| Ray Dalio, Bridgewater Associates (Bloomberg) |
Ray Dalio’s Bridgewater Associates posted very strong results in its main macro funds last month. As a result, the world’s largest hedge fund firm was able to nearly wipe out the losses it had been suffering from all year.
In October, Bridgewater’s Pure Alpha I fund returned about 6.1 percent. This cut the fund’s loss to just 0.6 percent for the year. Meanwhile, Pure Alpha II gained about 9.94 percent in October and is now down about 0.36 percent for the year.
Bridgewater’s risk parity fund, All Weather, which usually moves in the opposite direction of Pure Alpha, fell about 1.51 percent last month. Even so, it is still up 12.59 percent for the year.
It is not exactly clear what drove October’s sharp rebound in the Pure Alpha funds. In the first half of the year, when the funds were down, Bridgewater lost money on long positions in Japanese and European equities as well as a short position in the Japanese yen, which was one of the best-performing currencies at the time, according to an investor in the funds.
In general, Dalio has made it clear he is very bearish and worried about the global economy. In a speech in early October at the 40th annual Central Banking Seminar, Dalio repeated a theme he has been hammering away at for some time: This is an abnormally slow growth environment, monetary policy tools will be much less effective going forward, the risks are asymmetric to the downside, future investment returns will be very low, and economic stagnation is attracting impatient middle- and lower-income earners to “dangerous populism and nationalism.” It’s a warning he has sounded before: In September 2015, Dalio predicted that returns across many asset classes would average only about 3 percent to 4 percent over the next decade.
Dalio has been emphasizing the theme that we are at the end of a long-term debt cycle. This will leave little that central banks can do to gain any effectiveness from quantitative easing “as the risk premiums and spreads are compressing,” he said in the October speech.
“The wealth gap and numerous other factors make lending to spenders more challenging,” Dalio added in the speech. “This is a global problem. Japan is closest to its limits, Europe is a step behind it, the U.S. is a step or two behind Europe, and China is a few steps behind the United States.” However, Dalio stressed that unlike in 2007, he does not see signs of a bubble and a debt crisis.
Dalio did not explicitly lay out in the October speech how his portfolios are positioned for this environment. But he did tell the audience that the bond market is overvalued, stressing there is a limit to how negative bond yields can go.
“Their expected returns relative to their risks are especially bad,” he added. “If interest rates rise just a little bit more than is discounted in the curve, it will have a big negative effect on bonds and all asset prices, as they are all very sensitive to the discount rate used to calculate the present value of their future cash flows.”
Dalio noted it would take only a 100-basis-point rise in Treasury bond yields to trigger the worst price decline in bonds since the 1981 bond market crash. “And since those interest rates are embedded in the pricing of all investment assets, that would send them all much lower,” he warned.
At the same time, Dalio said a number of the riskier assets look attractive in relationship to bonds and cash, “but not cheap in relationship to their risks.”
In fact, if this current valuation environment persists, Dalio said, nonfinancial assets such as gold could become more attractive than holding bonds, especially if currency volatility picks up.
Not a pretty picture.
