David A.

Rosenberg July 17, 2009

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

MARKET MUSINGS & DATA DECIPHERING

Breakfast with Dave

IS THE U.S. DOLLAR NEXT?
IN THIS ISSUE
It is the second anniversary of the credit crunch and after all of the fiscal and
monetary policy initiatives, the best we get are ‘green shoots’ and now that story • Is the U.S. dollar the next
is getting stale. Go back two years and you will see that the funds rate was policy shoe to drop?
5.25%. Today it is zero. The fiscal deficit was 2.0% of GDP two years ago. • Cautious on claims;
Today it is 13%. Mortgage rates were 6.5%. Today they are 4.7%. Homeowner seasonal factors may be
affordability with all the government measures is 70% stronger today than it was in play here, not the
then too. The Fed’s balance sheet then was $850 billion. Today it is bloated at economy
$2 trillion. The government has tried just about everything. Or has it? What if • The Philly Fed index was a
we were to tell you that the one policy tool that is unchanged since the summer brown shoot
of 2007 is … the U.S. dollar? It is exactly the same level now, on any trade-
• Business conditions still
weighted measure, as it was back then. The greenback is struggling at the 50- very weak
day moving average, and this could well be the next policy shoe to drop.
• No recovery in home
If we would have told you two years ago that we would have a deficit/GDP ratio building
of 13% and a Fed funds rate of 0%, would you have believed that real GDP
growth would still be negative? Two years ago, it was running at nearly 5%. The
unemployment rate was at 4.7% — today it is twice that level. The S&P 500 was
1,550 — today the bulls are content with 930. Consumer confidence was 111 —
today it is 49. The inflation rate was nearly 3.0% then, it is -1.4% now. All this,
two years after the onset of the most dramatic monetary, credit and fiscal policy
easing in 70 years.

The key, really, is the unemployment rate. It may be a lagging indicator for the
economists, but for a politician it is a perfect coincident indicator — especially for
incumbents seeking re-election. There are lots we do not know about the future
and the error term around any forecast is far wider than it has been in the past.
Just take a look at the massive range in the FOMC’s real GDP growth forecast for
2010 – from as low as 0.8% to as high as 4.0%. In a $14 trillion economy, that
gap is not exactly trivial. But what caught our eye was the unemployment rate
projection — 8.5% to 10.6% is the range of forecasts. So, there is someone at
the Fed who sees a 10.6% unemployment rate, which would put it within striking
distance of the 10.8% peak reached in November-December 1982.

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July 17, 2009 – BREAKFAST WITH DAVE

We think there is a nontrivial chance that we actually see the unemployment

rate hit new post-WWII highs next year, and it comes down to how businesses We believe that we will
managed their payrolls during this economic downturn. While more than 6 actually see the jobless
million jobs have been lost, what that number masks are the near 9 million rate hit new post-WWII
people who saw their full-time positions eliminated. There were 3 million who highs next year
were pushed into part-time work, and in fact, there are now a record 9 million
Americans working part-time because of the weak economy, which is a 64%
increase from a year ago. Against this backdrop of a growing part-time
workforce, the private workweek was cut 2.3% this down-cycle to a record low
33.0 hours.

What does all this mean? It means that when the economy does begin to
recover, when we finally get to the other side of the mountain, companies are
going to raise their labour input first by lifting the workweek from its record low.
Just to get back to the pre-recession level of 33.8 hours would be equivalent to
hiring 3 million workers. And, the record number of people working part-time
against their will are going to be pushed back into full-time, which will be great
news for them, but not so great news for the 125,000 - 150,000 new entrants
into the labour market every month. They won’t have it so easy because
employers are going to tap their existing under-utilized resources first since that
is common sense. Also keep in mind that there are at least 4 million jobs in
retail, financial, construction and manufacturing jobs lost this cycle that are not
coming back. In fact, the number of unemployed who were let go for permanent
reasons as opposed to temporary layoff rose by more than 5 million this cycle.
This compares to the 1.2 million increase in the 2001 tech-led recession and in
the 1990-91 housing-led recession (when Ross Perot talked about the sucking
sound of jobs into Mexico).

