breakfast with dave 010410

8/14/2019 Breakfast With Dave 010410

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David A. Rosenberg January 4, 2010Chief Economist & Strategist Economic [email protected]+ 1 416 681 8919

ARKET MUSINGS & DATA DECIPHERING

Breakfast with DaveWHILE YOU WERE SLEEPING

IN THIS ISSUE

Reviewing some 2010macro and market themes

The recession in the U.S.may not be over just yet

Same contractionarymessage in theConference Boardsmeasure of consumerconfidence in the U.S.

How can there be arecovery if tax revenuesare still declining?

The late-payment U.S.economy

Moderate holiday cheer

Secular shifts in spendingand investing behaviour ..get use to it

Deflation is the number 1risk in the U.S.; bondbears have it backwards

Improvement in initialjobless claims, but slackpersists

U.S. small businesses stillin a funk

Gold will glitter again

Challenges for the equitymarkets

Re-emergence of

emerging markets

As Jack Torrance said to the bartender, Its good to be back, Lloyd. After a

phenomenal two-week vacation that involved a top-to-bottom tour of the Holy

Land with my three boys, it is good to be back in the saddle again. And it goes

without saying that there was plenty of time spent praying at the Western Wall

(kotel) appropriate for any bear enduring the most pronounced surge off of a

low in recorded history.

The year 2010 started much in the same way as 2009 did with global equities

firm (Asia Pac up 1% overnight, building on the 34% advance last year; emergingmarkets rising 0.6% today after a 75% surge in 2009) and bonds selling off (last

year, U.S. equities outperformed the long bond by a record 46 percentage points!).

Commodities are strong this morning too (oil is back above $80/bbl and is riding

an eight-day winning streak) in the aftermath of some strong export data out of

Korea (mostly bound for China, which posted a solid PMI reading this morning

it jumped to a five-year high of 56.6 in December from 55.2 in November,

beating market expectations of 55.4 and the best level since April 2008) and

French auto sales, which zoomed ahead 49% YoY. U.K. home prices

(Nationwide survey) are now reportedly rising at their fastest pace since

November 2007 (+5.9%). The cold weather snap has also helped push natural

gas prices up as it nudges towards $6.00/btu this morning.

Gold is up almost $20/oz and seems to have successfully tested the 50-day

moving average during the recent corrective phase. Copper just hit a fresh 16-

month high. A softer tone to the DXY (trade-weighted U.S. dollar) may also be at

play. What does not fit the bill, however, in terms of the sudden turnaround in

the CRB index is the faltering Baltic Dry Index of global shipping rates.

As we mentioned, government bonds are taking a bit of a hit to start off the new

year and that may also be related to the news that PIMCO has trimmed its

holdings of U.S. Treasuries and U.K. Gilts; the firm has also become more

cautious on corporate bonds, is underweight TIPS as well as mortgages, and

neutral on munis (running light on risk it seems and acknowledging that it is

hugging the benchmarks with no bold positioning). Sentiment is so bearish

towards Treasuries that the Ried Thunberg index of bond market optimism hascratered to 42 (50 is neutral).

Please see important disclosures at the end of this document.

Gluskin Sheff + Associates Inc. is one of Canadas pre-eminent wealth management firms. Founded in 1984 and focused primarily on high networth 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,

visitwww.gluskinsheff.com


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January 4, 2010 BREAKFAST WITH DAVE

Based on the market commentary we have gleaned, there also seems to be this

interpretation out there (mis-interpretation, in our view) that in separate

speeches yesterday, Messrs Bernanke and Kohn sounded hawkish because

they mentioned that monetary policy should be pre-emptive and forward-looking.

If Bernanke is truly the mogul over the 1930s that everyone claims he is, then

an early withdrawal of rate stimulus seems like a low-odds event unless he

wants to risk a repeat of 1937-38.

Everyone is pre-occupied

with the Feds exitstrategy this year but

in our view there is no

such strategy

It still amazes us, more than six months after making the transition to the buy

side, as to how many sell side economists and strategists out there who

hyperventilate over the moment, cant for some reason see much beyond the

next quarterly GDP or ISM report, and are so clueless over the lessons that

history have to provide in the aftermath of a credit collapse.

REVIEWING SOME 2010 MACRO AND MARKET THEMES

Everyone is pre-occupied with the Feds exit strategy this year. But there is no

such strategy because it is evident that the economy will never be able to recover

without sustained doses of government stimulus. Interest rates are either going to

be in a trading range or trend lower. We had mentioned emphatically a month ago

that the Treasury market was at near-term risk, but looking ahead, bull flatteners

in bonds are very likely going to be the best strategy, if for any other reason that

the consensus is positioned the other way.

