Welcome to The Longview, your monthly digest of global economics, market trends and global asset allocation. I'm Chris Watling.

Markets have rallied aggressively from their mid-July lows of 865, 870 on the S&P 500. Since that time, we've put on about 15 or 16 per cent, a sharp rally driven by better-than-expected earnings results and a continuation of improving macro-data. Since the March lows the S&P is up 50 per cent, a size of rally that's very similar in magnitude to that which we saw from the end of 1974, after that vicious bear market, all the way through to the middle of 1975. Equally, in that time, mid-'75, after that 50 per cent rally, we then had a pullback. And perhaps this is the template for what we're seeing today in equity markets - a pullback before a further rally through into 1976. Many of our indicators are suggesting we're building towards that. Medium-term indicators are starting to flag up sell signals. Medium-term risk appetite indicators are both now on strong sell. Our Colvin model, which measures the degree of overextension in global risk assets, is also at a very high level, equal to the highs we've seen in recent years. While sentiment is building and our sell-off indicator, which is designed to warn of these way of risk aversion, is also building towards its key plus-20 level, at which it flags up a potential of a possible timely and imminent wave of risk aversion. Given these signals, we think it's time to start reducing the overweight. We've gone from 5 to 2.5 percentage points overweight on our recommended asset allocation in equities. And we're looking for all those indicators to reach those sell levels before we then start to pull back to neutral, probably sometime in August while we sit out and await a possible wave of risk aversion, or at least a prolonged period of consolidation before the next move higher in equity markets.

If this was a normal recession, the case for an economic recovery would be regarded as strong. Firstly, we've seen very dramatic and significant policy response over the course of the last 12, 18 months, whether you're looking at interest rates, quantitative easing, fiscal stimulus or bank recapitalisation. Secondly, it's been a very long recession, longer than all prior post World War II recessions, which in and of itself suggests we're likely to be coming to the end. Third, and perhaps most importantly, the economic adjustment is well-advanced. Companies have retrenched, they've cut costs. They're now cash flow positive. Households have readjusted their savings rates, up from zero to average levels, and so on. And fourthly, the macro-data is suggestive and consistent with an evolving economic recovery, whether you're looking at housing data that's stabilising and starting to pick up in the West, or whether you're looking at manufacturing data that's improving, auto sales picking up and so on. There's a clear case from the macro-data that a recovery is evolving. This, however, is not a normal recession. This is a financial crisis that induced the recession. It's accompanied by high levels of indebtedness in the West. And as a result, comparisons are being made with Japan in 1990 that went through its own financial crisis with bursting of stock market and property bubbles of that time. This is a key and critical question. Is America repeating the mistakes of Japan in 1990 and its following two decades? So what did happen in Japan? Well, Japan has clearly, over the last two decades, undergone what's known as a balance sheet recession. Falling asset prices for two decades, following the bursting of the stock market and property bubble have undermined balance sheets in the corporate sector and the financial sector. As a result, the corporate sector, suffering on its asset side of its balance sheet has sought to use all its excess cashflow to pay down debt, rather than invest in future earnings growth and therefore invest in the economic growth of that country. Consequently, we've seen two decades of stagnation whereby the economy has not really grown in any dramatic way, as the government has stepped in to fill the void created by the absence of the corporate sector. This is what's known as a classic balance sheet recession. Land prices are off 50 per cent over 20 years, falling year after year after year. And equally, the stock market falling dramatically as well. So the key issue is, is America going to experience the same fate that we've seen in Japan over the last two decades? Our argument would be, there are two key groups of reasons why America's fate will be different and why it won't suffer the balance sheet recession that we've seen in Japan since 1990. The first key reason is that of the demographic profile of the United States of America that is significantly different from what we have in Japan, and most particularly, significantly different amongst the age group of those that are 25 to 44 years old. This is the key age group where people buy houses, take out large mortgages and borrow on credit cards to go out and fund their lifestyle. From the age of 45 onwards, people tend to save, start paying off debt and thinking about retirement. So if you have a growing group of 25 to 44 year-olds, you have natural demand for housing, natural demand for credit and a natural driver of economic growth. In Japan, that group has been shrinking since 1975. And indeed, the rate of contraction of that age group is about to accelerate going forwards. In America, in contrast, while it has been shrinking since 1995 to today, it's set to start growing once again, creating that natural demand for housing and that natural demand for credit that helps push economies onwards and upwards. Now the second key reason is also that of policy response. The policy response, as we've already mentioned in America, has been dramatic and swift, and stands very much in contrast to what we saw in Japan. In Japan, post the crisis in 1990, it took them five years to get interest rates close to zero. It took them 7 to 10 years to recapitalise the banking sector, 11 years to engage in quantitative easing. In America and the rest of the West, we've seen all these policy responses enacted within 12 to 18 months of the start of the crisis. And indeed, just looking at something like LIBOR spreads as an indicator of the success of the policy response, we see those spreads in America have fallen dramatically back to pre-crisis levels within six months of the peak. In Japan, it took five years for those LIBOR spreads to fall all the way back to pre-crisis levels. It's for those two key reasons, the better demographic profile and the faster policy response, that the American experience is much more likely to be that of the Nordic countries in the early 1990s. In the early 1990s, the Nordic countries suffered their own financial crises and deep recessions. But because of those better demographic profiles, fast policy response, they entered, after two or three years, a strong and sustained economic recovery. Indeed, it's for those reasons that we think America won't be like Japan. America won't suffer a two-decade balance sheet recession. And indeed, it will emerge and a recovery will continue. And with that, equity markets will continue to rally on a trend basis over coming quarters and perhaps even years. That was The Longview. You can download this program from Cantos, from the iTunes Store, or indeed from our own website, longvieweconomics.com. Please do get in touch through the website if you have any questions. We hope you enjoyed watching. We look forward to seeing you next month. Goodbye.