Economy

Highlights US Reflation: The Georgia senate victories for the Democratic Party have returned the bond-bearish “Blue Sweep” scenarios to the forefront. More fiscal stimulus and an easy Fed will extend the policy-driven reflation of the US economy and financial markets. US Treasury Strategy: Stay underweight US Treasuries, with below-benchmark duration exposure, in global bond portfolios. Stay overweight TIPS versus nominal US Treasuries and continue to position for more bear-steepening of the Treasury curve. Global Corporate Sector Valuation: Developed market investment grade corporate spread valuations look stretched. Maintain only neutral levels of spread risk for higher-quality corporates while targeting sectors that look undervalued across the majority of regions, such as Energy and Financials. Avoid universally expensive consumer sectors such as Retailers, Restaurants, and Food & Beverages. Feature Chart of the WeekUS Policy Reflation Is Negative For USTs In a week of stunning US political events, the most important one for financial markets was not the mob invasion of the US Capitol. The Georgia senate runoff votes completed the unfinished business of the 2020 US elections, with Democratic Party candidates winning both seats. This effectively delivered a change in party control of the US Senate to the Democrats, with a 50/50 seat split that would give incoming Vice-President Kamala Harris the potential tiebreaking vote. With the Democratic Party now in control of the US House of Representatives, the Senate and the White House, the bond-bearish “Blue Sweep” scenario that we discussed in our pre-election Special Report last October – with greater odds that the highly expansionary Biden policy agenda can be more fully implemented - is now coming to fruition.1 The benchmark 10-year US Treasury yield broke above 1% after the election results, continuing to climb to 1.13% yesterday. The overall US Treasury market action has continued the reflationary trends seen in the latter half of 2020, with a bear-steepening of the Treasury curve and wider inflation breakevens in the TIPS market (Chart of the Week). Treasuries continue to underperform other developed economy government bond markets (in USD-hedged terms), continuing a move that started back in the spring of 2020. We expect these trends to remain in place over the next several months, given the current and likely future monetary and fiscal policy mix in D.C. The Biden Boost To US Treasury Yields BCA Research’s newest service, US Political Strategy, launched last week with a discussion of the US fiscal policy outlook after the Georgia senate elections.2 The conclusion was that the most radical parts of the Democratic Party agenda will be difficult to pass given their narrow majorities in the House and Senate, but some sizeable fiscal stimulus is still likely. In the near term, an expansion of the COVID relief passed in the December stimulus bill, such as boosting monthly checks to individuals from $600 to $2000, is likely to come relatively quickly after Biden is inaugurated via a “reconciliation bill”. Additional stimulus measures could also be enacted, partially funded by some rollback of the Trump tax cuts. Beyond that, the Biden administration will attempt to push through some of the more expansionary parts of incoming president’s campaign platform related to items like infrastructure spending. In the end, the expectation is that the US fiscal drag (a reduction in the deficit) that was set to occur in 2021 after the massive stimulus measures enacted in 2020 will be much smaller with full Democratic control in D.C. This will help boost US GDP growth this year. A greater implementation of the Biden agenda would have a more lasting impact on US economic growth in the following years. Last September, Moody’s published a report that compared the policy platforms of Candidate Biden and President Trump, running the details of the agendas into the Moody’s US economic model.3 The analysts concluded that under realistic assumptions about how much of the Biden platform would be implemented under a “Blue Sweep” scenario, US real GDP growth would average 6% in 2021 and 2022 under President Biden, a full two percentage points higher than the baseline scenario (Chart 2). This would also drive the US unemployment rate back toward pre-pandemic levels more quickly. Moody’s concluded that the Fed would start hiking rates in 2023 under the Democratic sweep scenario, similar to the current pricing in the US overnight index swap (OIS) curve, but with a more aggressive pace of tightening expected over the subsequent two years (bottom panel) – a bond bearish outcome that would push the 10-year Treasury yield back to 2% by the end of 2022 and 3% by