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

As the rally persists in markets commentators continue to come out expressing their expectation that markets are going to pull back and the rally is overdone. Clearly, if you look at a number of indicators, it's possible to draw that conclusion. Markets are clearly overextended. If you look at our global equities overextended indicator it's at two standard deviations on the plus side - a strong sell signal. Our Colvin models indicating that risk assets across the global spectrum are overbought throughout the geographies and clearly, you look at things like fund manager surveys from Merrill Lynch, they talk about extreme optimism over the global economic outlook and the fact that people are very optimistic about where markets are going to go from here in corporate profits. But whilst markets may seem overbought, not all indicators are giving the same message. Indeed, there's a degree of confusion amongst our indicators. We have a sentiment indicator that's on sell, one that's on buy. It's an unusual position we've not had and not seen in recent years. We have an asset allocation scoring system that's medium and we have a number of other indicators like medium-term risk appetite gauges which have unwound their sell signals of a month ago. So, the indicators aren't giving a clear picture and what's key at times like this is understanding the macro and what's key is being confident in one's forecast that the global economy is starting to recover and markets are starting to discount a new economic cycle. And indeed, if we look back in history over the last 100 years, at the performance of equity markets as they discount new economic cycles after major 50 per cent or so bear markets, we see that there is plenty of historical evidence that demonstrates that markets rally persistently and aggressively for very long periods of time. Indeed, there are about seven comparisons, seven 50 per cent bear markets or larger since 1900 and, indeed, in all instances the rally has been above 50 per cent or beyond. Indeed, as much as 140 per cent in 1903. So if we apply that model to today, with the market having rallied a mere 40, 45 per cent so far, if history is any guide, then the rally should continue for several months, or indeed quarters more with plenty more to go for in terms of upside.

So given that expectation of a strong initial rally in markets as they discount a new economic cycle, the key question we have to ask ourselves is how do we judge when that initial rally might have come to a close and a period of consolidation might be upon us in equity markets? In our view there are three key ways of doing that. Firstly, it's to look at other risk barometers, whether you look at volatility or high yield corporate bond spreads, or other assets as measures of risk and the normalisation of risk. On high yield corporate bond spreads, for example, they're currently trading at about 750 basis points above US Treasuries. A normal level that suggests a normalisation in risk is about 300 basis points. So even though high yield spreads have rallied all the way from 2000 to 700 in terms of their spread, there is further to go. A second key method is to look at the steepness of the yield curve. The bond market is the best forecaster of economic recoveries and the best forecaster of economic recessions. Since the mid and late 1970s the bond markets forecast five recessions, of which there have been five and it has forecast five recoveries, of which there have been four and arguably we're now in the fifth. When the bond market starts suggesting to us growth may be slowing, it may well be a time to expect some consolidation in equity markets. And a third key method, perhaps the easiest to get a hold of, is to wait for liquidity to start to be withdrawn from the system, to wait for the market to start to anticipate rate hikes from the Federal Reserve. Because what we see after recessions in the initial rallies is those rallies persist until things like one-year bond yields in the US start to meaningful move higher. Now given that it takes the Fed on average 24 months to raise rates after a recession and the bond market doesn't start anticipating that at the one year level until seven months before, that suggests there is a lot more to go for in this rally and that suggests another reason why you should stick with equities until we see signs of inflation, noises from the Fed and concerns about rates starting to rise going forwards. That was the Longview. You can download this programme from Cantos's website, from the iTunes store or indeed from our own website longvieweconomics.com. 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.