The first rule in the money game is recognizing that there are no silver bullets. Asset pricing is a black box. It’s become somewhat less of a black box after a half century of analysis by financial economists, but what we don’t know about how markets work still dominates by far.
Much of what we do know has come from reverse-engineering the system’s output. We can see prices and we can measure their fluctuations and linkages in countless ways. The trouble is that the financial gods forgot to give us the code that produces the output. That leaves us with the thankless ask of predicting returns indirectly. But even then we’re working with imperfect information. Ours is a world of ex post data. We know the past, but that’s a poor window into the future. We have the output but we’re forever debating the input. As a result, the link between ex post and ex ante data is shaky. That doesn’t mean we should ignore the historical record, but it should only be one of several layers of analysis for developing capital market assumptions.
Much of what we discuss on the pages of The Beta Investment Report is focused on developing equilibrium risk premiums and then integrating those long-range forecasts with our near-term outlook. To the extent there’s a divergence of some magnitude, and we’re reasonably confident in our assumptions, we have some basis for adjusting the asset allocation for the market portfolio, which we define broadly, as per finance theory. A global value-weighted mix of stocks, bonds, commodities and REITs is a reasonable definition, a.k.a. our proprietary Global Market Index.