Taking into account asset class valuations

Valuations are a poor indicator for tactical allocation. An asset class can remain expensive or cheap for a very long time. But when valuations become extreme relative to their own history, the probability of a return to this historical average becomes likely over a horizon of a few quarters or years, amplifying the performance of cheap assets and conversely reducing that of expensive ones.  

The expected return on a government bond depends heavily on the yield to maturity at the time of purchase. If interest rates are historically low, the expected return will be low until maturity, and in the meantime, the market value of the bond could suffer from a rise in interest rates. Conversely, if the yield to maturity is historically high, a fall in rates can lead to additional performance. 

For corporate bonds, the expected return depends on the level of yields on government bonds considered risk-free and the credit spread, which provides the additional return that compensates for the risk of default by the company. The level of credit spreads varies according to the economic cycle. Since 2000, there have been five periods when credit spreads widened significantly, only to narrow again in the following quarters.

The idea behind smart benchmarks is to invest structurally more in corporate bonds when spreads are historically high and vice versa.    

For equity markets, it is important to use a valuation metric that is not dependent on the economic cycle. That is why we use CAPE, the cyclically adjusted price-to-earnings ratio. For more information on this subject, see Professor Robert Shiller's website (Yale University https://shillerdata.com).

History shows that there is a direct link between the level of the market's CAPE index and its expected return over the next 10 years.