david a. rosenberg chief economist & strategist

8/14/2019 David a. Rosenberg Chief Economist & Strategist

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David A. Rosenberg January 11, 2010 Chief Economist & Strategist Economic [email protected]+ 1 416 681 8919

MARKET MUSINGS & DATA DECIPHERING

Breakfast with DaveMARKET THOUGHTS TO START OFF THE WEEK

IN THIS ISSUE

• Market thoughts to startoff the week — the risk

trade is back big time

• From the sublime to theridiculous — this continues

to be the Houdini market;it goes up on any news,good or bad

• One overvalued market —on a normalized ShillerP/E basis, the S&P 500 iscurrently overvalued by27%

• Fiscal drag? U.S. stateswere forced to cutspending by 5.4% lastyear and not even thatclosed the massive fiscalgap caused by a record12.5% slide in therevenue base

• An ongoing creditcontraction in the U.S. —consumer credit plungeda record $17.5 billion inNovember

• Shortage of income — aswe saw in last Friday’saverage hourly earningsdata, there is preciouslittle income growth to befound in the labourmarket

• Holiday shopping in theU.S. came in better than

expected

• U.S. commercial realestate in a deep funk

The risk trade is back big-time, despite the soft tone to the payroll data. Investors are

looking ahead to earnings season, starting today with Alcoa, and see that the

consensus has some nice tidings — like a +184% YoY trend in S&P earnings; +8% ex-

financials. So there is excitement building, as inevitable as it has been given the

depression in earnings a year ago (the base effect here is huge for Q4) that a record

nine quarters of negative YoY earnings is about to be snapped.

Even better, revenue growth is expected to be +7.6%, which would represent the

first positive quarter since 2008 Q3 (again, helped by complimentarycomparisons from a year ago) — and up from the 6.3% consensus estimate for

top-line growth back in November. At the same time, the fact that total EPS

consensus estimates for Q4 have actually come down in the past two months

(by $1.72 per share to $15.80), as per today’s WSJ (see page C2) is reason to

be bulled up because this “bodes well for another round of big earnings beats”.

That is today’s sentiment — good news is good news and bad news is good

news. The fact that we just saw the first bank failure of the year (Horizon bank

in Washington State) or the largest contraction of U.S. consumer credit ever

recorded largely went unnoticed.

The focus overnight was on the Chinese trade data, which showed a 17.7% YoY

jump in exports in December — more than four times the consensus estimate and the first increase in 14 months. Imports are also booming (+55.9% YoY!) and

China just printed auto sales for 2009 that came in at 13.6 million units, which

surpassed the U.S.A. for the first time and were up 4% from a year ago (U.S. sales

sagged 2% by way of comparison). Still, after sanctioning a whopping three basis

point increase in interest rates last week, China’s Finance Minister also warned

against withdrawing stimulus measures “too early”. Concerns over “exit

strategies” are starting to fade.

So what we have on our hands are sizeable equity market gains overnight

together with discernible gains in the commodity complex, notably gold and oil —

West Texas Intermediate is now at a 15-month high. Copper is coming back

after a two-day slump as reports stream out of China showing that imports of the

red metal climbed for back-to-back months after a brief respite. (Warning here— all that import activity has not been translated into usage because from our

lens, copper stockpiles have risen 85% since mid-2009 and now stand at a six-

year high. The last time copper inventories were at today’s level, the price was

sitting closer to $2.00 a pound, not $3.50.)

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 11, 2010 – BREAKFAST WITH DAVE

Corporate bond risk continues to decline as CDS prices are indicating. Investors

are also emboldened by the continued steepening of the U.S. yield curve — the

2-year/10-year spread has widened 10bps on the past week to a near-record

285bps. The reason it seems for the positive reaction to the payroll data is what

it means for the Fed — futures is now pricing in a Fed tightening by June, at 33%

odds, down from over 50% a week ago. Hence, an apparent green light for beta

trades as we saw with Asian equities spiking 1.1% today — and have put

together advances in 13 of the past 14 sessions. We suppose that one would

have to call that a trend, though seemingly supported by speculative inflows

from foreign investors.

