Equities: We maintain our year-end forecast for the MSCI AC World ex US at 375 (11.8% price return). The supports are: Policy: Our aggregate policy indicator is twice as loose as it was at the peak of the GFC and looks set to remain very loose. Our monetary conditions indicator also is close to the loosest it has been on record (with Fed Chairman Powell stressing a focus on the ‘true’ unemployment rate, which is triple pre-virus levels). Fiscal/monetary policy, pent-up demand and wealth effects risk pushing US GDP growth to c8% this year, but even then we struggle to see the first rate rise coming earlier than is being priced in by the market (i.e. 2H 2022). ERP, not P/E: The ERP is 7.2% versus a warranted ERP of 5%. Even the P/FCF for the US is at only average levels. In the past four years, the key driver of multiples has been the TIPS yield, but we continue to believe that the bulk of the rise in yields will be driven by inflation expectations, as was also the case for the first 40 months post the GFC. The start of a bond-to-equity switch: The correlation between equities and bond yields is starting to turn positive (in October ‘20 and February ‘21, equities fell as bond yields rose), and this should encourage a bond-to-equity switch. The last four occasions correlations turned positive, equities were higher six months later (by an average of 6%). Shorter-term supports: Excess liquidity (money supply over nominal GDP) remains extreme; earnings revisions would imply higher markets, and to get a level of earnings revisions that justifies current levels would require only 60% of PMIs globally to be over 52. Stage of the cycle: A year into a bull market, equities historically have risen 80% of the time over the subsequent 12 months (by an average of 15%) and equities typically have continued to do well until the output gap closes. Tactical indicators are not at sell levels: Additionally, flows do not look excessive: flows into equities are only c10% of flows into bond/money market funds since January 2020, and the corporate sector is still a net buyer despite a rise in IPOs. Credit spreads have remained very tight. The rise in VIX has not been accompanied by a rise in credit spreads (credit normally leading equities at major market turns).

US 10Y bond yields risk hitting 1.75-2%: The risks to bonds are 8% US GDP growth, 10-year breakeven inflation rising to 2.5% and the Fed buying only a third of new issuance. We think the ECB/BoJ will cap any meaningful rise in yields through purchases, and the attractive currency-hedged yield pick-up in turn caps US yields. The Fed can use forward guidance to cap the rise in yields (with the market pricing in one rate hike in 2022 and nearly three in 2023), and we believe it would want to do so. We think credit presents a greater risk than equities when credit quality is close to the worst it has been, duration at the longest and spreads very compressed.

Risks to our view: The biggest risk to equities is too much US growth (with excess saving, fiscal easing and wealth effect amounting to c15% of GDP). We worry when US 10-year bond yields rise above 2%, inflation expectations go above 3% or there is a large rise in the TIPS yield. The other risk is China (tightening policy, PMIs are at 9-month lows and property developers are underperforming sharply). The upside risk is that we have many preconditions for a bubble but only two of the 15 indicators we track suggest we are in one now.