We had also warned that the bearish stance on the U.S. dollar was too broad and

that we could see a near-term countertrend rally that would cause a reversal in

commodity prices and gold, which would open up a nice buying opportunity; that

time has come.

There are several troubling aspects to the outlook for equities.

We opine that we are

about to see a nice

buying opportunity in

commodities and gold

1. From a valuation perspective, the S&P 500 is discounting a 5% GDPgrowth performance in 2010, which seems hardly likely.

2. The general public has stubbornly resisted to join the party and as such,the flow of funds landscape looks circumspect now that the shorts havebeen covered and the hedge funds have made up for their 2008 disaster,which means they can now afford to be more risk averse.

3. Sentiment is wildly bullish.4. Equity market technicals look tenuous stalling at the 50% retracement

level for the S&P 500.

5. The policy backdrop out of Washington is increasingly interventionist, andjust as Japan accentuated its multi-year malaise by not allowing zombiecompanies to go belly up, current initiatives by the Administration is ineffect thwarting a durable recovery in real estate by enacting measures

that delay the foreclosure process.

Concerns over health care reform and taxation are substantial hurdles for the

small business sector too, in terms of hiring plans and capital spending intentions,

and this is on top of near-record low levels of industry capacity utilization levels.

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As we outline below, consumer confidence and spending plans are still at

recession levels. Any improvement we saw during the holiday season is largely

due to the effects of rampant fiscal and monetary stimulus. In 2010, the big story

will be the renewed upward trend in the personal savings rate.

In 2010, the big story

will be the renewed

upward trend in the

personal savings rate in

the U.S.

A focus on defensive sectors in a sub-par economic environment would seem in

order. We go into 2010 with consensus expectations for an earnings recovery

every bit as intense as the downbeat expectations were heading into 2009. This

means the surprise will most likely be towards the downside. As a result, the

sectors that have been out of favour for the past nine months utilities, staples

and health care are likely to outperform. As for health care, it is probably

worthwhile mentioning that this is the only S&P sector that managed to outperform

the broad market during the massive positive-return period of 1990-2000 and

again in the negative-return era of 2000-2010. This is otherwise known as a

secular bull market (and telecom services, by way of comparison, was the only

sector to underperform in both decades).

RECESSION MAY NOT BE OVER JUST YET

Focus on defensive

sectors in a sub-par

economic environment

would seem in order

Quote of the month goes to the former National Bureau of Economic Research

(NBER) dean of dating business cycles, Martin Feldstein:

The recession isnt over. In a Bloomberg Radio interview on December 17th.

That seems pretty blunt, doesnt it?

But he may be right. Imagine that the best we could do with the gargantuan fiscal

and monetary stimulus was a 2.2% annualized growth in real GDP in the third

quarter (real Gross Domestic Income (GDI) was closer to a 1% annual rate!). This

result must be put into three perspectives:

1. It came in the face of $100 billion of real stimulus out of Washington.This means that 90% of the growth in Q3 came courtesy of Uncle Samsgenerosity. In other words, the economy basically stagnated in the thirdquarter when GDP is measured organically.

2. What is normal is that the first quarter of post-recession growth is thatreal GDP expands at a 7.3% annual rate; 2.2% is really nothing to getexcited about its actually quite worrisome.

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CHART 1: REAL GDP GROWTH IN THE FIRST QUARTER OF AN ECONOMIC

EXPANSION/RECOVERY

United States: Real GDP

(quarter-over-quarter percent change at an annual rate)

17.2

4.6

9.7

7.7

11.5

3.1

7.6

5.1

2.73.5

7.3

2.2

0

2

4

6

8

10

12

14

16

18

20

1950 Q1 54 Q3 58 Q3 61 Q2 71 Q1 75 Q2 80 Q4 83 Q1 91 Q2 02 Q1 Average Current *

Quarter #1 of the Economic Expansion/Recovery

Source: Haver Analytics, Gluskin Sheff

3. Never in recorded history has growth coming out of a string of declinesbeen as weak as what we just witnessed. Considering all the governmentefforts to usher in a V-shaped recovery, what we saw unfold in the realeconomy in Q3 admittedly quite divorced from the action in financialmarkets was, in a word, sad.

Coming off a four-quarter contraction that saw real GDP decline at a 4% annual

average rate, the best the economy could do in Q3, with all the stimulus and

bailouts in the world, is muster a 2.2% annualized advance. The steepest four-

quarter slide in the post-WWII era was followed by the wimpiest rebound; that

really says something. To think we have legions of economists (see Gene Epstein

in Barrons as a classic example) claiming the recession has ended. Really? Is

2.2% growth in 2009 Q3 really that much better than the 1.5% pace posted during

the tax-cut euphoria in 2008 Q2?