Perhaps the most

profound statisticregarding investortolerance for risk lies inthe high-yield market asopposed to the equitymarket

And, the greenback is back to being flat on its back — the DXY is off 55bps and in the

process of retesting its 100-day moving average of 76.50 (the U.S. dollar just

slumped to a three-month low against the Euro — that countertrend rally in the

greenback seems to have been short-circuited). The resource-based currencies are

on fire, with the Canadian dollar fast approaching parity again too.

Other data overnight from Europe were also constructive in the form of French

industrial production, which rose 1.1% in November (after declining 0.6% the month

before), more than doubling consensus estimates. And we see that in Australia, job

ads surged 6% MoM in December.

Perhaps the most profound statistic regarding investor tolerance for risk lies in

the high-yield market as opposed to the equity market. (Though emerging

markets also register — look at Brazil, where the Bovespa surged 83% in 2009

on a record $12 billion net inflow of capital from foreign investors — remember,

this was exactly what the outflow looked like in 2008). While everyone seems so

fearful of government supply, companies with junky credit ratings managed to

raise $2.4 billion in the first week of the year (see page C2 of the WSJ). The last

time it managed to do that, the U.S. economy was humming along at over a 4%

annual rate! This follows on the heels of the $147 billion of fresh supply in

2009, which was a record.

Meanwhile, while retail investors have been avoiding the equity market, the

appetite for yield — no matter the quality of the credit — is enormous as cash

inflows into high-yield mutual funds and ETFs came to a huge $288 million in

the week ending January 6 — the twentieth net inflow in a row, totaling $5.9

billion. It may pay to note that this flurry took place even as four high-yield rated

companies defaulted, which, if sustained, would imply a 9.5% default rate, which

few have in their forecast (the rating agencies are between 6% and 7% for the

most part versus 10.9% in 2009).

As with equities, a lot of good news would seem to be priced in — or at least

whatever bad news there was has been priced out. After all, high-yield spreads

have tightened to 917bps from 4,419bps just over a year ago despite the fact

that a record total of 265 companies defaulted on their debt last year; twice

what we saw in 2008 (the prior high was 29 in 2001).

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It’s a busy week ahead on the data calendar; U.S. retail sales on Thursday and

CPI, industrial production and University of Michigan consumer sentiment on

Friday. And there are various Feds speakers and $170 billion of new Treasury

supply for the bond crowd to mull over.

An interesting political

anecdote, the economyhas now shed 7.24 million

jobs since the recessionhas begun, and half of theloss has occurred sinceObama took office. This isnow his recession

Inflation is clearly on everybody’s mind and with that in mind the government

has decided to kick-start the supply season with $10 billion in TIPS offerings

(see page C1 of today’s WSJ). Either Uncle Sam is screaming “uncle!” himself

and acquiescing to demand for inflation protection (indeed, TIPS have generated

fixed-income investors with a 12.8% total return over the past year versus a

2.2% loss for plain-vanilla Treasuries) or he sees an opportunity here to raise

extremely low-cost funds because despite all the concerns, inflation is not going

to come back for a very long period of time.

FROM THE SUBLIME TO THE RIDICULOUS

This is what the weekend Wall Street Journal had to say regarding the market

reaction to Friday’s payroll data (page A5). “Stocks edged higher Friday, with

disappointment over the jobs report offset by expectations that the news would

keep the Federal Reserve from raising rates.”

So we are left with the impression that had the number come in at +85,000 and

the market rallied, that we would have been notified that even as rate hike

expectations intensified, there was no need to worry because the economy was

so strong.

This is why this is called the Houdini market — it goes up on any news, good or

bad. The good news is evident; the bad news is always rationalized.

Meanwhile, we thought it was an interesting political anecdote that the economy

has now shed 7.24 million jobs since the recession has begun, and guess what?

