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GMO Forecast Accuracy Test

| | Posted in: Investing Expertise

A subscriber suggested an update of "GMO's Stunningly Accurate Forecast?" with out-of-sample testing of GMO forecasts. To investigate, we test GMO's 7-Year asset class real return forecasts of December 31, 2010 and July 31, 2013. We first match the 11 GMO asset classes covered in these forecasts to exchange-traded funds (ETF), as follows:

  1. U.S. equities (large cap) - SPDR S&P 500 ETF Trust (SPY).
  2. U.S. equities (small cap) - iShares Russell 2000 ETF (IWM).
  3. U.S. high quality - Invesco S&P 500 Quality ETF (SPHQ).
  4. International equities (large cap) - iShares MSCI EAFE ETF (EFA).
  5. International equities (small cap) - iShares MSCI EAFE Small-Cap ETF (SCZ).
  6. Emerging equities - iShares MSCI Emerging Markets ETF (EEM).
  7. U.S. bonds (government) - iShares 20+ Year Treasury Bond ETF (TLT).
  8. International bonds (government) - SPDR Bloomberg Barclays International Treasury Bond ETF (BWX).
  9. Emerging bonds - iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB).
  10. Inflation-indexed bonds - iShares TIPS Bond ETF (TIP).
  11. Short-term U.S. Treasuries (30 days to 2 years) - iShares 1-3 Year Treasury Bond ETF (SHY).

We adjust monthly ETF returns for inflation using monthly changes in U.S. Consumer Price Index (CPI), with change in CPI for July 2020 estimated as the monthly average for the rest of the sample. In contrast, GMO apparently assumes constant annualized inflation of 2.5% for both forecasts. We then calculate real compound annual growth rates (CAGR) for each over specified forecast horizons. Using GMO forecasts, dividend-adjusted ETF prices and CPI data during December 2020 through July 2020, we find that:

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