As the founder of Bridgewater Associates–not only the largest hedge fund in the world, but the hedge fund that made the largest cumulative net profit ever of $50 billion–Ray Dalio is a man whose market opinions matter.
Not necessarily because what he has to say is always accurate, though it may be well-reasoned and well-argued, but because he, like other legendary investors, have the capacity to influence market sentiment and action.
A week or so before the February 2 market decline, Ray Dalio made the following statement to an audience in Davos:
“We are in this Goldilocks period right now. Inflation isn’t a problem. Growth is good, everything is pretty good with a big jolt of stimulation coming from changes in tax laws. If you’re holding cash, you’re going to feel pretty stupid.”
And then this happened…
Ray Dalio subsequently responded in a Linkedin post. WARNING lots of technical and jargonistic language:
“In the “late-cycle” phase of the short-term debt/business cycle, when a) an economy’s demand is increasing at a rate that is faster than the capacity for it to produce is increasing and b) the capacity to produce is near its limits, prices of those items that are constrained (like workers and constrained capital goods) go up. At that time, profits also rise for those who own the capacities to produce those items that are in short supply. Then the acceleration of demand into capacity constraints and rise in prices and profits causes interest rates to rise and central banks to tighten monetary policy, which causes stock and other asset prices to fall because all assets are priced as the present value of their future cash flows and interest rates are the discount rate used to calculate present values. That is why it is not unusual to see strong economies accompanied by falling stock and other asset prices, which is curious to people who wonder why stocks go down when the economy is strong and don’t understand how this dynamic works. If the prices for stocks and other assets that do well when growth is strong continue to decline (which is typical), that and the credit market tightening leads demand to fall until demand is significantly less than the capacity to produce, which leads interest rates to fall and central banks to ease as their concerns about economic weakness supersede their concerns about inflation; that causes stock and other asset prices to rise. Such is the nature of the “short-term market and business cycle.” That is why it is classically best to buy stocks when the economy is very weak, there is a lot of excess capacity in the economy, and interest rates are falling (and to sell stocks when the reverse is the case).”
So, where are we now? Here’s Dalio’s statement, which we’ve parsed into bullet points:
- we are in the “late-cycle” part of the short-term debt/business cycle…
- but we don’t know precisely where we are…
- we don’t know exactly how far we are from the top in the stock market and then the economy…
- though it is clear that we are past the top in the bond market.
And here is Dalio’s mea culpa:
“About 10 days ago, that’s where I thought we were. However, recent spurts in stimulations, growth, and wage numbers signaled that the cycle is a bit ahead of where I thought it was.”
Dalio was referring to the February 2 Employment Situation report in which it revealed a jump in hourly earnings, its biggest rise since 2009”:
“These reports understandably led to the reactions in bonds, which affected stocks as they did. Then on Friday, we heard the announced budget deal that will produce both more fiscal stimulation and more T-bond selling by the Treasury, which is more bearish for bonds. And soon ahead, we will hear about a big (and needed) infrastructure plan and the larger deficits and more Treasury bond selling that will be needed to fund them. In other words, there is a whole lot of hitting the gas into capacity constraints that will lead to nominal rate rises driven by the markets. The Fed’s reactions to them and the amount of real (inflation-adjusted) rate rises that will result will be very important, so we will be monitoring this closely.”
In the end, Ray Dalio and Bridgewater have a turned slightly bearish in light of the recent developments.
So what’s troubling about this flip-flop in position? Well, it brings to the fore an important point that market participants tend to miss.
There’s a possibility that Ray Dalio’s assessment was right on, but that things changed fundamentally and rapidly in a manner that couldn’t have been anticipated.
Markets contain an underlying volatility that isn’t always apparent on the surface. And this volatility tends to strike when people least expect it.
To call Dalio’s position a “flip-flop” is to focus too closely on Dalio himself.
- There’s a problem with the term “flip-flop” in that it states an implicit (moral) imperative: you should “stay the course.” Why? Don’t know. It’s just a notion that a lot of people, for one reason or another, tend to believe.
- But “staying the course” often carries another implicit assumption: it is possible to use “reason” to predict the “future” accurately; enough to warrant “staying the course.” The problem is that markets are neither simple nor mechanistic, so that predicting the future course of the market is infinitely more complex than predicting the actions of your toaster oven.
Whereas focusing on the markets—namely, its rapidly shifting dynamics—will reveal the fallibility of such notions.
Having shifted focus from the investor to the markets, it becomes clear that to flip-flop is to exhibit a necessary adaptability to change. And this is probably what Ray Dalio did. But as long as we call it a flip-flop, we are allowing “language” to distract us from the actualities of the market; a dynamic of change that is not predictable, not always calculable, and one that requires a constant and agile shift in tactics and strategy.
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