the end of 2023. We expect the Fed to normalize US monetary policy at a slower pace than Moody’s, but we do agree on there is still plenty of upside potential for Treasury yields over the next 1-2 years. This will initially come more from rising inflation breakevens than real yields. Currently, US TIPS breakevens are drifting steadily higher, even as realized US inflation is starting to cool off a bit (Chart 3). The 10-year breakeven is now up to 2.1%, a level last seen in 2018 but still below the 2.3-2.5% level we deem consistent with the market expecting that the Fed’s 2% inflation target will be sustainably achieved. The idea that inflation breakevens can widen without higher realized inflation may seem odd on the surface, but it is not unprecedented. In the years immediately after the 2008 financial crisis, when the Fed kept rates at 0% while the economy recovered from the Great Recession, TIPS breakevens rose alongside very weak US inflation. Chart 2How 'Bidenomics' Can Be Bond-Bearish Chart 3Fed Policy Stance Favors Wider TIPS Breakevens With the Fed having shifted to an Average Inflation Targeting framework last year, we don’t expect the Fed to turn more hawkish too quickly. We expect the Fed to keep the funds rate well below US realized inflation for at least the next couple of years and likely longer, keeping real US interest rates negative and preventing an unwanted flattening of the Treasury curve (Chart 4). The Fed’s low interest rate policies will also make it easier to service the growing stock of US government debt during the Biden Administration (Chart 5). Net-net, we continue to see additional upside for US Treasury yields in the aftermath of the “Blue Sweep”.  Chart 4US Policy Mix Favors UST Curve Steepening Net-net, we continue to see additional upside for US Treasury yields in the aftermath of the “Blue Sweep”. We expect the benchmark 10-year Treasury yield to rise to the 1.25-1.5% range over the next six months, with higher yields possible if the market begins to question the Fed’s commitment to keeping the funds rate anchored at 0% - an outcome that could occur by year-end if the Fed starts to consider a slower pace of Treasury purchases via quantitative easing (Chart 6). Chart 5Low Interest Rates Help Service Rising Debt Chart 6More Upside Room For UST Yields We continue to recommend an overall US Treasury investment strategy that will perform well as yields rise. Stay underweight US Treasuries, with below-benchmark duration exposure, in global bond portfolios. Stay overweight TIPS versus nominal US Treasuries and continue to position for more bear-steepening of the Treasury curve. Bottom Line: The odds of a major US fiscal spending boost from the incoming Biden Administration, both in the short-run and over the medium term, are now much higher after the Georgia senate elections. More fiscal stimulus and an easy Fed will extend the policy-driven reflation of the US economy and financial markets. Maintain positions that will benefit from higher Treasury yields. Finding Value In Global Investment Grade Corporate Bond Sectors As we discussed in our 2021 Model Bond Portfolio Update published last week,4 the strong performance of global spread product in H2/2020 has led to an across-the-board narrowing of credit spreads, with investment grade spreads hovering close to, or below, pre-COVID levels in developed markets (Chart 7). Predictably, this has stretched valuations to historically expensive levels across developed economy investment grade corporate bond markets. Our preferred measure of spread valuation, the 12-month breakeven spread, measures how much spread widening is required over a one-year horizon to eliminate the yield advantage of owning corporate bonds versus duration-matched government debt. We then show those breakeven spreads as a percentile ranking versus its own history, to allow comparisons over periods with differing underlying spread volatility. These breakeven spread percentile rankings for investment grade corporates are now at the bottom percentile in the US and below the 25th percentile level in the euro area, UK, Australia, and Canada, indicating that there is limited potential for additional spread tightening from current levels (Chart 8). Chart 7Investment Grade Spreads At Or Below Pre-Covid Lows As the gains from the “beta” of owning corporate credit have been largely exhausted, it now makes sense to pay more attention to the “alpha” in corporate debt markets by looking at relative valuations across sectors. To accomplish this, we return to our cross-sectional relative value framework, which we last discussed in the summer of 2020.5 Readers should refer to that report for details on our framework methodology. In this report, we apply our relative