David A.

Rosenberg June 5, 2009

Chief Economist & Strategist Economics Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING
You don’t even have to go to the equity market page on Bloomberg to know what IN THIS ISSUE
sort of day it’s going to be — just check out the Yen-Euro cross rate, another
barometer of investor risk appetite. We see that it is on the decline, which is a • Canadian employment — a
thumbs-up for everything that is not a safe-haven. The Aussie dollar is up 0.5% big decline in May
as neither the Reserve Bank of Australia (or the Bank of Canada for that matter) • The Investor Intelligence
can keep these beta-currencies down (Sterling, as an aside, is being hit by survey shows that 42.5%
intensifying concerns over the longevity of Gordon Brown’s government). of PMs are now bullish on
the equity market; 25.3%
are now bearish
Emerging market equities rallied 0.9% today and are up 2.0% for the week; Asia
finished today’s session with a healthy 0.6% advance. We see that the FT-SE is • It’s employment day in
up more than 1.0% (politics ostensibly only matter for currencies and bonds, not North America; we already
for equities) and the rest of the continent has gained 0.7%. got the Canadian number,
it was B-A-D
U.S. futures are in the green and Treasuries are selling off once again, • Consumer spending and
apparently caught in a no-win situation; if the Fed doesn’t step in and buy more housing still in the
government bonds, investors are going to conclude that there is not enough doldrums
demand to absorb all of the new supply coming on stream. Yet, if the Fed were • Bank of Canada talks
indeed open to the idea of expanding its bloated balance sheet further, then the down the loonie (without
‘monetization of debt’ would cause the inflation-phobes to panic and sell their much success)
long-duration paper. As we said, a no-win situation. • Deleveraging cycle in the
U.S. is far from over
With the economy still in recession, little hope of a vigorous recovery when it
does come around, and widening excess capacity (not to mention a hugely
positive ‘carry’) one would have expected the yield on the 10-year T-note to be in
a 2.0-3.0% range as opposed to the near 3¾% yield we have today. The 10-year
note is on a knife’s edge having given up most of its recent rally. We are still
constructive on the bond market, but let’s just say that at this point we are
nervous bulls. No sense being dogmatic.

But fixed income is not limited to govies. We have for some time, and still do,
favour high-grade corporates regardless of what Treasuries do — at least this is a
market where, in classic ‘Fisherian’ fashion, supply is creating its own demand —
the amount of global issuance in the last year has tripled and spreads have
continued on a narrowing path. Look for that to continue.

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June 5, 2009 – BREAKFAST WITH DAVE

As for commodities, oil is bid around $69/bbl — up 5.0% for the week — as is
copper (also up around 5.0% for the week). Gold is consolidating. The U.S.
dollar is stable today but with the 50-day crossing below the 200-day moving
average the bear market is entrenched, which is a net positive for the
commodity complex. (Though why the Euro should strengthen on an ongoing
basis given the region’s deep problems is a bit of a mystery — for one example,
turn to Baltic Storm Threatens Euro Banks on page C12 of the WSJ).

On the data front, all we saw were some benign inflation data across the pond —
UK input prices +0.4% MoM in April and -9.4% on a YoY basis (steepest deflation
rate in seven years) while core output prices edged up 0.2%; and the ECRI
leading inflation index for the EMU hit a historic low in April — down to 82.4 from
84.1.

WE CAN UNDERSTAND ALL THE ANGST SURROUNDING INFLATION

We just don’t agree with it. Inflation is about a sustained uptrend in the
absolute price level; commodities going up only really tell us about what is When we read about
happening to relative prices, that’s all. Because precious few final-state price cuts failing to
manufacturers or domestic retailers have any pricing power at all, the run-up in lift sales volumes,
basic material costs either comes at the expense of profit margins or, as we just we start to
saw in the Canadian employment data, the labour market. For a taste of what contemplate the
we are talking about, go to Discounting by Pricier Chains Fails to Give Retail prospect that this
Sales a Lift on page B3 of the WSJ. When we read about price cuts failing to lift cycle is turning
sales volumes, we start to contemplate the prospect that this cycle is turning
more Japanese
more Japanese with every single data point. (Japan also enjoyed sporadic
‘green shoots’ too — they are called cherry blossoms over there — and
intermittent stock market rallies and bond market selloffs, but the fundamental
trend was really in one direction for the last 10-15 years for the economy and
the asset classes.)