Weve got news for you, the contours of the 2008 Q2 GDP performance was more

solid than what we saw in the third quarter of last year because back then at least

we experienced a 2.7% annualized pickup in real final sales compared to 1.9% in

the latest quarter. Come to think of it, the economists touting the recovery today

are the same ones who were still clinging to the soft landing forecast in the spring

and summer of 2008 and used that years second-quarter positive GDP headlineas justification for their view. The lingering effect from the massive doses of

stimulus and the positive accounting from reduced inventory withdrawal will

undoubtedly provide a positive GDP reading for the fourth quarter as well.

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Make no mistake, in the

U.S., it is still all about

housing; and this is

more than three years

after the onset of the

collapse

Be that as it may, we wonder aloud as to whether the folks at the NBER will be

as quick to declare the onset of recovery as has been the case with the

mainstream economists and talking heads on bubble-vision. Seven of the past

eight recessions back to the late 1940s saw exactly two quarters of positive

headline growth. But what is key for calling the end of any recession, in a

word, is sustainability. This recovery argument, in our view, very much remains a

show-me situation.

Make no mistake, it is still all about housing more than three years after the

onset of the collapse. As Karl Case told the New York Times (the Case as in Case-

Shiller): If prices sink 15% from here, which is a possibility, and the 2008 and

2009 loans go bad, then were back where we were before in a nightmare.

Indeed, while the C-S home price index has managed to rise for five months in a

row, the rate of growth has slowed markedly and prices in nine of the 20

metropolitan cities were either flat or down sequentially in October. In fact, before

the seasonally adjustment factor was applied, the C-S index stagnated in October

and we also saw another house price index, calculated by LoanPerformance,

actually decline 0.7% during the month.

We also see that in the current edition of the Economist (page 54) that on a

price-income ratio basis, U.S. home prices are now 3% undervalued and on a

price-rental basis, are 14% overvalued (above long-run average). In other words,

three years into this epic deflation in residential real estate, we have yet to fully

satisfy Bob Farrells Rule #2 Excesses in one direction will lead to an opposite

excess in the other direction. By definition, the prospect that the bottom in

home prices is ahead of us and not behind us will prove to be the big surprise

this year for a consensus view of significant recovery in output, employment,

spending and profits.

25% of U.S. homeowners

(or 15 million

households) with a

mortgage are upside

down

Keep in mind that 25% of U.S. homeowners with a mortgage are upside down

right now (15 million households with negative equity) which portends more

foreclosures coming down the pike and more inventory in the pipeline. This in turn

poses a cloud over the home price outlook in 2010 even with the Obama teams

stepped-up loan modification process, which thus far has been a failure.

Also consider that this bailout-crazed policy team is lending GMAC another $3.5

billion to cover the financial agencys mortgage losses. Have a look at "U.S. Loan

Effort is Seen as Adding to Housing Woes" on the front page of Saturdays NYT.

The most important conclusion is that "banks have been using temporary loan

modifications under the Obama plan as justification to avoid an honest accountingof the mortgage losses still on their books. Only after banks are forced to

acknowledge losses and the real estate market absorbs a now pent-up surge in

foreclosed properties will house prices drop to levels at which enough Americans

can afford to buy

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Mr. Case added that the probability is very high of serious double-dip like 1982.

That would certainly leave the stock market vulnerable to a retest or possibly even

a breach of the March lows. That is really the unknown was this a 1930-style

bounce in the market (+100%) which was doomed to fail (followed by a 30%

correction) or the 1933 rally that history tells us marked the end of the

fundamental bear market.

SAME CONTRACTIONARY MESSAGE IN THE CONFIDENCE DATA

The Conference Boards measure of consumer confidence in the U.S. rang in at

52.9 in December, up from an upwardly revised November reading of 50.6 (was at

49.5). This is extremely low for an economy that has benefitted from such

dramatic monetary and fiscal easing. In fact, consumer confidence is still lower

today than it was at the depths of despair in each of the past three recessions

dating back to the early 1980s. Moreover, in economic expansions, consumer

confidence averages 102; and in recessions, it averages 72.

So, the fairest way to look at the data is that confidence is at a level that is 20

points below what we typically see in a garden-variety recession. If there is a

recovery that economists, strategists and investors see, it certainly seems to have

bypassed the very part of the economy that is the most dominant the household

sector. The S&P 500, by the way, is trading in a fashion that in the past would

have been consistent with a consumer confidence reading closer to 85.