value framework to investment grade corporate bond markets in the US, euro area, UK, Canada and Australia. Chart 8Valuations Look Stretched On A Breakeven Spread Basis US In Table 1, we present the latest output from our US investment grade sector valuation model. In keeping with the framework used by BCA Research US Bond Strategy, we use the average credit rating, duration, and duration-squared (convexity) of each sector as the model inputs. As the gains from the “beta” of owning corporate credit have been largely exhausted, it now makes sense to pay more attention to the “alpha” in corporate debt markets by looking at relative valuations across sectors. Table 1US Investment Grade Corporate Sector Valuation & Recommended Allocation To determine our US sector recommendations, we not only need to look at the spread valuations from the relative value model, but we must also consider what level of overall US spread risk, which we measure as duration-times-spread (DTS), to target. With valuations for US investment grade looking stretched, we are looking to target only a neutral DTS at or around that of the benchmark index. Investors willing to take on a greater amount of spread risk should look at the beaten-up Airlines sector, which offers the most attractive risk-adjusted valuation in US investment grade within our model. The sweet spot, therefore, is the upper half of Chart 9, around the dotted horizontal line denoting the benchmark DTS. Given the large amount of spread narrowing seen since we last published these models, there are fewer obvious overweight candidates, with most sectors priced close to our model-implied fair value. However, Finance Companies, Lodging, and REITs are interesting opportunities that fit our “risk budget”. Investors willing to take on a greater amount of spread risk should look at the beaten-up Airlines sector, which offers the most attractive risk-adjusted valuation in US investment grade within our model. Sectors to avoid, meanwhile, are Restaurants, Environmental, and Other Utilities. Chart 9US Investment Grade Corporate Sectors: Risk Vs. Reward Euro Area In Table 2, we present the results of our euro area investment grade sector valuation model. The independent variables in this model are each sector’s duration, trailing 12-month spread volatility, and credit rating. Note that we will be using the same independent variables in our UK model. Table 2Euro Area Investment Grade Corporate Sector Valuation & Recommended Allocation In keeping with our neutral stance on euro area investment grade, we will be targeting an overall level of spread risk at or around the benchmark. Therefore, we are interested in overweighting sectors in the upper half of Chart 10 that are close to the overall index DTS. Chart 10Euro Area Investment Grade Corporate Sectors: Risk Vs. Reward On that basis, Subordinated Debt, Brokerage Asset Managers, and Integrated Energy seem appealing overweight candidates while Airlines, Independent Energy, and Building Materials are ones to avoid. UK In Table 3, we present the latest output from our UK relative value spread model. We are currently overweight UK investment grade, one of the best performers in our model bond portfolio universe last year. Although investment grade spreads are below pre-pandemic lows, the major factor to watch is how the economy adjusts to the Brexit trade deal. Table 3UK Investment Grade Corporate Sector Valuation & Recommended Allocation As with other regions, our ideal overweight candidates here are those with positive risk-adjusted residuals and a relatively neutral DTS—represented in the upper half of Chart 11 near the dotted line. The best overweight candidates are concentrated within Financials, with Brokerage Asset Managers, REITs and Insurance appearing attractive. Tobacco and Railroads also fit our criteria. Meanwhile, Metals and Mining, Aerospace, and Restaurants are sectors to avoid. Chart 11UK Investment Grade Corporate Sectors: Risk Vs. Reward Canada Table 4 shows the output from our Canadian relative value spread model. The independent variables in this model are: sector duration, one-year ahead default probability (as calculated by Bloomberg) and credit rating. While we do not have an allocation to Canadian corporate debt in our model bond portfolio, our key insight regarding other markets also applies here—historically expensive valuations for the overall market mean that we recommend keeping exposure to spread risk neutral while finding pockets of value where available. Table 4Canada Investment Grade Corporate Sector Valuation & Recommended Allocation On that basis, some of the most appealing overweight candidates, shown in the top half of Chart 12, are Finance Companies, Office and Healthcare REITs, Brokerage