IT’S NONFARM PAYROLL SURVEY DAY

The consensus is looking for a 520,000 decline — the optimists would inevitably
treat this as a ‘green shoot’ since it is a second-derivative improvement relative
to the 539,000 falloff in April, not to mention the -741,000 print posted in
January. But do they realize that the worst number we ever saw in the 2001
recession was -325,000? Just to put a 500,000+ decline into perspective.

ADP recorded a 532,000 decline; the Monster employment index also dipped
two points last month; non-manufacturing ISM employment is a lowly 39; and
jobless claims have remained above 600,000 now for 18 straight weeks — the
longest stretch ever. Not until they fall below 500,000 will it be safe to call the
recession as being over.

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June 5, 2009 – BREAKFAST WITH DAVE

WE ALREADY GOT THE CANADIAN NUMBER! B-A-D

• Canadian employment -41,800 in May, double the decline expected by the
Canadian jobless
market
rate surged to an
• All the drop was in full-time too — down 58,700 — which more than wipes 11-year high;
out the 39,400 gain in April (Canada has lost 224,000 full-time jobs this Ontario’s
year — some ‘green shoot’) unemployment rate
hits a 15-year high
• The unemployment rate surged to an 11-year high of 8.4% from 8% (was
6.6% at the start of the year)
• Manufacturing employment plunged 58,400 — brings YTD carnage to
162,100
• Ontario employment slid 60,000 — the unemployment rate in the province
is now 9.4% — the highest since June 1994!

Bottom Line: This is bullish for GoC bonds and rather bearish for the Canadian
dollar; the slide in manufacturing jobs attests to the high degree of CAD
overvaluation even with the commodity price backdrop. I still maintain it should
be closer to 83 cents right now and I am pretty sure the BoC would agree.

TOO MUCH BULL?

The Investor Intelligence survey shows that 42.5% of portfolio managers are now
bullish on the equity market; 25.3% are now bearish. This looks to be an
overbought market, from our vantage point. As a sign of how selective the
market is right now regarding the data, the ISM orders number that came out on
Monday — highest since November 2007 — was the toast of the town. But the
fact that non-manufacturing ISM orders FELL 2.6 points to 44.4 (and this covers
90% of the economy) has been hardly mentioned in the media or research
commentaries.

CONSUMER SPENDING IN THE DOLDRUMS

The chain store sales that came out for May in the U.S.A. were very soft — same-
May U.S. chain store
store receipts down 4.6% YoY in May. The consensus was looking for a 3.6%
sales lacked ‘green
gain so this also lacked ‘green shoot’ veracity — not only that but fully 66% of shoot’ veracity
retailers fell short of their revenue targets! Apparel sales slipped 5% YoY,
department store sales fell 9.4% and luxury retailers posted a whopping 18.1%
falloff. We must still be in recession because the only positive performer was
the drug stores — a 0.9% gain. Discounts stores are down but outperforming —
off 3.5% on a YoY basis.

BANK OF CANADA TALKS DOWN THE LOONIE (WITHOUT MUCH SUCCESS)

“In recent weeks, financial conditions and commodity prices have improved
significantly, and consumer and business confidence have recovered modestly.
If the unprecedentedly rapid rise in the Canadian dollar (which reflects a
combination of higher commodity prices and generalized weakness in the U.S.
currency) proves persistent, it could fully offset these positive factors. “

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June 5, 2009 – BREAKFAST WITH DAVE

The Bank of Canada indeed referenced the surge in the Canadian dollar in
yesterday’s press statement; it did not mention the loonie at all in the April The BoC talks down
statement. The bottom line is that the loonie is on the BoC’s radar screen and the loonie … without
as such I think the currency has put in a near-term top, notwithstanding my much success
secular bullish stance. With policy rates where they are — the Bank’s options
are limited insofar as it could intervene in the FX market or embark on more
forceful quantitative easing — the June statement is either bearish for the CAD,
bullish for bonds, or both. In a nutshell, the BoC recognized that the loonie has
overshot the recent upturn in commodity prices. That it verbalized its concern in
the press statement is significant insofar as the Bank does not generally make it
a habit to openly discuss the currency market.

