 10-Year TIPS Breakeven Rate
(percent)
3.0

2.5

QE3 announced

2.0

1.5

QE2 announced

OT announced

1.0

0.5

0.0 Oct/08 Apr/09 Note: Source: Bloomberg, Gluskin Sheff

QE1 announced
Oct/09 Apr/10 Oct/10 Apr/11 Oct/11 Apr/12

55

FED POLICY GEARED TOWARDS DOLLAR WEAKNESS AND HIGHER GOLD PRICE
United States
The DXY Dollar Index
(index)
84.5

Gold Price
($/troy oz)
1,780

83.5

1,740

82.5

1,700

81.5

1,660

80.5

1,620

79.5

1,580

78.5 Apr/12 May/12 Note: Source: Bloomberg

Jun/12

Jul/12

Aug/12

Sep/12

1,540 Apr/12

May/12

Jun/12

Jul/12

Aug/12

Sep/12

56

FED DRIVES REAL RATES INTO NEGATIVE TERRAIN

United States: Yields on Treasury Inflation Protected Securities
(percent)

5-year TIPS
4.0

10-year TIPS
3.5 3.0

3.0
2.5

2.0

2.0 1.5

1.0
1.0

0.0

0.5 0.0

-1.0
-0.5

-2.0
Jan/08 Jan/09 Jan/10 Note: Source: Bloomberg, Gluskin Sheff Jan/11 Jan/12

-1.0
Jan/08 Jan/09 Jan/10 Jan/11 Jan/12

57

ARGUABLY THE MOST COMPELLING ARGUMENT FOR EQUITIES

United States: S&P 500 Dividend Yield and Five-year T-note Yield
Yield Levels
(percent)
6

Spread
(basis points)
400 Widest since 1958!

5
Five-year T-note Yield

200

4
-200

-400

2
S&P 500 Dividend Yield

-600

-800

S&P 500 Dividend Yield Five-year Treasury Yield Spread

-1,000

0
Jan/02 Jan/04 Jan/06 Jan/08 Jan/10 Jan/12 Note: Source: Standard & Poors, Federal Reserve Board, Haver Analytics

-1,200

'53

'58

'63

'68

'73

'78

'83

'88

'93

'98

'03

'08

58

A TALE OF TWO INCOMES

United States
(billions)

Interest Income
1500.0

Dividend Income
850.0 800.0 750.0

1400.0

1300.0
700.0

1200.0

650.0 600.0 550.0

1100.0

1000.0 500.0 900.0 Jan/06 450.0 Jan/06

Jan/07

Jan/08

Jan/09

Jan/10

Jan/11

Jan/12

Jan/07

Jan/08

Jan/09

Jan/10

Jan/11

Jan/12

Note: Source: Bureau of Economic Analysis, Haver Analytics

59

DIVIDEND PAYOUT RATIO AT RECORD LOWS

United States: Dividend Payout Ratio
(percent)
70%

60%

50%

40%
Historical average

30%
Record lows!

20% 1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010
60

Note: Note: EPS based on GAAP up to 1977 and Pro forma from 1978- present Sources: : Bank of America Merrill Lynch, Standard & Poors, Cowles commission, Gluskin Sheff

CORPORATE BOND YIELDS LOW IN ABSOLUTE TERMS BUT HIGH IN RELATIVE TERMS
United States: BBB-rated Corporate Bond Yield and Spread off Treasury
Yield
(percent) 11

Spread
(basis points)
900 800 700 600 500

10
9 8 7

400

6 5 4 3

300 200 100 0

Pre-Bubble Average

'97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
Note: Source: Bank of America Merrill Lynch

'97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
61

CORPORATE DEFAULT RATES MATCH STRONG BALANCE SHEET FUNDAMENTALS

United States: High Yield Corporate Bond Default Rates
(percent)
16.0% 14.0% 12.0% 10.0% 8.0% 6.0%
4.0%

Historical Average

2.0%
0.0% Jan/95

Jan/97

Jan/99

Jan/01

Jan/03

Jan/05

Jan/07

Jan/09

Jan/11

Note: Shaded region represent periods of U.S. recession Source: Barclays Capital

62

CORPORATE SECTOR FINANCES IN GOOD SHAPE

United States: Nonfarm Nonfinancial Corporate Business (percent)
Liquid Assets to Short-term Debt Ratio
60 55 50