We should also mention the fact that even though consumer confidence did

manage to rise in December, that

It was the led by the expectations component, which jumped to 75.6 from70.3 in November, the highest reading since October 2007. Hope springing

eternal?

The current conditions index actually fell to 18.8 from 21.2 to stand at itslowest level in 27 years (facts on the ground).

Auto buying intentions in December hit a record low.CHART 2: AUTO BUYING INTENTIONS HIT RECORD LOW IN DECEMBER

United States: Conference Board Consumer Confidence Survey:

Plans to Buy an Automobile Within Six Months (percent)

0505050

12

10

8

6

4

2

Shaded region represent periods of U.S. recession. Source: Haver Analytics, Gluskin Sheff

Consumer confidence in

the U.S. remains

extremely low in the

context of the massive

monetary and fiscal

policy


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Plans to buy a home in the next six months aged to the lowest level in 27years.

CHART 3: HOME BUYING INTENTIONS AT ITS LOWEST IN 27 YEARS

United States: Conference Board Consumer Confidence Survey:

Plans to Buy a Home Within Six Months

(percent)

0505050

5.25

4.50

3.75

3.00

2.25

1.50

Shaded region represent periods of U.S. recession


Vacation plans fell to their second lowest level of the past 40 years.HOW CAN THERE BE A RECOVERY IF TAX REVENUES ARE STILL DECLINING?

One would think if we were actually in a recovery that state and local governments

would start to be seeing the private sector generate some much-need tax

revenues. Far from it.

In the third quarter, and this was with the benefit of a 3.6% lift in property taxes

(amazing), tax receipts at the lower levels of government fell 7% in Q3 from a year

ago. Sales taxes are down 9% (seems just a bit at odds with the retail sales data,

no?) and income taxes off 12%. If that is what a recovery does to fiscal finances,

imagine what the backdrop will look like if the economy actually does pull a

double dip.

THE LATE-PAYMENT ECONOMY

Not only do we have 1-in-7 Americans with a mortgage in arrears or the foreclosure

process, and a bank-wide credit card charge-off rate that now exceeds the 10%

mark, but

... Legal firms are waiting three more days on average to get paid. Architect/engineering firms are seeing their bills get paid an average of five

days later than normal.

Tax preparation, bookkeeping and payroll service companies are beingdelayed 10 days.

Check out Later Payments Are Jamming the Economys Gears on page 2 of the

Sunday NYT.

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MODERATE HOLIDAY CHEER

Holiday retail sales inthe U.S. did end on a

strong note, but keep in

mind that any

comparison from a year

ago will be exaggerated

Let us first keep in mind that any calculation from year-ago levels receives a hugely

exaggerating lift from the post-Lehman economic detonation in the fall of 2008.

And while the MasterCard SpendingPulse data did show that YoY sales came in at

+3.6% through Christmas Eve that extra one shopping day this year since

Thanksgiving meant a great deal adjusted for that, sales rose 1.0% YoY, which

was within the -1.0% to +2.6% range of estimates heading into the holiday season.

Be that as it may, sales did far exceed the most pessimistic scenarios, and that

reflects the more aggressive inventory management this year compared to last as

leaner stockpiles prevented a repeat of the pronounced discounts that crushed

retailer margins in 2008 as opposed to more "physical" or volume buying on the

part of consumers. After all, confidence indices remain mired at levels consistent

with recession.

The losers this year were apparel and most luxury goods, as well as department

stores (-2.3%) but electronics were a big winner (+5.9%) as were online sales

(+15.5%). Within the big retailer camp, Macys, Costco, Target, and Kohls appear

to have provided the greatest upside surprises.

SECULAR SHIFTS IN SPENDING AND INVESTING BEHAVIOUR

GET USED TO IT

Crisis breeds behavioural change. This time is no different. Consumer attitudes

towards homeownership have changed semi-permanently. This is why the

government has to bribe people to buy homes with extended and expanded tax

credits.

Consumer attitudes towards discretionary spending have also changed materially.

This is why the government again has to bribe people to buy cars through cash for

clunkers programs. But have a look atJob Losses Cut Into U.S. Drivingon page

A3 of weekend WSJ lower gas prices and exuberant financial markets didn't

prevent the number of miles Americans drove from declining in 2010 for the

second year in a row. Talk about a secular shift in behaviour for a nation of

passionate drivers.

For a taste of how Americans are changing their former free-spending ways, have a

look atAmericans Doing More, Buying Less, a Poll Funds on page 12 of the

Sunday NYT. A New York Times/CBS News poll found that nearly half of Americans

are now spending less time buying non essentials and over half are spending

less money in stores and online. And, it was no picnic getting through the front

page article Living on Nothing but Food Stamps without shedding a tear. Wherethe mainstream economists manage to see the macro backdrop through their

rose-colored glasses in the midst this ongoing credit collapse and economic fallout

is one of lifes true mysteries.

