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8/8/2019 Breakfast With Dave 010511
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David A. Rosenberg January 5, 2011 Chief Economist & Strategist Economic [email protected]+ 1 416 681 8919
MARKET MUSINGS & DATA DECIPHERING
Breakfast with DaveWHILE YOU WERE SLEEPING
• What the bulls may beignoring ... at their peril ...plus some ideas for 2011
• Fed less than impressed
with the economicbackdrop
• Troubles with the profitforecasts
• ADP surges! But is it for
real?
• Slowing trend in corecapital expenditure orders... this may throw awrench into bullishbusiness spending forecasts for 2011
• U.S. consumer finished the year in decent shape
• While you were sleeping:wave of selling acrossEurope and Asia; U.S.dollar firming; euroslipping; commoditycomplex heading south;Aussie and Kiwi down;loonie declined from itslofty perch
IN THIS ISSUEThe markets have turned completely manic. After starting off the year on a very
strong footing on virtually no net new information over the outlook, we see a
wave of selling today across Europe and Asia (Asian equities were due for a
breather — this was the first decline in eight days). Bonds have turned the corner
and are back in rally mode. The U.S. dollar, predictably since it is still considered
to be a less-cyclical and more-safe unit, is firming and is retesting the 100-day
moving average (m.a.) after briefly breaking below the 50-day m.a. exactly 24
hours ago.
Even though U.S. auto sales came in a smidgen above expectations at 12.5
million units annualized in December (barely meeting replacement demand), the
whispered numbers were far higher due to the huge discounting that had been
going on to close the calendar year. And, the news from Reis that shopping
center vacancy rates jumped to 10.9% in Q4 from 10.6% a year ago served as a
stark reminder that sorry, no, the American consumer is not really operating on
all engines despite a better than expected holiday shopping season that was
aided and abetted by what will likely turn out to be a temporary equity wealth
effect that pulled down the savings rate for a brief time.
Inflationist's may love the fact that G.E. just announced a hefty price hike on
appliances, but there are still other significant pockets of deflation, such as the
fact that shopping mall rents are down 1.5% over the past year.
The euro is slipping again as Eurozone refinancing challenges come back onto
the front burner and People’s Bank of China officials are openly discussing their
concerns surrounding China’s disturbing inflation backdrop — hinting at more
policy tightening. As a result, the commodity complex, as well as the resource-
based currencies, is heading south (copper is down 1.4% today and oil is off the
boil, though the damage to the economy has already been done as we explain
below — also see Oil Price Enters Danger Zone on the front page of today’s FT);
gold is hugging the 100-day m.a. line nicely after yesterday’s descent. The
Aussie and Kiwi are down now for three days in a row and the loonie has
declined from its lofty perch for the first time in ten sessions.
As for credit, it remains to be seen whether we see some spread widening given the massive slate of new corporate issuance on tap for this quarter (see Bond
Wave Strikes on Both Sides of the Atlantic on page 12 of the FT). Pound for
pound, we still prefer corporate bonds to equities, which would have been a very
good call for 2010 by the way, and we would view any widening in spreads as a
terrific buying opportunity.
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
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Barrons.com ran an article yesterday quoting some obscure analyst criticizing
our macro economic and bond yield call for 2010, basically ridiculing us, calling
for a contraction in either Q3 or Q4 and for the yield on the U.S. 10-year note to
get as low as 2% or below. Here is the reality. The U.S. economy was clearly
sputtering by the spring and summer and we were calling for that early on as the
consensus was gazing at 5%+ fourth quarter growth in Q4 of 2009 and 3%+ in
the first quarter of 2010. Only when the long arm of the law — another round of
monetary and fiscal stimulus — was extended to give Mr. Market a nice lift did
the clouds part. That shows how fragile this recovery has been and remains —
just read the FOMC minutes to get a glimpse of the array of downside risks cited
(more on this below). While the 10-year yield did not finish the year at 2%, it
almost got there in the fall and nobody, except us, was calling for that a year
ago. So put that in your pipe and smoke it.
Only when the long arm of the
law — another round ofmonetary and fiscal stimulus —
was extended to give Mr.
