David A.

Rosenberg June 19, 2009

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

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave — A Snapshot

DAVE IS ON VACATION AFTER TODAY AND WILL JOIN YOU AGAIN FOR
BREAKFAST ON JUNE 29. TILL THEN.

WHILE YOU WERE SLEEPING

IN THIS ISSUE
Risk appetite picks up: Equities are firm in Europe and Asia today and U.S.
futures are flashing green. In FX, the Yen is slipping and commodity currencies • It seems that it’s too
are firming again — essentially confirming the up-move in equities. Government much effort for the
bond yields are also higher, up one beep here and across the pond. Libor/OIS markets or for most
economists to dig beneath
spreads are narrowing. On the data front, German PPI was flat in May and down the surface in most of
3.6% on a YoY basis, the steepest deflation rate in 22 years. Lower bond yields these economic reports
are a good thing: Courtesy of the bond vigilantes taking a respite, the rate on
• Where are the roots for
the 30-year fixed mortgage fell 21bps last week to 5.38%. Delinquency rates
the next cycle?
still rising sharply: This is not particularly the case in the U.S. multi-family
sector where defaulted apartment loans backed by CMBS broke above 5.0% in • Our thoughts on corporate
bond spreads
May while the default rate for retail/lodging pierced the 3.0% threshold.
• A rudderless leader?
WHERE ARE THE ROOTS FOR THE NEXT CYCLE? Keep in mind that while
While many investors are consumed with the rapid expansion of the Fed’s the LEI was impressive,
both months had a
balance sheet and money supply, the ongoing contraction of the household diffusion index of 70%
balance sheet is a far more pronounced event that renders deflationary risks the
more predominant near-term risk. This may not be any more evident now than it • Philly cheese steak. Yes,
the Philly Fed index
was in the reflation days of early 2002 when government stimulus also ran
improved dramatically in
rampant, but we believe that the second half of the year will have shown more June, but beneath the
defensive and income-oriented strategies to have carried the day as it did back veneer, only 30% of
then. respondents stated that
conditions improved
Post-credit collapse and asset deflation cycles are always gripped with fragility; • Market led by multiple.
the intermittent beta-trades and flashy rallies only serve to tell us that nothing Forward P/E ratio for the
moves in a straight line. From our lens, the stock market is only really back to S&P 500 is at 14.5x and
the levels of last October when Warren Buffet was telling everyone to buy trailing P/E has expanded
from 17.0x to 23.3x now
equities in the op-ed section of the New York Times. The reality is that the rally
really looks fatigued even with yesterday’s bounce — the S&P 500 has made no
headway at all since the very beginning of May.

THOUGHTS ON CORPORATE SPREADS

Chart 1 is a bar chart of Baa corporate spreads comparing where we are
(374bps) to where we were (611bps at the end of last year) as well as to other
periods of intense economic, financial and geopolitical strains. To be sure,
corporate spreads have come in a long way from their nearby crisis highs but
looking at prior peaks around major events and economic downturns, it does
appear as though there is still a lot of very bad news priced into the sector.

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June 19, 2009 – BREAKFAST WITH DAVE

CHART 1: CORPORATE SPREADS —

WHERE THEY STACK UP AGAINST PRIOR PEAKS
United States: Baa Corporate Spreads (basis points)
1932: Great Depression 724
1937-38: Relapse 381
1962: Cuban Missile Crisis 113
1970: Recession 315
1973: OPEC Embargo 221
1975: Recession/Inflation Scare 413
1980-81: Recession/Latam Crisis 329
1982: Penn Square Bank Failure 377
1987: Stock Market Collapse 268
1990-91: Recession/Real Estate Crisis 239
1995: Tequila Crisis 180
1997: Asian Crisis 175
1998: LTCM Crisis 277
2001: Tech Wreck 306
2001: 9/11 Terrorist Attacks 353
2002: Enron / WorldCom Crisis 390
2008: Credit Collapse 611
Current 374

Source: Haver Analytics, Gluskin Sheff

MARKET LED BY MULTIPLE

The notion that we had moved to Armageddon lows in equities does not seem to
hold water. After all, the forward P/E multiple on the S&P 500 at the lows was
11.7x. That was not a multi-decade low or some massive standard-deviation
figure — we were actually lower than that at the October 1990 lows when the
multiple was 10.5x and frankly, coming off the 1987 collapse, the forward P/E
had compressed to 9.8x. As it now stands, the multiple is back very close to
where it was at the October 2007 market high when the multiple had expanded
to 15.0x. The range on the forward P/E over the last quarter-century is between
9.8x and 21.8x (excluding the tech bubble), so at 14.5x currently, it is hardly the
case that this market can be viewed as a bargain.

On a trailing earnings basis, the P/E multiple has actually widened, from 17.0x
at the lows to 23.3x currently, a huge multiple expansion. At this stage of the
2003 recovery, the multiple hardly expanded at all, earnings were driving the
rebound; coming off the October 1990 lows, the multiple expansion four months
into the rally was closer to 2x; and the powerful surge in the post-1982 recovery
saw a 3x multiple point expansion at this juncture — not 6x!

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June 19, 2009 – BREAKFAST WITH DAVE
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June 19, 2009 – BREAKFAST WITH DAVE
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