David A.

Rosenberg January 28, 2011

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

MARKET MUSINGS & DATA DECIPHERING

Lunch with Dave

IS THERE REALLY JOY IN MUDVILLE?
IN THIS ISSUE
We may as well start with the good news.
 Is There Really Joy in
First, a look at the fourth-quarter GDP data, while a tad light on the top line Mudville?
versus the consensus and whispered estimates of 4% did confirm that the  Home Sales: California
spring and summer lull was just that, as opposed to the onset of a double-dip Dreamin’? We continue to
downturn. The 3.2% annualized real growth rate followed a 2.6% trend in Q3 and believe that housing
1.7% in Q2. The configuration of the GDP report — large inventory drag with solid fundamentals look very
weak
final sales along with the effects of the payroll tax cut — should help real GDP
growth maintain its trend in the current quarter.  Initial Jobless Claims:
Snowed Out: seasonal
The critical test will be the second quarter, when the incremental fiscal stimulus factors turn more
aggressive in the coming
fades and the effects of higher food and energy prices depress the “real” macro weeks and recent
numbers. Look for an air pocket next quarter, especially if jobless claims stay snowstorms have likely
above 400k and signal ongoing sluggish labour market conditions. Let’s not affected the data
forget that real wages have deflated in three of the past four months and that
home prices have deflated now for five months running at a non-trivial 10%
annual rate.

The story within the story was the resurrection of the American consumer who
lifted his/her spending at a 4.4% annual rate. This is the strongest gain since
the first quarter of 2006, when credit was flowing freely, unemployment of 4.5%
was triggering sizeable organic wage growth and rallies in both equities and
housing were generating personal wealth, at least on paper. It would be a bit
dangerous to extrapolate what we just saw in the fourth quarter because the
QE2 juice squeezed by Uncle Ben generated a sizeable wealth effect that helped
pull down the savings rate from 5.9% in the third quarter to 5.4% in the fourth (it
should NOT be lost on anyone that real consumer spending at +4.4% growth
managed to more than double the comparatively sluggish 1.8% annualized
increase in real disposable income). Strip out this non-recurring factor and real
GDP growth would have come in closer to a ho-hum 2.8% annual rate last
quarter. That actually is not really that impressive for a sixth quarter of post-
recession recovery, when real GDP growth is typically chugging along at roughly
a 6% pace.

Be that as it may, consumers were in a buying mood in Q4 and were buying

cyclical stuff like autos (+45% QoQ at an annual rate — you read that right),
furniture/appliances (+11.4%), clothing (+14.2%) and recreational goods
(+15.8%). Nice splurge. And if this was just a pent-up demand story, aided and
abetted by the Fed’s and Federal government’s efforts to ignite a spending
bounce, then it could very well be that this story is over. There is nothing in the
historical post-bubble-collapse guidebook to suggest that consumer spending
mounts a sustained comeback this early in the deleveraging cycle. At some

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
January 28, 2011 – LUNCH WITH DAVE

point, and it could be in coming months, the government runs out of steroids
and Mother Nature resumes her course. At some point, and it could be
in coming months, the
The U.S., being the hedonistic society that it is, looks upon consumption as the government runs out of
ultimate source of prosperity and saving as a dirty six-letter word. While steroids and Mother Nature
consumer spending did fabulously well, again largely on the continued resumes her course
“stimulative” efforts by the Fed and the Federal government, the other 30% of
the economy actually fared quite poorly in Q4 — essentially stagnating (a puny
0.2% annualized growth rate). In fact, while the consumer enjoyed its fastest
growth rate since the first quarter of 2006, the remainder of the economy
posted its softest showing since the first quarter of 2009, when the economy
was plumbing the depths of the recession.

Commercial construction was essentially flat last quarter and hasn’t shown any
life in over three years. Capital spending was equally disappointing — slowing
sharply, to a 5.8% annual rate from 15.4% in Q3 and the blistering near-25%
surge in Q2. Much of the softness showed up in computers/peripherals (1.3%
growth from 45.3% in Q3) and transportation equipment (-26.6% annualized in
Q4 — seems like consumers were buying cars and businesses were shedding
them!). Housing ticked up statistically at a 3.4% annual rate after the 27.3%
plunge in Q3 — it’s really just classic bear market math considering the level is at
the same level today as it was in the second quarter of 1971. Government
spending contracted fractionally both at the federal and state/local levels and
we can certainly expect this to persist through the balance of the year and likely
beyond.

The biggest surprise in the data was the inventory line which subtracted 3.7
percentage points from headline GDP growth. We haven’t seen that happen in There was a massive
22 years and this has left the consensus believing that a reversal of this
improvement in the real trade
deficit, which added over 3.4
negative contribution will provide a nice cushion in the current quarter. Be that
percentage points to the top-
as it may, there was a massive improvement in the real trade deficit, which
line GDP print
added over 3.4 percentage points to the top-line GDP print. This last happened
in the second quarter of 1980 and only one other time before that (first quarter
of 1975). It goes without saying — looking at what radical fiscal tightening is
about to do to most of the European economy and what the downdraft in the
Chinese and Indian stock markets are starting to signal about emerging growth
— it would probably be appropriate to view the foreign trade support that the U.S.
economy received in the fourth quarter to be completely transitory (it should be
duly noted here that both inventories and net exports were unusually influenced
by the surge in oil prices which wreaked havoc with the import price deflator).