In other words, the unemployment rate could well stay on an upward trajectory The U.S. government has
for the next few years. As we said, 10.8% would be a headline-grabber because practically exhausted all
that is the post-WWII high, and what we do know with certainty is that 2010 is of its policy options…
special because it is a mid-term election year. The last Democratic president except for one, the U.S.
with an ambitious health care plan was Bill Clinton and if you recall, his party dollar
was crushed in the 1994 mid-term elections and his agenda was derailed by
Newt Gingrich’s ‘Contract with America’. We are convinced that President
Obama is well aware of this, and more than likely well aware that a record
unemployment rate (at least in the ‘modern era’) could well be a political hot
potato for any incumbent, and it is debatable whether a year from now he will be
able to continue to deflect the jobless rate problem onto W.

As we said above, the U.S. government has practically exhausted all of its policy
options … except for one; the U.S. dollar. It is the only policy tool that has not
budged one iota since the crisis erupted two years ago. As we mull this over, we
recall all too well this great book that a client referred us to a few years back and
it was Robert Rubin’s autobiography – “In An Uncertain World”. What we
learned (as did the client and whoever else has read it) was obvious — the
United States will always do what is in its best interest. Full stop.

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July 17, 2009 – BREAKFAST WITH DAVE

The best chapter was the reasons for bailing out Mexico in 1995 — it was about
politics, not just economics. We see significant
downward pressure on
In addition to knowing it is going to be an election year in 2010, we also know the U.S. dollar by this
that we have a President who has, step by step, been taking feathers out of time next year
FDR’s cap in dealing with this modern day depression. The one item that has
yet to be utilized is U.S. dollar depreciation, and if memory serves us correctly,
FDR snuffed out the worst part of the Great Depression when he unilaterally
devalued the dollar to gold in 1933 by 40% (and fixing the price of gold at
$35/oz). We’re not sure that President Obama is going to re-price the dollar
price of gold. Then again, can anything be ruled out? But we are sure that as
the unemployment rate makes new highs and increasingly poses a political
hurdle in a mid-term election year, that it would make perfect sense, for a
country that always operates in its best interest — even if it may not be in
everyone’s best interest — to sanction a U.S. dollar devaluation as a means to
stimulate the domestic economy.

Remember, this is a premise. We are just conjecturizing. But it is interesting

that the dollar is the only financial metric that is at the same level today as it
was two years ago, and we are of the view that the risks are high that the
greenback will be on a significant downward path by this time next year. With
that in mind, investors should be thinking of how to hedge or protect the
portfolio against this not-so-remote possibility, namely:

• Commodities
• Gold
• Canadian dollar
• Resource sectors of the stock market
• U.S. sectors that have high foreign exposure (materials, industrials, staples,
health care)
• Canadian sectors that benefit from lower import costs (consumer stocks) but
lose export competitiveness (manufacturers)
• Canadian bonds (a higher Canadian dollar will keep inflation low, hence
reinforcing positive fixed-income returns)
PITHY MARKET THOUGHT:
Keep in mind that Dell is the end-user and Intel is the primary producer. And
keep in mind that CIT Group means a whole lot more to the economy (financing
half of the small business sector) than Goldman Sachs (who specializes in
producing trading revenues). This rally is coming off oversold levels of a week
ago and is going to need confirmation to keep going. Watch the divergences as
they occur.

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July 17, 2009 – BREAKFAST WITH DAVE

CAUTIOUS ON CLAIMS
The Bureau of Labor Statistics said that the move in claims has nothing to do
U.S. initial jobless
with any improvement in the economy. I think this is all about the fact that with
claims are now down
GM and Chrysler in bankruptcy and all the permanent shuttering of plants and
two weeks in a row…
workers, there are fewer of these employees left that go though the normal
seasonality may be at
seasonal shutdowns. So, fewer seasonal layoffs in the auto sector, I firmly play here, not the
believe, are behind these recent declines in initial jobless claims. We will know if economy
this thesis is correct in a few weeks. (Also keep in mind that the shutdowns
happened in June this year, not July, as is normal, and hence this is giving a
skew downward to the claims data. To reiterate, these numbers are telling us
nothing about the economy.)

Claims dropped 47,000 to 522,000 in the July 11th week, on top of a 48,000 slide
the week before — combined falloff of 95,000. At the same time, the non-
seasonally adjusted data soared 108,000 over the past two weeks. Go back to
the same two weeks in 2008 and you will see that a similar decline in unadjusted
claims (-115,000) translated into an 18,000 drop in the seasonally adjusted data.

So something with the seasonal factors is at play here; not the economy. Note
that in the month after the seasonal auto effects ran their course last year,
claims popped up more than 80,000.