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Moreover, consumer attitudes towards credit have also shifted radically in this new

era of frugality, which the government is trying to fight through its own largesse,

and willingness now to lift the Fannie and Freddie bailout limits entirely de facto

nationalizing the mortgage market so that loan modifications can be effectively

crammed down the throat of the lending community.

Consumer attitudes

towardshomeownership, credit

and discretionary

spending have changed

get use to itWe are on the precipice of a massive mandatory consumer debt-forgiveness

program that will likely see private sector credit taps turned off for good but the

government will be there to provide the financing. This is the next bubble

government finance (but as Richard Koo points out in this weeks Barrons

interview, this is what the government must do to prevent an all-out deflationary

depression as the private sector deleveraging continues unabated).

But what the Obama team is finding out, and will continue to find out, is that you

can fight human nature for only so long. Capitalism is there to isolate the flaws,

and as far as the financial system (and the housing market) is concerned, there

are still far too may loose ends that have to be worked out. The prime reason

why it appears that home prices have stopped falling is because all the games

being played by the public sector in delaying the foreclosure process, which has

left a record volume of homes off the market (and in the process dramatically

skewing down the inventory data, which are still well north of years supply when

measured accurately).

Banks are eager to pay off their TARP money to avoid compensation limits but also

with the confidence that if they fall into problems again, they are too big to fail and

Uncle Sam has already established the bail out precedent. Nobody seems to

notice that of the $7.4 trillion of U.S. banking sector assets, there are still some

$346 billion that are classified as Level 3 illiquid loans or the equivalent of their

entire core capital level. According to the Economist, these loans are being carried

on the books at a $76 billion premium to fair value, suggesting that we are

nowhere near close to achieving true price discovery.

One has to wonder what sort of year lies ahead for the financials, which led the

bear market rally of 2009. If the FASB is successful in implementing new

accounting rules that will rectify these valuation gaps, which in turn will reduce

shareholder equity and regulatory capital.

Indeed, perhaps it is these concerns that have undercut the financial sector

shares, which are down close to 10% from the nearby highs and have basically

done nothing now for four months despite the massive subsidy the banks are

receiving in the form of the super-steep I-shaped yield curve.

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If the financials are sputtering, then one can expect the rest of the market

to follow. They led on the way down in 2007; and they led on the way up in

2009.

As for investing, it also

seems that the general

public is changing its

waysThe general public seems to have a better grasp as to what is going on than the

mainstream sell-side strategists, who continue to recommend that private clients

take on undue risks. Instead, the typical retail investor is thanking his/her lucky

stars that he/she can now get out of his/her equity position at a 65% premium to

the price levels we saw at the lows in March. There is no way that Ma and Pa

Kettle ever dreamed that they could liquidate at these prices so soon off the lows

and that is what they are doing.

Instead of capitulating and throwing money at the market in classic price-chasing

fashion, the general public is also changing the way it approaches its investments

just as it is changing its approach towards budgeting, borrowing and housing.

These are secular changes, as the post-bubble history book attests. So it is

interesting to see that nine months and 65% off the market lows, individual

investors are not being lured by Wall Street research and the media by adding to

their already overweight equity positions but instead have continued to sell into

the rally and rebalance their portfolios. More than 25% of the household asset mix

is still in equities; ditto for real estate. But less than 7% is in the broad fixed-

income market. That is the part of the asset mix that is expanding the most, and

sorry, this is not some sort of contrarian call for the equity bulls but rather a sign,

yet again, that a fundamental shift in behaviour is taking place. Get on the bus or

you will be left behind.

The big call for 2010 may be less on what the economy and Fed do, and more on

what happens with fund flows. Will the selling from the retail investor outlast the

buying from hedge funds and short-covering? The story for 2009 was that the

equity market received some strong buying power from massive short-coverings

after the government corralled the banking system, hedge funds regaining their

taste for leverage, and mutual fund portfolio managers taking down their cash

ratios back to late-2007 levels. But while the institutional buying was solid,

conspicuous by their absence, beyond the corporate insiders, were retail investors.

They were not just on the sidelines, but net sellers through most of 2009.

We just got the mutual fund data for the past month and the past week:

Talk about a behavioural shift in approach. American investors pulled $2.8 billion

out of equity funds in November, the third outflow in a row. Year-to-date, stock

funds saw net redemptions of $4.1 billion despite a 20% up-year in the market,

and this followed a $213.5 billion outflow in 2008. It may be safe to say that the

equity cult is dead. When it makes it to the front pages of the tabloids, as it did inAugust 1979 with the now-famous BusinessWeek cover at that time, then maybe it

will be safe to call for the true bottom three years down the road.