Long-term Debt to Credit Market Debt Ratio

80

75

45
40

70

65

35 30 25
55 60

20 15
50

'70 '74 '78 '82 '86 '90 '94 '98 '02 '06 '10
Note: Source: Federal Reserve Board

'70 '74 '78 '82 '86 '90 '94 '98 '02 '06 '10
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BONDS HAVE A LOW WEIGHTING ON BOOMER BALANCE SHEETS

United States: Share of Household Assets
(percent)
100 90 80 70 60 50 40 30 20 10 0
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 46 35 37 48 53 29 27 21 20 14 17 18 18 30 33 34 31 30 31 36 48 47 46 39 21 26 23 25 26 2 3
2 2 2

4 20

25

27

24

55 46 32 33 26 27 44

47

42

Equities* Bonds** Cash and equivalents Other Note: *Include listed equity shares and equities held via mutual funds **Include government bonds, corporate bonds, commercial paper, agency- and GSE-backed securities, and municipal securities Source: Federal Reserve Board, Shiller S&P data set, McKinsey Global Institute

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RECORD FLOWS INTO INCOME-GENERATING FUNDS

United States (12-month moving total: US$ billions)
Bond Funds
450 Inflow 400 350 300 250 10 200 0 150 100 50 0 -50 '07 '08 '09 '10 '11 Outflow '12 -10 -20
-150 -100 -50

Hybrid Funds
50 Inflow 40

Capital Appreciation Equity Funds

100 Inflow 50

30
20
0

-30 Outflow -40 '07 '08 '09 '10 '11 '12

-200 '07 '08 '09 '10 Outflow '11 '12

Note: Source: Investment Company Institute (ICI)

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NOT AGED BUT STILL AGING

United States: Median Age of Baby Boomers
60
55

55 52

50 45 40 35 30 25
20 23

44

35

25

17

15 10 1974 1980 1982 1990 Recession Years

Note: Source: Census Bureau 68

2001

2009

2012

DEALING WITH DEMOGRAPHICS

United States: Share of Total Population
Age 25-49
(percent)
40%

Age 50-74
(percent)
Capital appreciation crowd
30%

Capital preservation crowd

29% 28%
27%

39% 38% 37%

26%
36% 35% 34% 25%

24% 23% 22%

33% 21% 32% '80 '90 '00 '10 20% '80 '90 '00 '10

Notes: Dashed lines represent forecast Source: Census Bureau

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HAPPY RETURNS IN INCOME STRATEGIES

Total Returns of Different Asset Classes
(year-over-year percent change, as of September)
40%

35%

30%

25%

20%

15%

10%

5%

0%

REITs

"Dogs" of the U.S. dow preferreds

High yield bonds

Note: Source: Bloomberg, Haver Analytics

Dow utilities High dividend Invest. grade Muni bonds 10-year strip 30-year strip paying TSX corp bonds stocks

Canadian provincial bonds

10-year Tnote

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INVESTMENT STRATEGY: SAFETY AND INCOME AT A REASONABLE PRICE (S.I.R.P)

1. 2. 3. Focus on safe yield: High-quality corporates (non- cyclical, high cash reserves, minimal refinancing needs). Corporate balance sheets are in very good shape. Equities: focus on reliable dividend growth/yield; preferred shares (income orientation). Whether it be credit or equities, focus on companies with low debt/equity ratios and high liquid asset ratios balance sheet quality is even more important than usual. Avoid highly leveraged companies. Even hard assets that provide an income stream work well in a deflationary environment (ie, oil and gas royalties, REITs, etc). Focus on sectors or companies with these micro characteristics: low fixed costs, high variable cost, high barriers to entry/some sort of oligopolistic features, a relatively high level of demand inelasticity (utilities, staples, health care these sectors are also unloved and under owned by institutional portfolio managers). Alternative assets: allocate significant portion of asset mix to strategies that are not reliant on rising equity markets and where volatility can be used to advantage. Precious metals: A hedge against the reflationary policies aimed at defusing deflationary risks money printing, rolling currency depreciations, heightened trade frictions, and government procurement policies

4. 5.

6. 7.

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DISCLAIMER The information, opinions, and other materials contained in this presentation is the property of Gluskin Sheff + Associates Inc. and may not be reproduced in any way, in whole or in part, without express authorization of the copyright holder in writing. The statements and statistics contained herein have been prepared by Gluskin Sheff + Associates Inc. based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This publication is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.

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