Asset Managers, Life Insurance, and Other Industrials. Meanwhile, we are staying away from Cable Satellite, Media Entertainment, and Environmental sectors. Chart 12Canada Investment Grade Corporate Sectors: Risk Vs. Reward Australia Table 5 shows the output from our new Australia relative value spread model. The independent variables in this model are sector credit rating, one-year ahead default probability (as calculated by Bloomberg), and yield-to-maturity. Due to the relatively small size of the Australian corporate bond market, we are focusing our analysis on Level 3 sectors within the Bloomberg Barclays Classification System (BCLASS) rather than the more granular Level 4 analysis we have employed for other markets. Table 5Australia Investment Grade Corporate Sector Valuation & Recommended Allocation As with Canada, we have no exposure to this market in our model bond portfolio but are looking to maintain a neutral level of recommended overall spread risk while looking at sectors in Chart 13 that show positive risk-adjusted valuations and have a DTS close to the Australian corporate benchmark. On that basis, Finance Companies and Insurance appear attractive while Energy, Technology, and REITs should be avoided. Chart 13Australia Investment Grade Corporate Sectors: Risk Vs. Reward Comparing Sector Valuations Across Regions The above analyses have allowed us to paint a picture of sector valuation within regions. However, there is added benefit in looking at risk-adjusted valuations across the three major corporate bond markets—the US, euro area and UK—with the intent of spotting broader sector level trends in the global investment grade universe that are not limited to just one market. Table 6 allows us to highlight some clear trends: Table 6Valuations Across Major Corporate Bond Markets Industrials such as Chemicals, Capital Goods, and Diversified Manufacturing look overvalued across the board. These cyclicals, which are deeply sensitive to the health of business investment and confidence, rallied strongly on vaccine optimism but now look overbought. On the consumer side, there is weakness in cyclicals such as retailers and restaurants, and non-cyclicals like consumer products and food & beverages. The new round of lockdowns instituted in Europe and the UK are a major risk for these sectors as we head into the final stretch before mass vaccination. Energy looks undervalued in all three regions. This result is supported by the outlook from our BCA Research Commodity & Energy strategists, who are bullish on oil and believe that Brent prices will average at $63/bbl in 2021 as demand continues to grow and OPEC 2.0 keeps a tight grip on supply. Financials look to be a bastion of value, with finance companies/institutions and insurance looking cheap across the board. These sectors have obviously benefited from the steepening in yield curves we have already seen but there is still remaining upside as inflation expectations continue to rise and push up nominal yields at the long-end of the curve. Financials look to be a bastion of value, with finance companies/institutions and insurance looking cheap across the board. Bottom Line: Developed market investment grade corporate spread valuations look stretched. Maintain only neutral levels of spread risk for higher-quality corporates while targeting sectors that look undervalued across the majority of regions, such as Energy and Financials. Avoid universally expensive consumer sectors such as Retailers, Restaurants, and Food & Beverages.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Shakti Sharma Research Associate ShaktiS@bcaresearch.com Footnotes 1 Please see US Bond Strategy / Global Fixed Income Strategy Special Report, "Beware The Bond-Bearish Blue Sweep", dated October 20, 2020, available at usbs.bcaresearch.com 2 Please see US Political Strategy Report, "Buy Reflation Plays On Georgia’s Blue Sweep", dated January 6, 2021, available at usps.bcaresearch.com. 3 The full report can be found here: https://www.moodysanalytics.com/-/media/article/2020/the-macroeconomic-consequences-trump-vs-biden.pdf 4 Please see BCA Research Global Fixed Income Strategy Report, "Our Model Bond Portfolio Strategy For 2021: Leaning Into Reflation", dated January 6, 2021, available at gfis.bcaresearch.com. 5 Please see BCA Research Global Fixed Income Strategy Report, "Hunting For Alpha In The Global Corporate Bond Jungle", dated May 27, 2020, available at gfis.bcaresearch.com. Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