The bulls point to all the dry powder sitting on the sidelines, just waiting to be put

into the market. Indeed, investors are liquidating their money market funds

there were outflows totaling $46.7 billion in November and $71.8 billion in

October. But this money is not heading in the direction of the equity market.

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Bond funds took in $44.9 billion in November the fourth highest ever and

through the first 11 months of 2009 the inflows to fixed-income funds came to a

record $349 billion; and this doesnt include the $20 billion through 2009 into

hybrid funds (+$3.4 billion in November).

The investing publics ongoing re-allocation towards the bond market was also

evident in the weekly data (to December 23rd). Instead of being lured by the move

in the S&P 500 and the Dow to new 15-month highs, and instead of being scared

off by the increase in market yields, retail investors plowed another $8.2 billion

into bond funds (on top of $9.87 billion the week before) and this was almost

triple what was put into equity funds.

Take note that U.S. equity PMs are now at the very low end of the historical

range in terms of cash ratios, at 3.9% (versus nearly 6% back in March) right

where they were in October 2007 at the market peak.

CHART 4: THE LIQUIDITY RATIO FOR EQUITY FUNDS ARE HOVERING AT

THE LOW END OF THEIR RANGE .

United States: Investment Company Institute (ICI)

Liquidity Ratio: All Equity Funds

(percent)

098765432109

6.5

6.0

5.5

5.0

4.5

4.0

3.5


In the fixed-income market, both government bond fund managers (3%) and

corporate bond fund manages (7.7%) are close to the high end of their

respective ranges.


12/17


13/17


Manufacturing capacity utilization rates are 68.4% and the U6 unemploymentrate is 17.2%. (Inflation? Come again?) The initial jobless claims

data out of the U.S. doessuggest that the pace of

firing has subsided

dramatically

The money supply (M2) is up 5% but velocity is down 5% from a year ago. Home prices are still in the hole by 8.5% compared to a year ago. Moreover, rents are down 3.5% from a year ago according to a survey just

compiled by MPF Research (net effective rents) with the U.S. vacancy rateclimbing to 7.8% form 4.8% at the end of 2007.

Stick in that net effective rent number in the CPI and we have news for you.

Core inflation may be closer to 0% than many think (currently reported at

1.7%).

IMPROVEMENT IN INITIAL JOBLESS CLAIMS, BUT SLACK PERSISTS

For the week of December 26, U.S. initial jobless claims came in better than

expected, plunging 22k to 432k the consensus was expecting an increase to

460k for the week. The prior week was revised slightly higher, to now show

454k versus the initial reading of 452k. This result was the lowest reading since

July 2008, although, the big drop this week may be due to a temporary distortion

related to the Christmas holiday looking at the same period last year, claims

slid 56k only to then bounce back sharply. So treat holiday data with care.

Nonetheless, initial claims have steadily declined since the all-time high of 674k

level hit back in March. For all of December, claims are at 459k compared to

480k in November, 524k in October and 545k in September, which certainly

does suggest that the pace of firings has subsided dramatically. The problem

remains that there is still a lack of hiring and the unemployment rate is likely to

remain on a rising trend as a result. Here we are, a decade into the millennium,

and there are as many jobs out there as there was at the end of 1999 and yet

there are 12 million more American workers vying for them.

The list of unemployed folks who cannot find a job is staggering and growing.

For example, continuing claims fell to 4.981 million for the week ending

December 19 versus 5.038 million the prior week the first time below the 5.0

million mark since early February. However, the improvement in this metric is

probably due to claimants exhausting their benefits as opposed to being hired

and these claimants are now receiving emergency employment benefits.

Indeed, the number of people receiving EUC rose 191,669 to a new record high

of 4,448,914.

but the problem

remains that there is

still a lack of hiring and

the unemployment rate

is likely to remain on a

rising trend

As the WSJ eloquently put it last Thursday (in the Ahead of the Tape column),

there are 5.6 million people who have given up looking for work and no longer

receiving benefits who are not counted in the official unemployment statistics

but if they do join the labor force in the coming year, and end up competing with

the 9.9 million who are drawing benefits today, the jobless rate is going to have

nowhere to go but up.

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What about all the share dilution we are going to see in the financial sector, not

to mention more writedowns after all, someone is going to have to pay for all

the Obama loan modifications (and its not going to the homeowner; that we can

assure you). Consider also that nearly 40% of distressed homeowners who had

their monthly payments cut by at least 20% in 2009 were delinquent again

within a year (data from the OCC and OTS). These people need more than rate

relief they need their principal lowered, which means that the banks are due to

take a hit.