To be sure, continuing claims plunged a record 642,000 to a still-high 6.273

million but this actually reflected bad news in the sense that it likely reflects the
end of the up-to-20 weeks extended benefits that President Obama provided
under the stimulus plan. These people are certainly not going to be doing very
much spending over the next little while. Also note that the claims data would be
much higher if a record number of unemployed folks weren’t seeing their benefits
cut off — see the chart below for an illustration of what we are talking about.

CHART 1: RECORD NUMBER OF UNEMPLOYED

SEEING THEIR BENEFITS END
United States
Unemployment Insurance Exhaustion Rate
50

45

40

35

30

25
73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09

Source: Bureau of Labor Statistics, Gluskin Sheff

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July 17, 2009 – BREAKFAST WITH DAVE

PHILLY CHEESESTEAK (WITH DAVE!)

The Philly Fed index was a brown shoot — coming in at -7.5 in July from -2.2 in The Philly Fed index was
May — in contraction phase now for 10 months in a row. Everything was a brown shoot —
negative but what caught our eye was the deterioration in the employment everything was negative
component, which moved to -25.3 from - 21.8. Inventories, at -15.4 from -15.3,
tell us that the business restocking story remains just that … a story. Shipments
did not confirm what we saw in the NY Empire index the day before — maybe
that prior number was a tech report. But the Philly Fed shipment data swung to
-9.5 from +2.1. And margins must be getting squeezed (outside of Goldman and
Intel, we suppose) because prices-received fell to -21.5 from -16.6 (oh, inflation,
where is thy sting?) while prices-paid went to -3.5 from -13.0 (margin
compression was also evident in that NY Empire index too).

As an aside, for all the chatter on how constructive the New York Empire index
was, the special question in the report showed that 62% have reduced their
production plans for the second half of the year; 21% stated they are boosting
output. This compares to the July 2008 survey which showed 35% intending to
cut and 22% planning to raise production — and we know how the second half of
2008 turned out. When asked whether the fiscal stimulus was having a positive
impact on the business, fully 93% said “no”. There you have it.

SECTORS THAT DID NOT SEE THEIR CAPU RATES HIT NEW LOWS THIS
CYCLE
These are the ones that very likely have the best top-line revenue potential and
they include: technology (especially telecom equipment), energy,
aerospace/defense, and food and beverage producers.

BUSINESS CONDITIONS STILL VERY WEAK

The MAPI (Manufacturing Alliance) business outlook index rose to 24 in 2Q from
the all-time low of 21 in the first quarter. This is less than half the 50 level a
year ago and the 65 level two-years ago. While it is nice to see a three point
uptick, the reality is that a 24 reading is the second lowest reading on record.
Capex plans stayed at a record low of 14 last quarter. Profit margins edged
down to 18 from 19 — a new all-time low.

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July 17, 2009 – BREAKFAST WITH DAVE

CHART 2: THIS IS WHAT A GREEN SHOOT LOOKS LIKE?

United States
MAPI Survey: Composite Business Index
(50+ = Growth, not seasonally adjusted data)

80

70

60

50

40

30

20
95 00 05
Source: Haver Analytics, Gluskin Sheff

CHART 3: NO IMPROVEMENT IN PROFIT MARGINS

United States
MAPI: Profit Margins Index {Cur Qtr vs Year-ago Qtr}
(50+ = Growth, not seasonally adjusted data)

100

80

60

40

20

0
95 00 05
Source: Haver Analytics, Gluskin Sheff

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July 17, 2009 – BREAKFAST WITH DAVE

NO RECOVERY IN HOME BUILDING

You really have to strain your eyes to see any meaningful improvement in the
You really have to strain
U.S. housing sector. The NAHB housing market index did improve in July to 17
your eyes to see any
from 15 — but this is still the eighth worst print on record! The sales outlook was
meaningful
stuck at 26. Remember — this is a diffusion index so anything under 50
improvement in the U.S.
represents a contraction. Imagine what the market would do if the ISM ever got housing sector
as low as 17 — investors were lamenting over a depression when it approached
30 late last year!

CHART 4: AND THIS — THIS IS A GREEN SHOOT TOO?

United States
Home Builders: Housing Market Index {Composite}
(All Good = 100)

80

60

40

20

0
85 90 95 00 05

Source: Haver Analytics, Gluskin Sheff

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July 17, 2009 – BREAKFAST WITH DAVE
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July 17, 2009 – BREAKFAST WITH DAVE
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