Half of the loss has occurred since Obama took office. This is now his recession,

and there is little doubt in our mind that the peak growth rate for the cycle will

be the 4%-ish inventory-led bounce in Q4 — look for sequential slowdowns the

rest of the way.

The ECRI smoothed leading index dipped to a five-week low (to what is still

considered a high level of 23.6% from 24%).

And in the irony of ironies, UPS upped its guidance on Friday and at the same

time announced a further 1,800 cut in management and administrative jobs (on

top of the 13,000 slice in 2009). So it would seem that the corporate mentalityof cutting your way to profit prosperity remains fully intact.

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Despite all that, all the S&P 500 has managed to do since mid-October is

advance 4.4%. In other words, the momentum is waning as 90% of this bear

market rally had already occurred from mid-March to mid-October and equities

have actually done very little ever since. Keep in mind that several bourses

globally have already peaked, including the Shanghai index (August 7), the

Korean Kospi (September 22) and the Hang Seng (November 17).

Fiscal strains are

intensifying and this isputting credit quality atrisk

ONE OVERVALUED MARKET

As we had mentioned last week, the S&P 500 on a normalized Shiller P/E basis

is overvalued by 27% (latest estimate from Shiller) at the current time. If you

think that is a high degree of excess, a report by Smithers & Co. suggests that

the degree of overvaluation is closer to 50%. Then go to Kopin Tan’s column in

this week’s Barron’s and you will see that:

• The degree of bullish sentiment in the latest Investor Intelligence Poll is a

huge 72%;

• Fully 85% of S&P 500 stocks are now above their 50-day moving averages,and;

• The median P/E multiple is now a whopping 22.2x.

Caveat emptor.

FISCAL DRAG?

At the state and local government, that is for sure. U.S. states were forced to cut

spending by 5.4% last year and not even that closed a massive fiscal gap

caused by a record 12.5% slide in the revenue base. Fiscal strains are

intensifying and this is putting credit quality at risk, as we saw with Moody’s

downgrade to Illinois’ debt last week, to A2 from A1. Only California has a lower

credit rating and now we see that Governor Schwarzenegger is going cap-in-hand

to the Feds for $6.9 billion (come on Geithner, that’s a drop in the bucket!). It’s

not just these two but Ohio, Arizona and New York are all in dire straits, as are

36 states in total that have fiscal gaps to fill this year. According to the Center

on Budget and Policy Priorities, the cumulative budget gaps that need to be

closed in 2010 and 2011 total $350 bill ion or an average annual drain on GDP

to the tune of 1½%.

In the U.S. states, thecumulative budget gapsthat need to be closed in2010 and 2011 total

$350bln or an averageannual drain on GDP to thetune of 1½%

AN ONGOING CREDIT CONTRACTION

The fact that the equity market could rally with the duo data on Friday of an

85,000 decline in payrolls and the record $17.5 billion plunge (data back to

1943) in consumer credit attests to the extent of the speculation there is and

the premise that we have a glaring gap between investor perception andeconomic reality. The consumer credit collapse in November represented the

tenth falloff in a row (this is an unprecedented string) and was more than triple

the $5 billion net paydown expected by the consensus.

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CHART 1: CREDIT CONTRACTION OF EPIC PROPORTIONS

United States: Consumer Credit Outstanding

(month-over-month change, US$ billions)

0505050

30

20

10

0

-10

-20

Shaded region represent periods of U.S. recession

Source: Haver Analytics, Gluskin Sheff

CHART 2: TEARING UP THE CREDIT CARDS

United States: Revolving Consumer Credit Outstanding(year-over-year percent change)

0505050

22.5

15.0

7.5

0.0

-7.5

-15.0

Shaded region represent periods of U.S. recession

Source: Haver Analytics, Gluskin Sheff

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SHORTAGE OF INCOME

Despite the credit

contraction, weak labourmarket and softeningincome conditions, holidayshopping did come inbetter than expectations…

As we saw on Friday in the average hourly earnings data in the U.S., there is

precious little income growth to be found in the labour market. And in the

markets, we have a combination of very low yields in the government bond arena,

and in equities we had a situation where dividend cuts caused investors to lose

$58 billion in 2009. A record 804 companies cut their payouts last year, so we

are now left with a yield on the S&P 500 of below 2% for the first time in over two

years. Short-dated, high-quality corporate paper still look quite good in this

environment, at least on a relative basis, as do utilities, which carry a 4% yield in

the U.S.A. and 5% in Canada.