It may seem that

emerging economieshave emerged

consider that China is

now the 3rd largest

economy in the world

and Brazil is now the

eighth largest

We would be surprised to see an earnings number this year much above $65.

That leaves the market priced at 17x forward earnings, which is a little rich, in

our opinion. In fact, even under the most optimistic scenario for profits, we are

looking at a 15x multiple, which is little better than the long-run average. So, no

matter how you cut it, there is a lot of growth priced into equity valuation at the

current time and as a result, returns can be expected to be rather low in the

coming twelve months. Bonds of all sorts still look good on a relative basis.

RE-EMERGENCE OF EMERGING MARKETS

Emerging market equity funds attracted a record $80 billion of new inflow in

2009, way more than reversing the $50 billion net selloff in 2008. Against this

backdrop, the emerging equity market index rallied a massive 75% last year

compared to the 28% rebound in the developed world. But perhaps the

emerging economies have already emerged because what has changed the

most in this first decade of the new millennium is the ranking that China enjoys

on the world GDP ladder from 10th rung to third in only 10 years (and Brazil

has moved from 10th spot to 8th).

No surprise then that over the past 10 years, the Chinese market has rallied140%, Brazil by 300% and India by 240%.


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Gluskin Sheffat a Glance

Gluskin Sheff+ Associates Inc. is one of Canadas pre-eminent wealth management firms.Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to theprudent stewardship of our clients wealth through the delivery of strong, risk-adjustedinvestment returns together with the highest level of personalized client service.OVERVIEW

As of September30, 2009, the Firmmanaged assets of$5.0 billion.

Gluskin Sheff became a publicly tradedcorporation on the Toronto StockExchange (symbol: GS) in May2006 andremains 65% owned by its senior

management and employees. We havepublic company accountability andgovernance with a private companycommitment to innovation and service.

Our investment interests are directlyaligned with those of our clients, asGluskin Sheffs management andemployees are collectively the largestclient of the Firms investment portfolios.

We offer a diverse platform of investmentstrategies (Canadian and U.S. equities,Alternative and Fixed Income) andinvestment styles (Value, Growth and

Income).1

The minimum investment required toestablish a client relationship with theFirm is $3 million for Canadian investorsand $5 million for U.S. & Internationalinvestors.

PERFORMANCE

$1 million invested in our Canadian ValuePortfolio in 1991 (its inception date)

would have grown to $15.5 million2

onSeptember30, 2009 versus $9.7millionfor the S&P/TSX Total Return Index

over the same period.$1 million usd invested in our U.S.Equity Portfolio in 1986 (its inceptiondate) would have grown to $11.2 millionusd

2on September 30, 2009 versus $8.7

million usd for the S&P500TotalReturn Index over the same period.

INVESTMENT STRATEGY & TEAM

We have strong and stable portfoliomanagement, research and client serviceteams. Aside from recent additions, ourPortfolio Managers have been with theFirm for a minimum of ten years and wehave attracted best in class talent at all

levels. Our performance results are thoseof the team in place.

Our investmentinterests are directlyaligned with those ofour clients, as Gluskin

Sheffs management andemployees arecollectively the largestclient of the Firmsinvestment portfolios.

$1 million invested in our

Canadian Value Portfolio

in 1991 (its inception

date) would have grown to

$15.5 million2 on

September 30, 2009

versus $9.7 million for the

S&P/TSX Total Return

Index over the same

period.

We have a strong history of insightfulbottom-up security selection based onfundamental analysis.

For long equities, we look for companieswith a history of long-term growth andstability, a proven track record,shareholder-minded management and ashare price below our estimate of intrinsic

value. We look for the opposite inequities that we sell short.

For corporate bonds, we look for issuers

with a margin of safety for the paymentof interest and principal, and yields whichare attractive relative to the assessedcredit risks involved.

We assemble concentrated portfolios our top ten holdings typically representbetween 25% to 45% of a portfolio. In this

way, clients benefit from the ideas inwhich we have the highest conviction.

Our success has often been linked to ourlong history of investing in under-followed and under-appreciated smalland mid cap companies both in Canada

and the U.S.

PORTFOLIO CONSTRUCTION

For further information,

please contact

[email protected]

In terms of asset mix and portfolioconstruction, we offer a unique marriagebetween our bottom-up security-specificfundamental analysis and our top-downmacroeconomic view.

Page 16 of 17

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

1. Not all investment strategies are available to non-Canadian investors. Please contact Gluskin Sheff for information specific to your situation.2. Returns are based on the composite of segregated Value and U.S. Equity portfolios, as applicable, and are presented net of fees and expenses.