Highlights We remain constructive on the economy and financial markets, … : US households have stored up a great deal of dry powder for consumption once the economy fully reopens, last month’s stopgap fiscal measures will help relieve pressure on the most vulnerable households, and the Georgia Senate results ensure that even more fiscal transfers are in store. … but there is a non-negligible risk that investors will get too excited about the positive backdrop: The exceedingly supportive policy backdrop could easily help the S&P 500 push into the low 4,000s, but it’s not clear what investors will have to look forward to for the rest of 2021 if it ascends to that level early in the year. We do not share the bubble-spotters’ alarm, but we are willing to study their arguments: We like to test our convictions by seeking out opposing views and we therefore read Jeremy Grantham’s bubble essay with great interest. We do not share his urgent concern, and our recommended asset allocations are nearly the mirror image of his, but we are taking a deep dive into his view and its implications. Feature As a grad student on the South Side of Chicago, I used to run on the bike path along the lake. On windless days, the three or four miles north from Hyde Park Boulevard felt especially easy, and I would think, “this is what it’s like when there’s no wind.” Then I’d head for home and discover there’d been a breeze behind me all along. A mile or two in, I’d realize it was no breeze and marvel at how I hadn’t noticed it on the way out. The moral of the story, as I told it then, is that if you think it’s not windy in Chicago, just turn around. Now it seems that it has a broader, weightier lesson: it can be easy to miss the wind when it’s behind you. Jeremy Grantham’s carefully reasoned bubble warning, posted online last Tuesday,1 has inspired us to re-examine our outlook and how widely it’s shared. We are not changing our view – we remain vigilantly bullish – but it is worth devoting ample time to consider the risks to it. This week, we highlight the elements of Grantham’s piece that most caught our attention; next week, we will discuss strategies to try to reduce an investor’s vulnerability to them. The Belated Blue Wave Grantham’s essay highlights vulnerabilities that could come to the fore sometime in the near future, but the Democratic sweep of Georgia’s Senate seats has immediate market implications. By virtue of Vice President-elect Harris’s tie-breaking vote, the Democrats will hold a majority in the 50-50 chamber beginning January 20th. The outcome ensures that the Biden administration will have slim majorities in both houses of Congress for its first two years (pending appointments and special elections). Although a five-seat House majority and the slimmest possible Senate majority will not give the incoming administration carte blanche to enact sweeping legislative changes, it will have an easier time pursuing its agenda than it would have had the Republicans held on to just one of the Georgia Senate seats. Item number one on that agenda is likely to be bulked-up fiscal aid for struggling households, states and municipalities. The economic and market significance of the blue wave is that Congress can now become a full partner supporting the monetary policy aim of erring to the side of providing too much accommodation. With the Fed pledging that it won’t take its foot off the gas any time soon, revived fiscal spending will provide the economy with an incremental reflationary boost that should benefit risk assets. Fiscal transfers will be at least partially funded with increased taxes on corporations and high-earning individuals. Profit margins will narrow, but empirical evidence of a relationship between tax rates and economic growth is elusive (Chart 1). Economic growth is largely a function of growth in the size of the working-age population and growth in productivity. Investment leads productivity – workers become more productive when endowed with more and better tools – but history suggests that investment spending is indifferent to corporate tax rates (Chart 2), as is productivity (Chart 3). Chart 1We Don't Like Taxes, Either ... Chart 2... But They Do Not Seem To Impact Investment ... Chart 3... Or Productivity Growth We are disposed to agree with the idea that higher taxes are a drag on growth. Transferring spending power from the private sector to government apparatchiks is not likely to improve efficiency. Business executives are as fallible as any other experts, however, and changes in tax rates have a smaller multiplier effect than the proposed spending measures. Net-net, we expect that the outcome of the Georgia run-offs will lead to slightly higher interest rates, a steeper yield curve, increased consumption and fewer defaults, a welcome mélange for credit performance and the equities that were left behind as investors flocked to COVID winners. A Slippery Slope Chart 4Bull Markets Tend To Go Out With A Bang [G]reat bubbles are where fortunes are made and lost – and where investors truly prove their mettle. For positioning a portfolio to avoid the worst pain of a major bubble breaking is likely the most difficult part. Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in. [Emphasis added.] As Jeremy Grantham lays it out, the latter stages of a bull market are especially perilous. Given that bull markets run hot before they end (Chart 4), it becomes fiendishly difficult to resist their pull. The recency bias drives an investor to focus on the most recent data points to the exclusion of older ones, pointing to higher expected returns than might be inferred from a more comprehensive sample. The phenomenon encourages equity overexposure at inopportune times if returns are mean-reverting. Professional investors are as susceptible to recency bias and overconfidence (fueled by having had the wind at their back) as non-professionals, and their judgment can be additionally clouded by career pressures. Those who achieve the longest tenures are at least subconsciously attuned to Keynes’ dictum that it is better to fail conventionally than to succeed unconventionally. Staying at the party too long with lots of others may hold far less risk than staking out a solitary position. The bottom line is that asset management incentives encourage groupthink, especially as late-stage bull markets go into overdrive. Dizzying Heights The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble. Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behavior, I believe this event will be recorded as one of the great bubbles of financial history[.] Bubbles are only identifiable in retrospect, but several aspects that financial historian Charles Kindleberger associated with manias are evident. Money is cheap and readily available and valuations are quite high. One could argue that anticipation of short-term capital gains is drowning consideration of future earnings for at least some equity investors or, as Grantham puts it, “stocks [are] rising … simply because they are rising.” Make no mistake: Equity valuations are demanding and de-rating appears more likely than continued re-rating. The main valuation metrics clearly indicate that equities are richly priced. The S&P 500’s forward earnings multiple is hovering around two standard deviations above the mean, at heights previously reached only in the late ‘90s and early ‘00s (Chart 5). Price-to-sales is at an all-time high, three standard deviations above the mean (Chart 6, top panel), while book (Chart 6, middle panel) and cash flow multiples (Chart 6, bottom panel) are elevated but not yet extreme. Price-to-sales should rise if markets believe pandemic-induced margin pressure is temporary and will reverse once the country is vaccinated, but the one-plus-sigma surge above pre-COVID levels would seem to be a bit much. Chart 5Equity Valuations Are Pushing The Envelope Chart 6Making A Run At '99-'00 Equity option and IPO activity is redolent of euphoria and overtrading. Equity call option volume has surged to record levels (Chart 7, top panel), reportedly on the back of an explosion in small retail activity, and the put-call ratio has fallen to dot-com-bubble levels as demand for exposure has swamped demand for protection (Chart 7, bottom panel). New IPOs have been coming fast and furious (Chart 8, top panel) at a relatively tender average age (Chart 8, bottom panel). Sponsors’ shift away from hoarding early- and middle-stage returns to inviting the public to share them may prove to be telling. There are many reasons to sell equity interests, but expecting them to blast higher isn’t typically one of them. Chart 7The Merry Men Of Sherwood Forest Have Discovered Options Are A Gas, Too Chart 8Take The Money And Run The Legend Who Cried Wolf This isn’t the first time Grantham or one of his colleagues has expressed concern about rising stock prices. It may be unduly harsh to call him a perma-bear, but GMO has consistently underestimated equities and the firm has seen its assets under management (AUM) cut in half over the last five years, to $60 billion, while its flagship asset allocation fund has lost over 60% of AUM. As an RIA firm executive told a Bloomberg reporter, “I can see how clients lose patience with them. They get defensive way before anybody else.2” It’s important to recognize different commentators’ biases/agendas when evaluating their arguments. Grantham calls out the broker-dealers as perpetual market cheerleaders, but he has a stake in convincing GMO clients and prospects that value investing principles are still relevant. BCA’s business model is far more insulated from markets’ direction, but our research services have a bias to fit inherently unruly markets into