Explain what additional step(s) Wuyan should have taken in the process of setting capital market expectations.

Wuyan reports that after repeatedly searching the most recent 10 years of data, she eventually identified variables that had a statistically significant relationship with equity returns. Wuyan used these variables to forecast equity returns. She documented, in a separate section of the report, a high correlation between nominal GDP and equity returns. Based on this noted high correlation, Wuyan concludes that nominal GDP predicts equity returns. Based on her statistical results, Wuyan expects equities to underperform over the next 12 months and recommends that the firm underweight equities.

Commenting on the report, John Tommanson, an investment adviser for the firm, suggests extending the starting point of the historical data back another 20 years to obtain more robust statistical results. Doing so would enable the analysis to include different economic and central bank policy environments. Tommanson is reluctant to underweight equities for his clients, citing the strong performance of equities over the last quarter, and believes the most recent quarterly data should be weighted more heavily in setting capital market expectations.

Jennifer Wuyan is an investment strategist responsible for developing long-term capital market expectations for an investment firm that invests in domestic equities. She presents a report to the firm’s investment committee describing the statistical model used to formulate capital market expectations, which is based on a dividend discount method. In the report, she notes that in developing the model, she researched the historical data seeking to identify the relevant variables and determined the best source of data for the model. She also notes her interpretation of the current economic and market environment.