What should we expect from Mr. Market? The answer’s always in doubt, but strategic-minded investors should run through the numbers anyway.
It’s hard to overrate the value of taking a hard look at investing assumptions. By continually putting an expected price on risk, we become better investors. There are no crystal balls, but the next best thing is improving our skills in the art and science of discounting the future as a tool for enhancing return…maybe.
As an example, in the next issue of The Beta Investment Report we forecast an expected equilibrium risk premium for the market portfolio of 2.5%. We arrive at that forecast from summing up the individual forecasts for each of the major asset classes based on their market-cap-informed share of the total portfolio. Overall, it’s a long-term prediction based on an equilibrium assumption and, we believe, a reasonable benchmark forecast, for reasons we discuss in some detail in the newsletter. But we can’t be sure that our forecast is accurate and so we need to stress test our assumptions a bit. Here’s a very brief illustration of the basic concept, including some of the give and take that keeps us forever wondering about what’s coming.