Risk Premia Forecasts: Major Asset Classes - Monday, March 5

The projected risk premium for the Global Market Index (GMI) ticked up in February to an annualized 4.6%, slightly above January’s forecast. Today’s revised estimate for GMI (an unmanaged market-value-weighted portfolio that holds all the major asset classes except cash) reflects the ex ante premium over the projected “risk-free” rate for the long run.

Adjusting for short-term momentum and medium-term mean-reversion factors (defined below) trims GMI’s ex ante premium fractionally to an annualized 4.5% forecast.

The forward estimates for GMI’s performance remain far below the benchmark’s historical return for the trailing 10-year period through last month. The benchmark earned a strong 8.8% annualized risk premium for the decade through February 2019 — well above GMI’s current unadjusted 4.6% long-run forecast.

All forecasts are likely to be wrong to some degree, but the GMI projections are expected to be somewhat more reliable vs. the estimates for the individual asset classes. Predictions for the specific market components are subject to greater uncertainty compared with aggregating forecasts, a process that may cancel out some of the errors through time.

For historical perspective, consider the chart below, which compares the rolling 10-year annualized risk premia for GMI, US stocks (Russell 3000), and US Bonds (Bloomberg Aggregate Bond) through last month. Note that GMI’s 10-year performance (red line) ticked up again last month to the strongest pace in the historical sample presented (since Jan. 2008). (Keep in mind that the trailing 10-year period for most asset classes is distorted at the moment because this time-period comparison uses an unusually weak period for a start date — February 2009. US equities and other markets bottomed in first quarter of 2009 — during the Great Recession. As a result, performance comparisons that start at or near Q1: 2009 will likely reflect inflated performances — performances that will likely fade to a degree as the early 2009 prices drop out of the analysis going forward.)

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Disclosure: None.

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