David A.

Rosenberg June 8, 2009

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

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

WHILE YOU WERE SLEEPING
Reversal of fortunes
IN THIS ISSUE
Equity markets are lower today — Europe off 1.8% thus far and Asia down 0.8%
even with a rally in the Nikkei (Korea, Hong Kong, Singapore and India all in the • Problem with equities may
red column). transcend just a weak
economic backdrop
Commodity prices are down across the board and resourced-based currencies • This is one very selective
are under some downward pressure (CAD above 1.12). Note that while we had market
been constructive on the commodity complex since last December, as with • Consumers paying down
equities, resource prices may have overshot the fundamentals — after all, crude debt in record amounts
oil prices are up more than 50% YTD and over 30% from a year ago even though • Secular labour market
U.S. stockpiles have risen about 20% from a year ago (enough to meet 25 days headwinds
of usage, up from 20 days this time in 2008). Also, when one reads articles like
Caterpillar’s Hopes For Recovery Built on Shaky Foundations on page 19 of
today’s Financial Times (FT), one wonders whether there is too much hype over
the sustainability of the global recovery (or the efficacy of the Obama
infrastructure package for that matter — there is an interesting article on the
front page of today’s New York Times (NYT), by the way, on the tensions
surfacing on the President’s economics team) — sales outside North America
account for over half of the world’s largest producer of construction equipment.

Credit default swap (CDS) spreads are widening as well but we see no flow into
government bond markets. In fact, Treasuries are selling off moderately yet
again as supply ($35 billion of 3-year notes, $19 billion of 10-year notes, and
$11 billion of long bonds hit the market this week — another $65 billion of new
Treasury issuance) and stagflation concerns are on the front burner. In our view,
the economy is too fragile to withstand a 4%+ yield on the 10-year note — it’s
one thing to have a Treasury selloff without private sector rates being affected —
but that is no longer the case and the proof in the pudding is the fact that
mortgage refinancings have sunk nearly 60% in the last two months.

Problem for equities may transcend just a weak economic backdrop: According
to data compiled by Bloomberg, there has been so much in the way of secondary
offerings that the share count in the S&P 500 is rising at a 3.4% annual rate so
far this year. Tack on the fact that in this age of cash-conservation, companies
are also slashing their dividend payouts by more than 20%, the sharpest decline
since 1938, and the combination of these two effects is likely going to shave
more than 4% from S&P 500 total returns this year. Considering that the S&P
500 total return has averaged 6% per year since 1900, the trimming impact
from a higher share count and lower dividend yield looks to be rather significant.

Please see important disclosures at the end of this document.

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June 8, 2009 – BREAKFAST WITH DAVE

ONE VERY SELECTIVE MARKET

The markets are in a phase right now where they are picking and choosing how
to respond to the incoming data, and this is indeed a very fascinating process. On a day when we had
Equities roared ahead and bonds sold off violently after we heard that the ISM the mother of all
index jumped in May to 42.8 from 40.1. We were put on notice from the experts ‘green shoots’, the
that this meant the recession was over. Then we saw the manufacturing S&P 500 could not
components of the nonfarm payroll survey on Friday, and in no way, shape or finish the session
form did it conform to the ISM poll. Manufacturing employment sagged higher
156,000. The factory workweek dropped at a 6.0% annual rate. The
manufacturing diffusion index — one would think this would at least line up with
the ISM — slipped from 19.9 to 12.0 in what was the steepest decline since
June 2008. In a month when the ISM jumps 2.7 points, the guts of the payroll
report point to a near 1% plunge in industrial output (believe us when we tell
that you that this is an extremely rare combination).

All we know is that on a day when we had the mother of all ‘green shoots’, a
payroll headline that came in 200,000 better than expected, the S&P 500 could
not finish the session higher. The rally has finally taken us all the way back to
the intra-day high for the year established back on January 6, but even as it
kisses the 200-day moving average, the S&P 500 seems to be struggling to
pierce this technical threshold and establish a whole new trading range:

• June 1st: 942.87

• June 2nd: 944.74
• June 3rd: 931.76
• June 4th: 942.46
• June 5th: 940.09

Remember, the intra-day high on January 6 was 943.85. That the S&P 500
could not be sustained above that level in the last five sessions despite the ISM
and nonfarm green shoots suggests that the ‘second derivative’ improvement is
already fully priced; the next leg up needs to see a sustained ‘first derivative’
turnaround in the economic data.