Market a nice lift did the
clouds part
There is no doubt that we have had an incredible bear market rally on our
hands. But that is exactly what it is. As we noted yesterday, as per Bob Farrell,
even these spasms can go further than anyone thinks. But after a monstrous
80%-plus rally from the March 2009 lows (over such a short time frame, and the
most pronounced bounce since 1955) this market has become seriously
overextended in our view. Meanwhile, we have practically every market pundit
extrapolating the recent trend into the future because that is the easy thing to
do. But the Farrell’s and Walter Murphy’s of this world have become very
cautious and frankly, that is good enough for us. The fact that Laszlo Birinyi
published a report yesterday concluding that the S&P 500 will rally to 2,854
(what … no decimal place?) by September 4, 2013 (oh, only another 125% from
here) is perfect. Absolutely perfect.
Meanwhile, the masses only see the returns, they do not see the risks that arenearly invisible to the naked eye. But we see the risks. We assess them; we
measure them, and we benchmark the returns against them. I recall all too well
that 2003-07 bear market rally — yes, that is what it was. It was no 1949-1966
or 1982-2000 secular bull run. It was a classic bear market rally, and did last
five years. I was forever skeptical because what drove that bear market rally
was phony wealth generated by a non-productive asset called housing alongside
wide spread financial engineering, which triggered a wave of artificial paper
profits. I knew it would end in tears … sadly, I didn’t know exactly when. I was
constantly defensive in my investment recommendations at the time and there
was a huge price to be paid for being bearish when there is a bull on your
business card, trust me on that one.
We have been patient and will remain so, with an eye towards maximizing risk-adjusted returns, not merely gross nominal returns, which are the only ones that
get reported. Remember those returns only count if they aren’t ultimately
reversed by excessive greed. At the current time, we believe our clients are well
served by our equity strategies (minimal cyclical exposure and a focus on an
income equity-hard asset barbell); our long-short strategies (vital in controlling
risk in the portfolio and underscore our focus on capital preservation thematic)
and our fixed-income products (outside of commodities, deflation in the
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developed world remains the primary trend and is in such a backdrop that
“yield” makes perfect sense). Bear market rallies are not the
same as secular bull markets — the former are to be rented,
the latter are to be owned
How the Fed and the federal
government in the future
manage to redress their
pregnant balance sheetswithout creating a major
disturbance for the overall
economy is a legitimate
question
As investors discovered that the world wasn’t flat after all from late 2007
through to early 2009 as the roof caved in for most, who remembered that I was
just plain wrong in 2003 when the S&P 500 surged 26% or even in 2006 when
it rallied 13%. It is quite amazing that as the market rolled over, nobody
remembered how “wrongly bearish” I was during those years in the wilderness
when everyone believed in the wonders of financial market innovation and the
democratization of the housing market. I recall a senior portfolio manager in
Texas scolding me in 2005 about how his nanny just got a subprime mortgage
to buy her first home … let’s hope he didn’t co-sign).
It is an amazing commentary on human behaviour that I was forgiven for having
been more focused on bonds and gold during those go-go leveraged years of
2003-2007, and then treated like a hero after the financial system collapsed
under its own weight of dramatic excess. It goes to show that in the final
analysis, as much as it hurts, not to be involved in a speculative rally that sees
the market surge more than 80%, it is much much tougher to actually
experience a correction in the other direction. For the time being, it takes
extreme courage and resolve to not jump on the bandwagon (“don’t fight the
Fed”) and buy “the market” at current expensive pricing points.
As far as equities are concerned, make no mistake, we are in the throes of an
intense bear market rally, which is likely at the very late stage. Nobody will know
to get out at the peak and as we saw in late 2007 and into 2008, many of the
“longs” will be trapped. Bear market rallies are not the same as secular bull
markets — the former are to be rented, the latter are to be owned. Those
claiming to be adept market timers today that have been and are staying long
will be repeating the same mistake they made three-years ago.
This is not the 1949-66 secular bull market that was underpinned by troops
coming home and spurring on a baby-boom that would unleash years of
tremendously strong domestic demand growth. The demographics in the U.S.A.
are now downright poor — just look at the ratio of the working age population to
the total population. Nor is this the 1982-2000 secular bull market that saw the
central bank usher in years of disinflation (the current one is trying desperately
to create inflation!) and a wave of innovation that saw the mainframe, the
personal computer, the Internet, and then the smartphone, a boom in the
capital stock that enhanced structural productivity growth and led to sustained
gains in private sector economic activity, which by the end of that secular bullrun, allowed the government to actually start to record budgetary surpluses.