17/17


IMPORTANT DISCLOSURES

Copyright 2010 Gluskin Sheff + Associates Inc. (Gluskin Sheff). All rights

reserved. This report is prepared for the use of Gluskin Sheff clients andsubscribers to this report and may not be redistributed, retransmitted ordisclosed, in whole or in part, or in any form or manner, without the expresswritten consent of Gluskin Sheff. Gluskin Sheff reports are distributedsimultaneously to internal and client websites and other portals by GluskinSheff and are not publicly available materials. Any unauthorized use ordisclosure is prohibited.

Gluskin Sheff may own, buy, or sell, on behalf of its clients, securities ofissuers that may be discussed in or impacted by this report. As a result,readers should be aware that Gluskin Sheff may have a conflict of interest

that could affect the objectivity of this report. This report should not beregarded by recipients as a substitute for the exercise of their own judgmentand readers are encouraged to seek independent, third-party research onany companies covered in or impacted by this report.

Individuals identified as economists do not function as research analystsunder U.S. law and reports prepared by them are not research reports underapplicable U.S. rules and regulations. Macroeconomic analysis isconsidered investment research for purposes of distribution in the U.K.

under the rules of the Financial Services Authority.

Neither the information nor any opinion expressed constitutes an offer or aninvitation to make an offer, to buy or sell any securities or other financialinstrument or any derivative related to such securities or instruments (e.g.,options, futures, warrants, and contracts for differences). This report is notintended to provide personal investment advice and it does not take intoaccount the specific investment objectives, financial situation and theparticular needs of any specific person. Investors should seek financialadvice regarding the appropriateness of investing in financial instrumentsand implementing investment strategies discussed or recommended in thisreport and should understand that statements regarding future prospectsmay not be realized. Any decision to purchase or subscribe for securities inany offering must be based solely on existing public information on suchsecurity or the information in the prospectus or other offering documentissued in connection with such offering, and not on this report.

Securities and other financial instruments discussed in this report, orrecommended by Gluskin Sheff, are not insured by the Federal DepositInsurance Corporation and are not deposits or other obligations of anyinsured depository institution. Investments in general and, derivatives, inparticular, involve numerous risks, including, among others, market risk,counterparty default risk and liquidity risk. No security, financial instrumentor derivative is suitable for all investors. In some cases, securities andother financial instruments may be difficult to value or sell and reliableinformation about the value or r isks related to the security or financialinstrument may be difficult to obtain. Investors should note that incomefrom such securities and other financial instruments, if any, may fluctuateand that price or value of such securities and instruments may rise or fall

and, in some cases, investors may lose their entire principal investment.

Past performance is not necessarily a guide to future performance. Levelsand basis for taxation may change.

Foreign currency rates of exchange may adversely affect the value, price orincome of any security or financial instrument mentioned in this report.Investors in such securities and instruments effectively assume currencyrisk.

Materials prepared by Gluskin Sheff research personnel are based on publicinformation. Facts and views presented in this material have not beenreviewed by, and may not reflect information known to, professionals inother business areas of Gluskin Sheff. To the extent this report discussesany legal proceeding or issues, it has not been prepared as nor is itintended to express any legal conclusion, opinion or advice. Investorsshould consult their own legal advisers as to issues of law relating to thesubject matter of this report. Gluskin Sheff research personnels knowledgeof legal proceedings in which any Gluskin Sheff entity and/or its directors,officers and employees may be plaintiffs, defendants, co-defendants or co-plaintiffs with or involving companies mentioned in this report is based onpublic information. Facts and views presented in this material that relate to

any such proceedings have not been reviewed by, discussed with, and maynot reflect information known to, professionals in other business areas ofGluskin Sheff in connection with the legal proceedings or matters relevant

to such proceedings.

Any information relating to the tax status of financial instruments discussedherein is not intended to provide tax advice or to be used by anyone toprovide tax advice. Investors are urged to seek tax advice based on theirparticular circumstances from an independent tax professional.

The information herein (other than disclosure information relating to GluskinSheff and its affiliates) was obtained from various sources and GluskinSheff does not guarantee its accuracy. This report may contain links to

third-party websites. Gluskin Sheff is not responsible for the content of anythird-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 andis 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 GluskinSheff.

All opinions, projections and estimates constitute the judgment of theauthor 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 noobligation to update this report and readers should therefore assume thatGluskin Sheff will not update any fact, circumstance or opinion contained in

this report.

Neither Gluskin Sheff nor any director, officer or employee of Gluskin Sheffaccepts any liability whatsoever for any direct, indirect or consequentialdamages or losses arising from any use of this report or its contents.

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