Oil prices just below $70/barrel have more than doubled from their lows; and
10-year note yields approaching 4% (which are now pulling up mortgage rates —
the 30-year fixed rate is all the way back to 5.45% — not to mention competing
now with a near 4% earnings yield on the S&P 500) are starting to put a bit of a
crimp in this rally. Once it becomes clear, before Labour Day, that the recession
is not coming to an end quite so soon (as the National Bureau of Economic
Research’s Robert Hall said Friday, it’s “way too early” to make that call), we
would be looking for a corrective phase to start taking place.

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June 8, 2009 – BREAKFAST WITH DAVE

Yes, yes, we are going to be hearing a lot of background noise about the ECRI
leading index improving to a 45-week high of -7.1% in the final week of May At this point in time,
(from -9.3% the week before and the record low -29.7% in December 2008). don’t be fooled by the
The reality is that during the expansion this index peaked in January 2004 — oh, improvement in the
about four years before the cycle ended. We want to be early, but not that early. ECRI leading index
That sharp selloff in the bond market may well end up sowing the seeds for a
sizeable rally because it has driven a hole in the mortgage refinancing boom,
which began in February and ended with a thud in May — the Mortgage Bankers
Association’s refinancing index is now 57% below the early April peak. Not only
that, but new home-buying activity has stalled out too, as the MBA purchase
index sagged at a 20% annual rate in May — the first time it has declined in
three months. Some of these green shoots just got shot!

Chart 1: THE ECRI LEADING INDEX IS IMPROVING

United States
ECRI Weekly Leading Index Growth Rate
Avg, %

30

20

10

-10

-20

-30
70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

As an aside, the part of the yield curve that got smoked the most following the
nonfarm payroll figure was not the “reflation-sensitive” long bond but rather the
2-year T-note whose yield soared 34bps to 1.29%. One would have thought we
printed +345,000 instead of -345,000 based on that reaction. Indeed, the
markets have now price in three Fed rate HIKES over the coming year. We
doubt this happens until the unemployment rate peaks and heads lower, and
that is likely going to take at least a year to unfold and/or until home prices stop
declining, and this could also take at least another year (see Robert Shiller’s
column on page 4 of the Sunday NYT business section — Why Home Prices May
Keep Falling).

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June 8, 2009 – BREAKFAST WITH DAVE

CONTRARIANS NOTE
There is a lot of good news priced into equities after an eight multiple-point Sentiment has swung
expansion and a 45% price surge in the S&P 500 over the last four months. wildly in the equity
Moreover, there is a lot of reflation priced into the Treasury market, where 10- market
year yields exceed the inflation rate now by 450bps. Sentiment has swung
wildly — at the March lows in the equity market, there were 31,332 net short
contracts on the CME (futures and options) as per the Commitment of Traders
report; today there are 23,096 net longs. During that same time period, the net
shorts for the 10-year T-note has risen from 60,500 to 127,188 and few times
have the bond pits been this bearish (the last time the CBOT showed a net long
position in the 10-year was late January).

CONSUMERS PAYING DOWN DEBT IN RECORD AMOUNTS

Ever heard of a plastic-burning party? Americans are cutting back on their credit
cards and other forms of debt at a record rate — paying down $15.7 billion of
their obligations in April on top of $16.5 billion in March and $10.9 billion in
February. In total, this three-month slide amounts to a credit contraction (not
including mortgages) of $172 billion, which is truly historic and deflationary too.

Chart 2: U.S. CONSUMERS GOING ON A DEBT DIET

United States

Consumer Credit Outstanding

(3-month change at an annual rate, blns)

300

200

100

-100

-200
70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

Although we are likely past the worst point of the recession, consumer spending
habits do not seem to be changing — the new frugality theme is very much
intact. This also happened in the Great Depression — the economy may have
bottomed in the summer of 1932 but attitudes towards discretionary spending
and credit changed for an entire generation. Have a look at the terrific article on
this enduring theme on page 4 of the Week in Review section of the Sunday New
York Times — The Recession, Wal-Mart Style. As the caption reads — “Pasta is
Big. Prime Cuts Aren’t. Toilet training is being fast-tracked.”

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June 8, 2009 – BREAKFAST WITH DAVE

The article quotes John E. Fleming, chief merchandising officer for WMT, who The new frugality
says: “We’re seeing a movement away from protein into carbohydrates. It theme remains intact
stretches the dollar a lot further. This whole idea of staying home and
entertaining at home, we’re seeing that everywhere.”