What is the major innovation today? The iPod? The iPad? Facebook? These
may be fun, but they don’t do much to promote the growth rate in the nation’s
capital stock or productivity.
What we have on our hands has been an economic revival and market bounce
back premised on unprecedented monetary and fiscal stimulus. How the Fed
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and the federal government in the future manage to redress their pregnant
balance sheets without creating a major disturbance for the overall economy is
a legitimate question and, sorry, does not deserve a double-digit market
multiple, in our view.
Don’t assume for a second
that Ben Bernanke has anymore rabbits in his hat or that
the new Congress is going to
fill anyone’s stockings with
more fiscal goodies towards
the end of the year
Maybe last quarter’s and next quarter’s GDP growth is relatively certain, but last
we saw, the stock market is a long-duration asset. If 2011 was a building block
for 2012, much like 1982 was for 1983, we would be impressed. But the
growth we will likely see in 2011 will be bought by the government and the Fed
at the expense of 2012 where there is likely going to be a huge air pocket, and
the presidential election of that year in the U.S. will likely be fought and won on
which party can successfully convince the voting public that the recession was
not its fault.
Just as the 2003-07 bear market rally was built on a shaky foundation of
unsustainable credit and house price appreciation, the current bear market rally
has been built on even shakier ground of surreal public sector intervention. This
may well have “saved the system” or “prevented a depression” back in the
opening months of 2009, as many like to believe; however, the reality (and even
former communist regimes figured this out a few decades ago) is that there is
no such thing as a free lunch.
The best buying opportunities for investors that actually do have a horizon that
lasts more than five months or even 15 months for that matter; investors that
are more focused on building wealth for the long-term as opposed to trying to
make recurring short-term trading profits, will happen when we see the payback
period. And this could happen sooner than you think. Don’t assume for a
second that Ben Bernanke has any more rabbits in his hat or that the new
Congress is going to fill anyone’s stockings with more fiscal goodies towards the
end of the year.
At least the editorial board at the Wall Street Journal get it. See page A14 of
today’s paper — The GOP Opportunity . To wit:
“John Boehner takes the Speakers gavel from Nancy Pelosi today, and the
transfer represents much more than a change in partisan control. It marks
perhaps the sharpest ideological shift in the House in 80 years, and it could set
the stage for a meaningful two-year debate over the role of the government and
the real sources of economic prosperity.”
As the chart below il lustrates, growth in the U.S. private sector capital stock has
actually turned negative for the first time since the post WWII era. This does not
bode well for future productivity gains, the U.S. economy’s non-inflationary
growth potential or consensus views that somehow a market multiple between
14x and 16x (depending on how it’s measured) is close to anything resembling
“fair-value”
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CHART 1: GROWTH IN PRIVATE SECTOR CAPITAL STOCKTURNS NEGATIVE
United States: Net Stock: Private Equipment & Software
(year-over-year percentage change)
05050505050505
Source: Bureau of Economic Anal sis /Haver Anal tics
25
20
15
10
5
0
-5
Source: Haver Analytics, Gluskin Sheff
While today’s ADP number for December was surprisingly strong, the reality is
that U.S. labour market remains in a state of disarray. The labour force gaps are
huge if not unprecedented. Fully 6.3 million Americans have been actively
looking for a job with no success for at least six months — a record, both in
absolute and relative terms, to the size of the workforce. One cannot help but
contemplate the looming social issues that will be involved if youth
unemployment rates at 25% and adult male jobless rates at 10% are sustained.
Even the Fed did not offer much hope in yesterday’s minutes that the dramatic
excess capacity in the jobs market will be resolved in the coming year, even with
the last gasp attempt to stimulate the economy with monetary and fiscal
steroids. Again, this is a source of uncertainty that would ordinarily require a
lower fair-value P/E multiple than a higher one.