tidy narratives. Disclosing the risks to our views is an essential part of our process, but the hypotheses we reject will always get less of an airing than the ones we embrace – no investor has time to read weekly 50-page deliberations. Why Now? The canonical BCA question – So What? – is meant to keep researchers focused on the market relevance of their inquiries. But we have long advocated for a second question – Why Now? – to keep our focus on timeliness. Spotting imbalances, which can take a maddeningly long time to reverse, isn’t enough to earn alpha. To translate macro analysis into promising investment ideas, an investor also needs to identify potential catalysts that might unwind the imbalance. Bull markets become exhausted once so much capital is invested in them that there is no one left to keep buying, just as bear markets end when the urgency to sell dissipates. Sentiment can offer clues into remaining buying or selling power, and the day before the Grantham piece appeared, an experienced financial advisor with a stellar portfolio management record emailed that, “This is one of the few times in my career where I feel like the market is simple and the consensus is right. It almost always feels like there is something obviously bad on the horizon but this market feels like there is really good news on the horizon.” I have known him for over 30 years and can attest to his intelligence, diligence and savvy. His clients are in excellent hands and his constructive take may well be spot on. Indeed, we hope so, since it dovetails with ours, but his assurance gave us pause. For now, it doesn't seem to be universal, as it contrasted starkly with this musing from another trusted confidante (a family office CIO) as 2020 was winding down, “What can be said about work other than make certain we don’t mistake this bull market for brilliance.” Valuation is a notoriously lousy timing indicator and sentiment is a squishy concept that is hard to pin down. Both can remain stretched for a long period of time. An investor shouldn't bet against them unless s/he has a good reason for believing they are on the verge of reversing. Perhaps not having to run on the relative performance hamster wheel like most professional investors gives the family office CIO, who also has a great track record, a little broader perspective, but every investor could use a dose of humility. Skepticism is an essential component of successful investing as well, especially as stocks are making new highs. If you think it’s not windy … Investment Implications We respect Jeremy Grantham’s experience and formidable accomplishments and listen closely to any insights he’s willing to share. We acknowledge that there are many signs of froth across financial markets and that the Kindleberger red line of purchasing assets without regard to their intrinsic merit could be crossed in the not-too-distant future. We echo the sentiment that central bankers are not omnipotent and that easy monetary policy is not a magical elixir. We do, however, assert that the combination of extremely easy monetary policy and a new round of fiscal aid offers equities and spread product a supportive backdrop that should be expected to hold throughout the year provided that markets don’t get over their skis by bidding up asset prices too far. The bottom line is that market vulnerabilities are cropping up but we disagree with the view that they are about to bring an end to risk asset outperform-ance. We remain overweight equities and spread product while keeping an eye out for anything untoward. As we have been saying for several weeks, we are bullish, albeit vigilantly so. One of our roles is to worry for our clients, and we are scanning the horizon for signs of trouble even more thoroughly than normal. Until we see those signs, or until risk asset prices rise so much that they sour their risk-reward prospects, we will stick with our call. On the last point, we are in complete agreement with Grantham: The one reality that you can never change is that a higher-priced asset will produce a lower return than a lower-priced asset. You can’t have your cake and eat it. You can enjoy it now, or you can enjoy it steadily in the distant future, but not both – and the price we pay for having this market go higher and higher is a lower 10-year return from the peak.   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1https://www.gmo.com/americas/research-library/waiting-for-the-last-dance/ Accessed January 5, 2021. Grantham is the octogenarian co-founder of Grantham, Mayo and van Otterloo (GMO), a value-oriented asset manager for institutional investors. 2 McDonald, Michael. "Grantham’s Bear Market Call Tests Patience of GMO Fund Investors," Bloomberg, November 24, 2020.