| Raymond Dalio, Bridgewater Associates (Bloomberg) |
Some of the world’s most prominent investors are worried about China’s economy. Bridgewater Associates founder Raymond Dalio is not one of them.
In a recent letter to clients, Dalio went so far as to say he is more confident in how China’s economy is managed than how those of the U.S. and Europe are managed. It’s a contrarian view: Investors have been worried about China since the Shanghai stock market started selling off in late June amid concerns over China’s slowing economy. In early August, China devalued its currency. The market sell-off eventually helped to spark a precipitous drop in the global stock markets as well as in commodity markets in late August.
But Westport, Connecticut–based Bridgewater is the largest hedge fund firm in the world, so Dalio is obviously no intellectual slouch.
“My view is controversial, but here it is,” states Dalio in his Daily Observations letter, dated January 8 and also signed by senior investment associate Mark Dinner. “There is much less risk of ignorant people choosing incompetent leaders in China than there is in most democracies, especially those in the U.S. and Europe,” the letter states. “Also, from having had a lot of contact with senior policy makers (especially senior economic policy makers in China), it is my assessment that they are as or more competent than those in the U.S. and Europe, and they can coordinate themselves better to take actions.”
The 20-page letter tries to put the events playing out in China and throughout the world — with global stock markets in free fall since the start of the year — in context and explain why Bridgewater is sticking with its bullish case for the Chinese economy, the second largest in the world. The letter was also written before China announced Monday that its economy grew by 6.9 percent last year, the lowest percentage in 25 years.
We recently reported that in 2015, Bridgewater’s Pure Alpha II Fund gained 4.7 percent, its Pure Alpha Major Markets fund rose 10.6 percent and its All Weather risk parity fund lost 7 percent.
In the letter, Dalio and Dinner stress that the current economic developments in China, which in part have rocked the global financial markets since the start of the year, should be looked at in the context of what transpires throughout the world.
The duo remind investors of the firm’s template, which stresses that three big forces interact to drive economic and market activity over time: productivity growth, the short-term debt cycle and the long-term debt cycle.
The managers go on to explain that three important equilibriums must be achieved or there will be an economic collapse, “which itself will eventually lead to adjustments toward equilibrium.” According to the report, the three are: debt growth is aligned with the income growth required to service debts; the utilization of economic capacity is not too high or too low; and projected return of cash is lower than the projected return of bonds, which in turn is lower than the projected return of equities. Governments have two levers to bring these equilibriums about: monetary policy and fiscal policy.
Dalio and Dinner say by understanding the equilibriums and levers and how they influence each other, “one can pretty well see what will come next. By seeing which equilibria are out of whack, one can anticipate what monetary and fiscal policy shifts will occur and by watching these shifts one can anticipate what the changes in these conditions will be.”
Dalio and Dinner add that companies, countries and currencies sort of swing like pendulums, moving from being underappreciated and cheap to too expensive, and usually, they self-adjust. The managers say policymakers mostly try to make sure these cycles transpire smoothly.
“Sometimes ignorant people choose incompetent leaders who make things worse than they need to be, while sometimes they choose skilled leaders who know how to do the best job possible of navigating through the inevitable ups and downs,” the letter adds.
Dalio and Dinner point this out in the context of China, which is now going through one of these cycles. They make the case that this is nothing new, and that many other countries have had to go through big cycle swings and economic restructurings. They point out that the U.S. has experienced four significant debt restructurings: in 1971, in 1982 during the Latin American debt crisis, the 1986 savings and loan crisis, and the 2008 debt crisis.
How do these kinds of crises turn out? It depends on how they are managed and the circumstances, Dalio and Dinner say. It is in this context that Dalio makes his assertion about China’s superior management versus the rest of the world.
“Of course, they have some major handicaps too, most importantly a less efficient system for allocating capital, natural resources and labor,” Dalio and Dinner say, referring to China. The managers expect China to go through these cycles like other countries that were well managed and went through them but did not spin out of control.
Dalio and Dinner also expect China’s real growth rates will remain stronger than in most other countries due to China’s especially strong productivity growth, “even through the cyclical adjustment process.” After that, Bridgewater is confident China will be positioned to do well again, “especially if policymakers move forward with their planned reforms.”
To that end, Dalio and Dinner reiterated their belief that China’s real GDP growth will be roughly 5 percent over the next ten years.