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CHART 2: OVER 6.3 MILLION UNEMPLOYED FOR OVER 26 WEEKS
United States: Civilians Unemployment for 27 Weeks or Over
(thousands)
105050505050505
Source: Bureau of Labor Statistics /Haver Anal tics
8000
6000
4000
2000
0
Source: Haver Analytics, Gluskin Sheff
CHART 3: THIS IS A RECORD 42% SHARE OF THE JOBLESS RANKS
United States: Unemployed for 27 Weeks and Over: % of Civilians Unemployed
(percentage)
105050505050505
Source: Bureau of Labor Statistics /Haver Anal tics
50
40
30
20
10
0
Source: Haver Analytics, Gluskin Sheff
CHART 4: YOUTH UNEMPLOYMENT RATE AT 25%
United States: Unemployment Rate: 16-19 Years
(percentage)
105050505050505
Source: Bureau of Labor Statistics /Haver Anal tics
28
24
20
16
12
8
4
Shaded areas represent periods of U.S. recessions
Source: Haver Analytics, Gluskin Sheff
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CHART 5: NEAR-10% UNEMPLOYMENT RATE FOR ADULT MALES
United States: Unemployment Rate: Men between 25-54 Years
(percentage)
105050505050505
Source: Bureau of Labor Statistics / Haver Anal tics
10
8
6
4
2
0
Shaded areas represent periods of U.S. recessions
Source: Haver Analytics, Gluskin Sheff
U.S. CONSUMER FINISHED THE YEAR IN DECENT SHAPE
The Redbook survey showed a 0.4% same-store sales gain to close out the year
and this resulted in 3.5% YoY pace which indeed was above target of a 3.2%
trend. According to the report, what helped the last week of 2010 were “post-
Christmas markdowns” and “clearance sales of seasonal inventory were
certainly a factor in post-Christmas buying”. There is no reason for deflationary
growth to be a negative for the fixed-income market but everywhere we look all
we see are bond bears.
SLOWING TREND IN CORE CAPEX ORDERS ... THIS MAY THROW A WRENCH
INTO BULLISH BUSINESS SPENDING FORECASTS FOR 2011
Yesterday’s manufacturing data tells me that we are off the boil as far as capital
spending growth is concerned and yet business spending is a key cornerstone
for the consensus regarding the 2011 macro outlook. Remember, capital
expenditure was up 15% last year, by far outpacing all other segments of U.S.
GDP (consumer spending was not even up 2% for the year as a whole, despite
the strong finish). Looking at the trend in new core capex orders, we are closing
the books in 2010 on a slowing path.
Yesterday’s manufacturing
data tells me that we are off
the boil as far as capital
spending growth is concerned
Over the past three months, core capex orders (capital goods orders excluding
defense and aircraft) have slowed to a 4.9% annual rate. Three-months ago,
this pace was running at 13.2% and six-months ago it was 39.3% at an annual
rate. This is actually the second softest trend since the recession ended in mid-
2009.
The second chart below is smoother and illustrates the six-month trend. In
November, it was running at an 8.9% annualized rate, which is okay as a stand-
alone print, but this masks the recent loss of momentum― this trend was north
of 20% both three- and six-months ago. And recall, we had the Fed embark on
QE2 and the investor-friendly election results prior to November. Also keep in
mind that over this three-month interval in which core order growth receded so
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sharply, the ISM orders index rang in near the 56 level. In other words, beware
of diffusion indices … they only tell you part of the story.
In terms of industry segments, fabricated metals, telecom equipment,
machinery and motor vehicles are now posting the sharpest slowing in order
books. By way of comparison, electrical equipment, computers, and steel are
exhibiting the best looking trends right now.
CHART 6: CAPEX ORDERS SLOWING
United States: Non-defense Capital Goods New Orders excluding Aircraft
(three-month percentage change annualized)
1098765432109
60
40
20
0
-20
-40
-60
Shaded areas represent periods of U.S. recessions
Source: Haver Analytics, Gluskin Sheff
CHART 7: THE SIX-MONTH TREND HAS SLOWED TO 8.9% FROM NORTH
OF 20% JUST A FEW MONTHS AGO
United States: Non-defense Capital Goods New Orders excluding Aircraft
(six-month percentage change annualized)
1098765432109
40
20
0
-20
-40
-60
Shaded areas represent periods of U.S. recessions
Source: Haver Analytics, Gluskin Sheff
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WHAT THE BULLS MAY BE IGNORING ... AT THEIR PERIL ... PLUS SOME
IDEAS FOR 2011 Obama just enhanced his
2012 re-election chances byappointing Daley as his chief
of staff
Nothing of course says that
the market can’t keep goingup over the near-term
The bullish case is pretty well established right now and there is no sense
repeating them but what may be ignored are these half-dozen risks:
1. How much of 2011 growth was borrowed from 2012 (the payroll tax cutand bonus depreciation allowance end in December 2011). This may bean issue heading into Q4.