The Bank also had this to say over the outlook — how one can make a bearish
call for the fixed-income market based on these comments, not to mention the
continued pledge to provide investors with a huge positive carry trade well into
next year:

“The already significant output gap will continue to widen through the third
quarter, putting downward pressure on inflation. The Bank continues to expect
that the global and Canadian recoveries will be more muted than usual … the
overall risks to its inflation projection remain tilted slightly to the downside.
Conditional on the outlook for inflation, the target overnight rate can be
expected to remain at its current level until the end of the second quarter of
2010 in order to achieve the inflation target.”

MORE EVIDENCE OF THE SECULAR SHIFT TOWARDS FRUGALITY

All one has to do is look at and admire the 13.0% increase in same store sales
at Dollar General in Q1 as one example — in stark contrast to the negative
results at most other retailers, not to mention the 9.2% in comparable sales at
Dollar Tree.

HOUSING STILL IN THE DOLDRUMS

First, we saw from Toll Brothers and Hovnanian that revenues and orders are
Revenues from the
still in freefall (the entire group is up 5.0% year-to-date, believe it or not).
major homebuilders
Revenues at both companies are down around 50.0% YoY; deliveries at
still in freefall
Hovnanian down 44.0% and signed contracts still down 29.0% from a year ago.

Second, MBA mortgage applications index fell 16.2% during the week ending
May 29 — the level is at its lowest in 13 weeks. This was on top of the 14.2%
decline seen last week. Since its recent peak, which was back just eight weeks
ago, mortgage applications have plunged nearly 50.0%. The refinancing index
(refi) is down 24.1% for the latest week, on top of the 19% fall seen last week.
The level on the refi index is at its lowest in 16 weeks and from its recent peak,
which also happened eight weeks ago, the index has shed nearly 60.0% (-57.0%
to be exact).

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June 5, 2009 – BREAKFAST WITH DAVE

This halt in activity was due to the massive rise in mortgage rates. The 30-year
mortgage rate zoomed 44bps to 5.25%, the highest level since the end of
January, and in the last two weeks mortgage rates have risen by 56bps. The
1-year ARM rate has also been gradually rising – up in five of out of the last six
weeks — and is currently at 6.61% — highest since the week of December 5.

DELEVERAGING CYCLE FAR FROM OVER

The chart below is the ratio of household debt to total net worth — it has
exploded to an all-time high of over 26.0%. Depending on where it normalizes —
either to the pre-bubble level of 20.0% or the long-run norm of 16% — we are
talking about between $3.0 and $5.0 trillion of debt elimination in coming years.
The household debt to asset ratio (see Chart 2), now at 21.0% versus prior cycle
lows of around 13.0%, would also be consistent with over $5.0 trillion of debt
elimination. While there will undoubtedly be help from Uncle Sam and the
lenders in the form of loan modifications and forgiveness, this overhang is still
too big for the taxpayer to absorb. A goodly chunk of this excess debt — bringing
credit into realignment with the permanently new and lower level of household
net worth — is going to have to be paid down (or defaulted on). This is the
lingering deflation risk that the bond bears have yet to factor in.

Chart 1: HOUSEHOLD DEBT-TO-NET WORTH AT AN ALL TIME HIGH

United States

Household Credit Market Debt as a share of Net Worth

(percent)

28

24

20

16

12

4
55 60 65 70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

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June 5, 2009 – BREAKFAST WITH DAVE

Chart 2: HOUSEHOLD DEBT-TO-ASSETS RATIO

United States

Household Credit Market Debt as a share of Assets

(percent)

24

20

16

12

4
55 60 65 70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

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June 5, 2009 – BREAKFAST WITH DAVE
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June 5, 2009 – BREAKFAST WITH DAVE
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