What’s hot?

• LCD televisions
• Popcorn/microwave poppers
• ‘Take and Bake’ pizzas
• Home repair products
• Car maintenance/motor oil/filters
• Pull-ups
• Vitamins/sleep aids/pain relievers
• Vegetable and herb seed

SECULAR LABOUR MARKET HEADWINDS

It was quite an experience sitting down and reading the assessment of Friday’s
employment data in the morning papers this past weekend:

• Hints of Hope in Jobless Data Even as Rate Jumps to 9.4% (NYT)

• Slower Jobless Lift Hopes (Wall Street Journal)
• Jobs Data Fuel Hopes Worst of Recession is Over (Financial Times)

All this excitement over a 345,000 payroll decline tells us that we have been in a
recession for so long now that we have all forgotten what an economic
expansion looks like. A 345,000 job slide is double what we were experiencing
before the Lehman collapse and is worse than the worst months in each of the
last two recessions. Admittedly, with the help of a 220,000 boost from the Birth-
Death model (compared with 174,000 in May 2007 — at the peak of the cycle),
the nonfarm data was better than consensus estimates and not nearly as bad
as what we had been seeing through most of this year when the declines were
hovering around 700,000 per month. Then again, the economy is no longer
contracting at a 6% annual rate, so why should anyone really be expecting
detonating job losses any more? The fact that the employment data are “less
bad” than a depression-style experience misses the point. Beneath the veneer,
there are secular deflationary headwinds in the labour market that the bond
market has a right to know before building on the knee-jerk reaction to Friday’s
headline data because we are concerned that the data are being misdiagnosed.

The number of full-time jobs that were cut in May totalled 407,000 and this
brings the tally since the recession began to 8.6 million, which is by far a record.
A normal recession typically sees 2.0-2.5 million full-time job losses. As
businesses see that the amount of credit to support the economy is going to be
at least $5 trillion lower than it was during the positive credit cycle, they are
looking to permanently adjust the size of their workforce.

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June 8, 2009 – BREAKFAST WITH DAVE

Chart 3: SINCE THE RECESSION BEGAN,

8.6 MILLION FULL-TIME JOBS HAVE BEEN SHED
United States

Employed: Employed Full-Time

(18-month change, thousands)

8000

4000

-4000

-8000

-12000
70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

The number of part-time workers rose 129,000 last month and by 2.5 million
since the recession began a year-and-a-half ago. So it’s not as if all the laid
off full-time workers are losing their jobs; nearly one-in-three are being pushed
into part-time work. But a record share of the 2.7 million working part-time —
more than one-third — are working part-time because they have no choice (due
to the weak economy). The number of people working part-time but want full-
time work has risen a record 70% over the past year. Remarkable and
disturbing.

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June 8, 2009 – BREAKFAST WITH DAVE

Chart 4: MORE PEOPLE ARE BEING PUSHED TO WORK PART-TIME

United States
Employed: Part-Time/Economic Reasons: All Industries
(thousands)

10000

8000

6000

4000

2000
90 95 00 05

Source: Haver Analytics, Gluskin Sheff

While there was so much focus on the change in the nonfarm payroll headline
figure, it was easy to miss the important shift taking place beneath the surface.
It may be true that companies are not cutting back on bodies as much as they
were earlier this year because nobody wants to let their skilled staff go despite
the lingering weakness in sales. So the strategy remains one of cutting back
on hours worked at the same time — not as many layoffs but the effort to
economize on the wage bill remains intact. What has happened this cycle is
that the shift towards part-time and away from full-time has led to a dramatic
reduction in the average workweek to a record low 33.1 hours. If we took into
account the total decline in labour input in May — the aggregate hours worked
index sagged 0.7% MoM — the total job loss in May exceeded 900,000. In
fact, this was almost exactly what the population and payroll concept adjusted
Household Survey showed, to very little fanfare (-833,000).