HOLIDAY SHOPPING BETTER THAN EXPECTED

Despite the credit contraction, weak labour market and softening income

conditions, holiday shopping did come in better than expectations. This by no

means suggests that the U.S. consumer is coming back strong — it is more a sign that retailers this year, in contrast to last, entered the holiday shopping season

lean and mean.

Average discounts were around 25% compared with 40% last year. And there was

a wave of last-minute and post-Christmas shopping. As a result, 75% of retailers

managed to beat their targets — with breadth we last saw back in March 2007.

Electronics, shoes and toys were the big winners, while apparel lagged but still did

quite well with the weather turning a tad frosty. Even luxury retailing did fine. It

seems the only laggard were the retailers that cater to the teenager crowd and

maybe this is where the 20% youth unemployment rate played a role.

… But this by no meanssuggests that the U.S.consumer is coming backstrong…

• The International Council of Shopping Centers peg the YoY sales growth rateat +2.8% (December/December).

• MasterCard’s Spending Pulse survey flagged a 3.6% increase (November 1 toDecember 24).

• Retail Metrics say that sales came in at +3% YoY in December, versus the+1.6% target.

That said, outside of the gift-card effect, there is no real catalyst out there for a

sustained pickup in spending. In fact, there is a serious hurdle ahead in the name

of higher energy costs. Gasoline prices have surged $1 a gallon since a year ago

and stand at a 15-month high of over $2.70/gallon and many market participants

are calling for $3+ by the spring. Keep in mind that every penny at the pumps

drains the equivalent of $1.3 billion from household cash flow, so this is

equivalent to a $130 billion drag on discretionary spending or over a 1% pay cut to

the average worker.

Then tack on what the cold snap is going to do the home heating bill (most regions

of the U.S.A. are 10% colder than normal). Already we see that retailers are

planning for this surge in natural gas and heating oil to divert 4% more of the

household budget towards energy needs through the winter months.

… In fact, the U.S.consumer is about to facesome serious headwinds

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On top of all that, mortgage rates have been drifting higher; up a quarter-point in

the past month, to 5.2% — a four-month high. Part of this reflects the rise in

Treasury yields and part of the rise is due to growing concern over the Fed’s exit

strategy in March when it plans to stop being a buyer for mortgage-backed

securities. The Fed now holds an unbelievable $909 billion of mortgage paper

on its balance sheet; in the past year, it has purchased 73% of the mortgages

that government-backed Ginnie Mae, Fannie Mae and Freddie Mac have turned

into securities. When you count in what the Treasury has done, the government

has bought over $1 trillion of mortgages or basically has nationalized the

housing market.

So, the Fed is basically three-quarters done its quantitative easing (QE) program if

things go as planned. However, according to the weekend WSJ (page A3), the

impact on mortgage rates from the Fed’s intended withdrawal is in the order of

50bps (as per Fed research) and 100bps (Hovnanian research).

COMMERCIAL REAL ESTATE IN A DEEP FUNK

The Q4 Reis data showed that office rents declined last quarter in almost all the

79 cities polled, sliding 9% from a year ago (a record deflation rate) as the

nationwide vacancy rate hit a 15-year high of 17%. Net effective rents in New York

have slumped 20%.

On the financial side of the equation, the commercial delinquency rate rose to

6.09% in December from 5.65% a month earlier — the highest ever since the

advent of the CMBS market.




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Notes:Unless otherwise noted, all values are in Canadian dollars.

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david a. rosenberg chief economist & strategist

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