2. Energy prices ― if oil breaks above $100 and gasoline prices approach$3.50/gallon then expect the consumer to sputter. Every penny at thepumps drains $1.5 billion out of household cash flow. At the moment, U.S.gas prices at the pumps are at $3.15/gallon, but consider that back inSeptember, it was closer to $2.70/gallon. This increase in energy prices ishardly the result of booming consumer demand, which we know from themonthly personal consumption expenditure data is down more than 2%from a year ago. This is nothing more than an exogenous negative shock,
which, at current levels, is approximately a $50-60 billion annualized drag from the U.S. household cashflow (basically absorbing half of the payroll
tax relief). If, as many experts predict, gas prices ultimately go to $4/gallon, then this would siphon another $100 billion into the gas tank. As for oil, the rule of thumb is that a 10% increase in prices shaves off 25 percentagepoints off GDP. This means that oil could be a near-one percentage pointhit to GDP growth.
3. The GOP-led House is pressing for $100 billion of spending cuts for thisyear. If enacted, and this could be part of a deal to resolve the debt ceiling issue looming this spring, could cause GDP estimates to be trimmed.
4. Obama just enhanced his 2012 re-election chances by appointing Daley ashis chief of staff. Either he is really going to move to the center, or he is
trying to cement the next election.
5. Everyone believes that a better employment picture will brighten the stockmarket’s prospects even more but in fact the opposite will happen asmargins get squeezed by rising labour costs. Remember what happened in1994. Be careful what you wish for.
6. I am hearing that the Fed is moving further away from entertaining thenotion of a QE3 program in the second half of the year. Something themarket will be grappling with in the second quarter, and I see that thesecond quarter may well offer up the best buying opportunity of the yearsince that is the quarter where the concern list will likely start to grow;lagged impact of China tightening shows through, big Europeanrefinancings, signs of no more QE, and the debt-ceiling issue hitting itspeak.
Nothing of course says that the market can’t keep going up over the near-term.
All I hear is about “not fighting the Fed” and “how great the economy is doing”
and maybe this will lure some fence-sitters into equities (as has already beenevident in the December fund-flow data). To be sure, the U.S. consumer has
surprised to the upside even with still-sluggish job market conditions, and the
stimulus impact will be most felt this quarter re: tax relief. But surely this is
already priced in. What may not be priced in is that much like 2010, the peak
rate of GDP growth for this year will be the quarter we are in right now (the peak
in 2010 was 3.7% in Q1). Until Bernanke uttered the words QE2 in late August,
the market was beginning to recognize the slowing pattern that was underway in
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the economy. If this pattern re-emerges this year, but the Fed no longer has the
willingness or ability to provide additional monetary stimulus, we could be in for
a great buying opportunity during the spring and summer months in particular.
Just as the onus was on the
double-dippers last summergiven the sentiment and
market action, the onus now is
clearly on the V-shaped
enthusiasts
To be sure, companies are still sitting on a hoard of cash but that is a better
guide for M&A and dividend payouts than for acceleration in capital spending,
which I see moderating this year as profit growth softens. Housing is going
nowhere. Ditto for commercial construction. The ISM index was decent but did
flag a slowing, if not termination, of the inventory cycle as well as a reduced
contribution to the economy from exports (this component is down two months
in a row). We also have escalating cuts at the state and local government levels
to contend with.
In a nutshell, just as the onus was on the double-dippers last summer given the
sentiment and market action, the onus now is clearly on the V-shaped
enthusiasts (by the way, they also dominated the landscape exactly a year ago
and were only proven to be correct after the tremendous monetary and fiscal
efforts to revive confidence and economic activity).
In terms of themes for 2011, we think that there are wide swaths of the fixed-
income market that offer good value at current pricing levels. Sentiment in
equities is overdone, but the barbell between hard assets and income-
generating securities still seems to have merit. REITs look expensive but some
of the fundamentals are beginning to show some improvement― office rents
and absorption firmed last quarter for the first time in nearly three years.
Volatility or the cost of insuring against a market correction is about as cheap as
it can be right now. Commodities are in a secular bull market but have moved a
tad too parabolic right now and speculative interest has picked up dramatically
of late ― with exploration budgets expanding sharply, the real play within the
space may be in oil and mining services.
The largest S&P 500 companies are sitting on 10% more cash than a year ago
at over $900 billion and that means more dividend payouts so the yield theme is
intact (255 companies raised their payouts last year compared to 157 in 2009).