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June 8, 2009 – BREAKFAST WITH DAVE

Chart 5: THE AVERAGE WORKWEEK IS NOW AT A RECORD LOW

United States
Average Weekly Hours: Total Private
(hours)

34.8

34.4

34.0

33.6

33.2

32.8
90 95 00 05

Source: Haver Analytics, Gluskin Sheff

The combination of slowing wage growth and declining hours is helping

Corporate America save on the wage bill, but of course this comes at the
expense of personal income and then aggregate demand; the aggregate
demand that is needed to grow top-line revenues. It is one thing when a few
companies do it, but right now two out of every three companies are shedding
labour. Average weekly earnings — the wage-based proxy for personal income
— has slowed to a mere 1.2% YoY, and as Chart 6 illustrates, is testing critical
support levels. They actually fell 0.2% MoM in May and over the last three
months, have deflated in rare fashion at a 0.7% annual rate. This is the
critical deflation that the bond bears do not see — not yet anyway — but the
Fed surely knows this and the view being expressed in the futures market that
we will see three rate hikes in the next year seems to be out of touch with this
wage contraction reality.

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June 8, 2009 – BREAKFAST WITH DAVE

Chart 6: GROWTH IN THE AVERAGE WORKWEEK

HAS SLOWED TO 1.2% YEAR-OVER-YEAR
United States
Average Weekly Earnings: Total Private
(year-over-year percent change)

5.25

4.50

3.75

3.00

2.25

1.50

0.75
95 96 97 98 99 00 01 02 03 04 05 06 07 08

Source: Haver Analytics, Gluskin Sheff

The chart below is some evidence that the bearish view on Treasuries, with all
deference to the fiscal outlook, may be overdone. There is over a 50%
correlation between wage growth and the 10-year T-note yield, and note the
divergence between the blue and red lines over the past couple of months.

Chart 7: TEN-YEAR NOTE YIELD FOLLOWS WAGE GROWTH

United States
Average Weekly Earnings: Total Private
(year-over-year percent change: thick line, right hand side)
10-Year Treasury Note Yield
(percent: thin line, left hand side)
5 6.75
r = 0.53

6.00
4
5.25

3 4.50

3.75
2
3.00

1 2.25
97 98 99 00 01 02 03 04 05 06 07 08

Source: Haver Analytics, Gluskin Sheff

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June 8, 2009 – BREAKFAST WITH DAVE

What makes this cycle totally different is that it is coming off three shocks: 1) a
housing shock; 2) a commodity shock, and; 3) a credit shock. The labor market
is adjusting to all three shocks, whose effects are going to linger for years, in our
view. In other words, there is a greater sense of permanency to the job losses
this time around compared to the past. In fact, permanent job losses came to
287,000 in May and 3.9 million since the recession began. Around two-thirds of
the employment decline this down-cycle has been permanent, which is
unprecedented.

Chart 8: 3.9 MILLION PERMANENT JOB LOSSES

SINCE THE RECESSION BEGAN
United States

Unemployed: Permanent Job Losers

(year-over-year difference)

4000

3000

2000

1000

-1000
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Source: Haver Analytics, Gluskin Sheff

Again, all the headlines over the weekend were about how the smaller decline
in nonfarm payrolls was heralding in the end of the recession. This is amazing
since the recessions of 2001 and 1991 never saw a number as bad as
-345,000, which we just saw on Friday. Be that as it may, what is important is
the growing pool of unemployed, which soared 787,000 in May — the fifth
highest on record. There are 14.5 million in the ranks of the unemployed, and
this swelled by a record six million over the last 12 months. So, it really is only
one part of the story that companies are no longer cutting as many jobs as
they were at the peak of the firing wave at the start of the year — nobody is
hiring the new entrants who are coming into the labour force (the labour force
expanded 350,000 last month). There is currently a record 12.8 million
unemployed Americans who are now looking for full-time positions that do not
exist — almost doubling in the last year. Now what do you suppose that is
going to do to the prevailing wage rates?

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June 8, 2009 – BREAKFAST WITH DAVE

The question is whether President Obama, as he takes more and more

feathers out of FDR’s interventionist hat, also embarks on programs that
enforce wage hikes in the unionized sector of the economy in this new populist
swing-the-pendulum era of ‘income redistribution’.

Chart 9: THE NUMBER OF UNEMPLOYED SOARED

SIX MILLION FROM A YEAR AGO
United States
Unemployment
(year-over-year difference)

8000

6000

4000

2000

-2000

-4000
50 55 60 65 70 75 80 85 90 95 00 05
Source: Haver Analytics, Gluskin Sheff

It is taking far longer for the pool of unemployed to find a new job compared to
any other cycle in the past five decades. The median length of time it is taking
to find a new job has risen sharply to a record 14.9 weeks in May from 12.5
week in April and 8.3 weeks a year go. Until this cycle, it was practically
unheard of for this metric to cross above 12 weeks — and we are now 25%
above that traditional peak of the past.

