To chase or not to chase—that is the question: Whether the portfolio is designed to suffer the swings and sorrows of outrageous equity allocations or to take to bonds against a sea of troubles …

"To chase or not to chase?"—a reference to the record highs posted by U.S. stocks this month—is the question Citigroup Inc. chief U.S. equity strategist Tobias Levkovich poses in a note to clients this morning, and attempts to answer.

The strategist hits on three potential drivers for stocks to set fresh all-time highs.
They include a pick-up in company earnings, new inflows into U.S. equities, and a catch-up in the relative value of stocks versus bonds—and he deems the likelihood of any of these materializing to be relatively low.

More than a month before the three benchmark U.S. equity indexes all closed at record highs on the same day, a survey of the bank's clients showed an increase in faith on the part of fund managers that analysts' estimates for earnings in 2016 are "appropriate," or in other words that likely developments are already priced in.

With equivocation that (thankfully) fails to match up to that displayed by the eponymous lead of Shakespeare's longest play, he says there's a lack of clarity on this front: "New positive developments would need to emerge to justify more in terms of net income generation," writes Levkovich. "With outstanding issues such as the impact of Brexit and/or fiscal policy post the U.S. elections, it seems challenging to come to any powerful conclusions at this juncture."

And while there are some signs that investors have been warming to U.S. equities, they remain a "fairly despised" asset class, according to Levkovich. Fixed income is likely to remain popular despite the potential of a disorderly unwind, the strategist believes.

"Home prices peaked in 2006 but people kept buying homes throughout 2007 and we suspect the same risk exists in bonds, especially those with negative yields, but losses will be taken before a major shift in sentiment occurs," he writes. "People tend to be stubborn and are often creatures of habit, thus change takes time and this is the fate of the Great Rotation."

On valuations, a different question from the pen of the Bard comes to mind. That is, Trolius of Troilus and Cressida's rhetorical swipe at fundamental analysis: "What is aught, but as 'tis valued?"

On this subject Levkovich cites a relative measure of market sentiment to make his case: he notes that the normalized earnings-yield gap suggests that stocks are likely to rise over the next three, six, and 12 months (when defining the earning-yield gap as the 5-year future yield of the 10-year Treasury, minus the S&P 500's earnings yield, using operating earnings per share).

For now, count the strategist among the camp who isn't expecting a fabulous gain in short order—unlike Antonio in Shakespeare's Merchant of Venice who, in his 17th Century innocence of negative rates, was able to anticipate a "return of thrice three times the value of this bond."