With all this cash, M&A will be a major theme (up 12% last year to $895 billion
according to Dealogic), which in turn means that financials that have a high
concentration in the merger space may not be bad places to be. Stock
buybacks have risen now for five quarters in a row and that may also end up
being a source for the cash hoard going forward, and, as such could help
establish a firmer floor under the equity market. (However, do not mistake that
comment for my view that this market is overvalued, overbought andoverextended at the current time, but that we should be entertaining the notion
of becoming more constructive when corrective phases set in that serve up
more compelling valuation metrics. A 16x multiple is seen today as fair-value
but in fact before the tech bubble, such valuation occurred less than 30% of the
time so this is hardly the norm.)
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Please forgive us, but we
counted two “downside” risks
in the FOMC minutes. The
word “upside” was never
mentioned.
FED LESS THAN IMPRESSED WITH THE ECONOMIC BACKDROP
While most economists and strategists have literally been tripping over
themselves to declare the onset of a sustainable V-shaped economic expansion
ahead, the tone of the December FOMC minutes was rather dismissive of that
prospect ― even as it acknowledged that the incoming data have been decent
(in light of the very accommodative stance of monetary policy currently in place):
With the recent data on production and spending stronger, on balance, than the
staff anticipated at the time of the November FOMC meeting, the staff revised
up its projected increase in real GDP in the near term. However, the staff’s
outlook for real economic activity over the medium term was little changed, on
net, relative to the projection prepared for the November meeting. The staff
forecast incorporated the assumption that new fiscal actions, some of which
had not been anticipated in its previous forecast, were likely to boost the level of
real GDP in 2011 and 2012. But, compared with the November forecast, a
number of other conditioning assumptions were less favorable: House prices
and housing activity were likely to be lower, while interest rates, oil prices, and
the foreign exchange value of the dollar were projected to be higher, on
average, than previously assumed. As a result, although the staff projection
showed a higher level of real GDP, the average pace of growth over 2011 and
2012 was little changed from the November forecast, and the unemployment
rate was still projected to decline slowly.
Indicators of production and household spending had strengthened, and the
tone of the labor market was a little better on balance. The new fiscal package
was generally expected to support the pace of recovery next year. However, a
number of factors were seen as likely to continue restraining growth, including
the depressed housing market, employer’s continued reluctance to add topayrolls, and ongoing efforts by some households and businesses to delever.
Moreover, the recovery remained subject to some downside risks, such as the
possibility of a more extended period of weak activity and lower prices in the
housing sector and potential financial and economic spillovers if the banking
and sovereign debt problems in Europe were to worsen.
Others pointed to downside risks to growth. One common concern was that the
housing sector could weaken further in light of the considerable supply of
houses either on the market or likely to come to market. Another concern was
the ongoing deterioration in the fiscal position of U.S. states and localities,
which could lead to sharp cuts in spending and increases in taxes. In addition,
participants expressed concerns about a possible worsening of the banking and
financial strains in Europe, which could spill over to U.S. financial markets andinstitutions, and so to the broader U.S. economy.
Please forgive us, but we counted two “downside” risks in the minutes. The
word “upside” was never mentioned. How do you like that, Mr. Potter? For sure
that’s got to be worth a 20% four-month rally, no?
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Guess what did show up no fewer than ten times? The word ‘housing’ and it
wasn’t very complimentary. All of sudden, the sector that helped the most in
getting us into this mess is still the one that poses the single greatest cloud to
the outlook.
The sector that helped the
most in getting us into this
mess is still the one that poses
the single greatest cloud to
the outlookTROUBLES WITH THE PROFIT FORECASTS
The consensus now sees $96 for S&P 500 operating earnings for 2011 which
would be a 14% boost from what we saw in 2010. Let’s assume that two
percentage points of that come from stock buybacks. That’s fine. Companies
have the cash to do that. So call it 12% EPS growth delivered from the economy.
We know that the ex-U.S. economy is going to slow down this year so the adage
of 50% being derived outside of America is not going to be such a bullish story in
the coming twelve months. The markets have already discounted this, which is
why the U.S. stock market has so vastly outperformed the rest of the world of
late. America is home to dramatic fiscal and monetary ease while Europe is
busy tightening the former and emerging Asia busy tightening the latter. Only
the U.S. reserves the right to ease policy on both fronts but this really does little
more than mask the underlying structural weaknesses in housing, jobs and state
and local government finances that were so eloquently described in yesterday’s
FOMC minutes.