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June 8, 2009 – BREAKFAST WITH DAVE

Chart 10: IT IS TAKING FAR LONGER TO FIND A JOB THIS CYCLE

United States
Unemployed: Weeks Unemployed: Median
SA, Number (I)

16

14

12

10

4
70 75 80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

Indeed, the number of people who have now been unemployed for at least a
half-year has surged 150% over the last year to stand at four million or double
the peaks of the past two recessions and one-third above the peak of the early
1980s downturn.

Chart 11: IT IS TAKING FAR LONGER TO FIND A JOB THIS CYCLE

United States
Unemployed: 27 Weeks & Over
SA, Thous (I)

4000

3000

2000

1000

0
80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

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June 8, 2009 – BREAKFAST WITH DAVE

There is a prevailing focus on the unemployment rate, which rose to 9.4% in

May, but a much more reliable measure of labour market slack is the
employment-to-population ratio which fell to 59.7% from 59.9% — the lowest
since October 1984.

Chart 12: EMPLOYMENT/POPULATION RATIO LOWEST SINCE OCT 1984

United States
Employment-Population Ratio
(percent)

66

64

62

60

58

56
80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

The unemployment rate for full-time workers has already crossed into double-
digit terrain (10.2%) — it was 5.5% a year ago! This is the sharpest increase
(470 basis points) over a 12-month span ever.

Chart 13: JOBLESS RATE FOR FULL-TIME WORKERS NOW AT 10.2%

United States
Unemployment Rate: Full-Time Workers
(percent)

12

10

2
80 85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

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June 8, 2009 – BREAKFAST WITH DAVE

The broadest measure of the unemployment rate that includes all measures of
labour market slack jumped in May to 16.4% from 15.8% in May and 9.8% a
year ago. So think about that; 1 in 6 Americans are either unemployed or
underemployed. Again, is it reasonable to assume, as the bond vigilantes
have, that we will experience a sustained inflationary surge out of this excess
labour supply environment?

Chart 14: THE ALL ENCOMPASSING JOBLESS RATE AT 16.4%

United States
U-6 Unemployment Rate: Unemployed+Marginally Attached+Part-Time Econ Reasons
(percent)

18

16

14

12

10

6
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Source: Haver Analytics, Gluskin Sheff

A record seven percentage point gap has opened up between the ‘officially
reported’ unemployment rate and the broader U-6 measure — this spread is
important as it captures the incremental headwind for the consumer sector
and by extension, a further problem for mortgage, housing, credit cards, home
equity lines of credit as well as car loans. Financials are going to be as
negatively influenced by this development down the road as retailers. The
labour market parameters for the Geithner stress tests are looking
increasingly out of date.

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June 8, 2009 – BREAKFAST WITH DAVE

Chart 15: A RECORD SEVEN PERCENTAGE POINT GAP BETWEEN THE

OFFICIAL JOBLESS RATE AND THE U-6 UNEMPLOYMENT RATE
United States
Official Unemployment Rate minus U-6 Jobless Rate
(percentage points)

2
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Source: Haver Analytics, Gluskin Sheff

Page 15 of 17
June 8, 2009 – BREAKFAST WITH DAVE
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not reflect information known to, professionals in other business areas of
Gluskin Sheff in connection with the legal proceedings or matters relevant
to such proceedings.
Any information relating to the tax status of financial instruments discussed
herein is not intended to provide tax advice or to be used by anyone to
provide tax advice. Investors are urged to seek tax advice based on their
particular circumstances from an independent tax professional.
The information herein (other than disclosure information relating to Gluskin
Sheff and its affiliates) was obtained from various sources and Gluskin
Sheff does not guarantee its accuracy. This report may contain links to
third-party websites. Gluskin Sheff is not responsible for the content of any
third-party website or any linked content contained in a third-party website.
Content contained on such third-party websites is not part of this report and
is not incorporated by reference into this report. The inclusion of a link in
this report does not imply any endorsement by or any affiliation with Gluskin
Sheff.
All opinions, projections and estimates constitute the judgment of the
author as of the date of the report and are subject to change without notice.
Prices also are subject to change without notice. Gluskin Sheff is under no
obligation to update this report and readers should therefore assume that
Gluskin Sheff will not update any fact, circumstance or opinion contained in
this report.
Neither Gluskin Sheff nor any director, officer or employee of Gluskin Sheff
accepts any liability whatsoever for any direct, indirect or consequential
damages or losses arising from any use of this report or its contents.
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