While the effects of the net exports “addition” and the inventory line
“subtraction” were largely a wash, we were not at all surprised to see our friends
at CNBC go straight to the “real final sales” data-point which strips out
inventories from GDP — and it did indeed zoom ahead at an eye-popping 7.1%
annual rate — a feat last accomplished in the second quarter of 1984. It is
probably important to note, as a sign of these heady times, that hardly anyone
has ever mentioned this metric, at any time since the recession officially ended,

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January 28, 2011 – LUNCH WITH DAVE

because it has performed so horribly — +0.2% in Q2’09, +0.4% in Q3’09, +2.1%

in Q4’09, +1.1% in Q1’10, +0.9% in both Q2’10 and Q3’10 and then... woosh! A Real final sales have managed
“seven-handle” in Q4’10, after one of the major droughts of the past half- to eke out a barely more than
century. 2% annual gain since the
recession ended … welcome to
Even with the Q4 bounce, real final sales have managed to eke out a barely the new normal
more than 2% annual gain since the recession ended, whereas what is normal
at this stage of the cycle is a trend much closer to 4%. Welcome to the new
normal.

CHART 1: REAL FINAL SALES IN HISTORICAL PERSPECTIVE

United States: Real Final Sales Six Quarters After A Recession Ends
(quarter-over-quarter percent change, average)

8%
7.2%
7%

6% 5.5% 5.6%
5.3%
5.2%
4.8%
5%
4.3%

4% 3.7%

2.8%
3%
2.1%
2% 1.6%
1.4%

1%

0%
49 Q4 54 Q2 58 Q2 61 Q1 70 Q4 75 Q2 80 Q3 82 Q4 91 Q2 01 Q1 Avg. Current
Last Quarter of Recession

Source: Bureau of Economic Analysis, Gluskin Sheff

There is no doubt that there will be rejoicing in Mudville because real GDP did
manage to finally hit a new all-time high in Q4. The recession losses in output
have been reversed (though what that means for the 7 million jobs that have to
be recouped is another matter). But, before you uncork the champagne, just
consider what it has taken just to get the economy back to where it was three
years ago:

 The funds rate moved down from 4.5% to zero.

 The Fed’s balance sheet expanded by more than 1.5 trillion dollars.
 The printing of M2 money supply of around 1 trillion dollars (the illusion of
prosperity).
 Expansion of federal government debt of 4.8 trillion dollars.
All this heavy lifting just to take the economy back to where it was in the fourth
quarter of 2007. As they rejoice in Mudville, the memory is conjured up of Billy
Joel bellowing out those famous words ‘is that all you get for your money?’

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January 28, 2011 – LUNCH WITH DAVE

With that being said, the bulls have the upper hand as they have since late
August. At this point, the best advice we can give is to remind everyone that we
entered 2010 with a 5% real GDP print in our hands. Back then, the most
dangerous thing anyone could have done was extrapolate that performance
through the winter, spring and summer months, when air pockets in the
economic data surfaced, as Fed and federal government stimulus faded, and
the equity market rode a wild roll coaster ride until Ben reclaimed his helicopter
license.

HOME SALES: CALIFORNIA DREAMIN’?

We were remiss in not pointing out yesterday that the huge jump in new home We saw more of the “California
sales in December (up 17.5% MoM ) was driven by a 70% increase in sales in effect” in the pending home
the West (following a 31% jump in November). The reason behind the huge jump sales data released yesterday
was the expiry of a first-time homebuyers’ tax credit in California, which ended in
December. This was similar to a national credit that expired in the spring of
2010 (where we saw a similar skew in the data). Excluding the West as a whole,
new home sales were up a paltry 1.4% in December. Similarly, existing home
sales saw large double-digit jumps in the West in November and December.

We saw more of the “California effect” in the pending home sales data released
yesterday (which tends to be a forward looking indicator of existing home sales).
Pending sales were up 2.0% (better than the 1% expected) but again we saw a
huge variation among the regions. In particular, the West saw a huge give-back,
with sales falling 13% versus the 17% gain in November. Looking through
special factors and the weather (which could play havoc with the December and
January data), we continue to believe that housing fundamentals look very weak
right now and point to the major slowing in the purchase mortgage applications
(which so far are down 9% in January).

INITIAL JOBLESS CLAIMS: SNOWED OUT

U.S. initial jobless claims jumped to 454,000 (expectations were for 405k) for
When you take a step back
the week of January 22 — a huge back-up from the prior week’s 403k tally. The and look at the recent trends
Labor Department pointed out that there were administrative problems in four it’s not encouraging to see
states relating to the snowstorms and may have influenced these numbers. We jobless claims have fluctuated
will also point out that the seasonal factors are very volatile post-holidays (we around the 425k mark since
had figured that claims would rise to around 425k because of the less October
aggressive seasonal factors).

The next few weeks’ data could be just as volatile as seasonal factors turn more
aggressive and recent snowstorms will likely affect the data. While it’s easy to
get caught up in the seasonal factors/weather it is worth noting that when you
take a step back and look at the recent trends it’s not encouraging to see
jobless claims have fluctuated around the 425k mark since October — which
hardly points to improving fundamentals.

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January 28, 2011 – LUNCH WITH DAVE

Gluskin Sheff at a Glance

Gluskin Sheff + Associates Inc. is one of Canada’s pre-eminent wealth management firms.
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Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to the
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As of December 31, 2010, the Firm
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We offer a diverse platform of investment
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1 September 30, 2010
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$1 million invested in our Canadian
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date) would have grown to
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$9.1 million2 on
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of interest and principal, and yields which
S&P/TSX Total Return
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January 28, 2011 – LUNCH WITH DAVE
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