Here’s the rub. It is not possible that a 4% nominal GDP growth is going to
deliver 14% earnings growth at this stage of the profit cycle, with margins
already flirting near all-time highs. This is not the early or even the mid stages of
the profit cycle ― the V-shaped bounce off the lows puts it closer to the latter
stages. Mid at best. Now when we are coming out of recession and margins are
positioned to expand sharply even with a modest bounce in the economy, it is
not rare at all to see double-digit gains in corporate earnings. It’s called the“rubber band effect”. Indeed, we saw this in 1993 when 5% nominal GDP
growth translated into 29% EPS growth; in 2002 when 3.5% nominal GDP
growth coincided with 18.5% profit growth; and again in 2009 when in fact a
-1.7% growth rate gave way to a 15% profits rebound. But at this stage of the
cycle, history shows that it would take between 6% and 8% nominal GDP growth
to allow for a 14% earnings stream.
The consensus of economists, as bullish as it is, see 4% nominal GDP growth in
2011. The strategists see 14% profit growth net of buybacks. Either something
has to give ― or at the least the economists and strategists should spend more
time in the same room with each other.
ADP SURGES! BUT IS IT FOR REAL?The U.S. ADP private payroll number was a record +297k in December. Surreal.
The market was looking for +100k. We never had a number remotely this strong
during the last economic cycle — last time we were close was in February 2006
when real GDP growth was 5.4% at an annual rate. Even the most bullish
forecast for Q4 is 4%, consensus is at 2.5%, so either we have something on our
hands that is much stronger than that or productivity is starting to sag. Or… this
number is BS. Take your pick.
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January 5, 2011 – BREAKFAST WITH DAVE
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The huge gain was centered in services (+270k) and especially in small (+120k)
and mid-sized (+123k) companies. I am thinking that this must be retail
oriented towards the better than expected holiday shopping season (financial
services actually posted a 6k decline and this sector represents a non-trivial 8%
chunk of total private payrolls). Goods-producing jobs rose a more moderate
27k, helped by a 23k gain in manufacturing, which seemed at odds with ISM
employment which actually dipped to a nine-month low.
We have U.S. payroll data back to 1940. There have been 111 times when
private service sector payrolls were +200k or more in a given month. Of those,
only 11 took place with the financial sector shedding jobs. In other words, for
the nonfarm payroll report to match what we saw in ADP would be a 1-in-10
event.
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January 5, 2011 – BREAKFAST WITH DAVE
Gluskin Sheff at a Glance
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 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 September 30, 2010, the Firmmanaged assets of $5.8 billion.
Gluskin Sheff became a publicly tradedcorporation on the Toronto Stock Exchange (symbol: GS) in May 2006 andremains 49% owned by its senior
management and employees. We havepublic company accountability andgovernance with a private company commitment to innovation and service.
Our investment interests are directly aligned with those of our clients, asGluskin Sheff’s management andemployees are collectively the largestclient of the Firm’s 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.
PERFORMANCE
$1 million invested in our CanadianEquity Portfolio in 1991 (its inceptiondate) would have grown to $9.1 million
2
on September 30, 2010 versus $5.9 millionfor the S&P/TSX Total Return Indexover the same period.
$1 million usd invested in our U.S.Equity Portfolio in 1986 (its inceptiondate) would have grown to $11.8 millionusd
2on September 30, 2010 versus $9.6
million usd for the S&P 500 TotalReturn 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 investment interests are directlyaligned with those of our clients, as Gluskin
She ff ’s management and employees are collectively the largest client of the Firm’sinvestment portfolios.
$1 million invested in our
Canadian Equity Portfolio
in 1991 (its inception
date) would have grown to
$9.1 million2 on
September 30, 2010
versus $5.9 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 companies with 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 in which 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
In terms of asset mix and portfolioconstruction, we offer a unique marriagebetween our bottom-up security-specificfundamental analysis and our top-downmacroeconomic view.
For further information,
please contact
questions@gluskinshe ff .com
Notes:Unless otherwise noted, all values are in Canadian dollars.
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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.
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January 5, 2011 – BREAKFAST WITH DAVE
IMPORTANT DISCLOSURES
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Gluskin Sheff may own, buy, or sell, on behalf of its clients, securities of issuers 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.
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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.
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