Before and immediately after it was clear that Donald Trump had been elected, the markets (especially the stock market) had negative votes on the man (thinking he might be irresponsible), while after he got elected, the markets reacted to the man’s policies—so the correlations reversed. That shift was due to the changing complexion of market participants—those who drove the markets after his election were largely those who kept their powder dry until they saw the outcome and chose to process (and bet on) the policies themselves. As for us, we chose not to bet on whether or not he would be elected and/or whether or not he would be prudent because we didn’t have an edge in predicting these things. We try to improve our odds of being right by knowing when not to bet, which was the case.In my opinion, the most important part in Ray's long post was this:
Having said that, we want to be clear that we think that the man’s policies will have a big impact on the world. Over the last few days, we have seen very early indications of what a Trump presidency might be like via his progress with appointments and initiatives, as well as other feedback that we are getting from various sources, but clearly it is too early to be confident about any assessments. What follows are simply our preliminary impressions from these. We want to make clear that we are distinguishing between a) the sensibility of the ideology (e.g., one leader’s policies might be “conservative/right” while another’s might be “liberal/left”) and b) the capabilities of the people driving these policies. To clarify the distinction, one could have capable people driving conservative/right policies or one can have incapable people driving them, and the same is true for liberal/left policies. To understand where we are likely to be headed, we need to assess both. To be clear, we are more non-ideological and practical/mechanical because to us economies and markets work like machines and our job is simply to understand how the levers will be moved and what outcome the moving of them is likely to produce.
The Shift in Ideologies
As far as the ideology part of that assessment goes, we believe that we will have a profound president-led ideological shift that is of a magnitude, and in more ways than one, analogous to Ronald Reagan’s shift to the right. Of course, all analogies are also different, so I should be clearer. Donald Trump is moving forcefully to policies that put the stimulation of traditional domestic manufacturing above all else, that are far more pro-business, that are much more protectionist, etc. We won’t go down the litany of particulars about the directions, as they’re well known, discussed in my last Observations, and well conveyed in the recent big market moves. As a result, whereas the previous period was characterized by 1) increasing globalization, free trade, and global connectedness, 2) relatively innocuous fiscal policies, and 3) sluggish domestic growth, low inflation, and falling bond yields, the new period is more likely to be characterized by 1) decreasing globalization, free trade, and global connectedness, 2) aggressively stimulative fiscal policies, and 3) increased US growth, higher inflation, and rising bond yields. Of course, there will be other big shifts as well, such as pertaining to business profitability, environmental protection, foreign policies/alliances, etc. Once again, we won’t go into the whole litany of them, as they’re well known. However, the main point we’re trying to convey is that there is a good chance that we are at one of those major reversals that last a decade (like the 1970-71 shift from the 1960s period of non-inflationary growth to the 1970s decade of stagflation, or the 1980s shift to disinflationary strong growth). To be clear, we are not saying that the future will be like any of these mentioned prior periods; we are just saying that there’s a good chance that the economy/market will shift from what we have gotten used to and what we will experience over the next many years will be very different from that.
To give you a sense of this, the table below shows that a) these economic environments tend to go on for about a decade or so before reversing, b) market moves reflect these environments, and c) extended periods of movements in one direction (which lead to confidence and complacency) tend to lead to big moves in the opposite direction (click on image).
As for the effects of this particular ideological/environmental shift, we think that there's a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation. When reversals of major moves (like a 30-year bull market) happen, there are many market participants who have skewed their positions (often not knowingly) to be stung and shaken out of them by the move, making the move self-reinforcing until they are shaken out. For example, in this case, many investors have reached for yield with the upward price moves as winds to their backs, many have dynamically hedged the changes in their duration, etc. They all are being hurt and will become weaker holders or sellers. Because the effective durations of bonds have lengthened, price movements will be big. Also, it’s likely that the Fed (and possibly other central banks) will increasingly tighten and that fiscal and monetary policy will come into conflict down the road. Relatively stronger US growth and relative tightening of US policy versus the rest of world is dollar-bullish. All this, plus fiscal stimulus that will translate to additional economic growth, corporate tax changes, and less regulation will on the margin be good for profitability and stocks, though for domestically oriented stocks more than multinationals, etc. The question will be when will this move short-circuit itself—i.e., when will the rise in nominal (and, more importantly, real) bond yields and risk premiums start hurting other asset prices. That will depend on a number of things, most importantly how the rise in inflation and growth will be accommodated, that we don’t want to delve into now as that would take us off track.
Let’s get back on track regarding whether the Trump administration will be…
…Capable or Incapable?
Our very preliminary assessment is that on the economic front, the developments are broadly positive—the straws in the wind suggest that many of the people under consideration have a sufficient understanding of how the economic machine works to run reasonable calculations on the implications of their shifts so that they probably won’t recklessly and stupidly drive the economy into a ditch. To repeat, that is our very preliminary read of the situation, which is too premature to take to the bank. Of course, we should expect big bumps resulting from big shifts regardless of who is engineering this big ideological shift.
So, what are we trying to say? The headline is that the ideological/environmental shifts are clear, their magnitudes will be large, and there’s a good chance that the “craziness” factor will be smaller and play a lesser role in driving outcomes than many had feared. In fact, it is possible that we might have very capable policy makers of the previously mentioned ideological persuasion in control. As always, we will keep you posted of our thinking as it will certainly change as we learn more.
As for the effects of this particular ideological/environmental shift, we think that there's a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation. When reversals of major moves (like a 30-year bull market) happen, there are many market participants who have skewed their positions (often not knowingly) to be stung and shaken out of them by the move, making the move self-reinforcing until they are shaken out.So, Bridgewater is calling an end to the 30-year bond bull market? Hallelujah! All those bond bubble clowns I exposed back in August turned out to be right on the money. The same goes for those delivering alpha gurus who in September warned us bonds are the bigger short.
Who in their right mind would go against the likes of a Paul Singer or God forbid, the great Ray Dalio and his economic machine?
"Son, What's Your Track Record?!?"
Back in late 2003 or early 2004, I took a trip with Gordon Fyfe, the former president and CEO of PSP Investments, to meet smart investors and peers. One of our stops was Bridgewater where we got to meet Ray Dalio.
As an aside, I had recommended an investment in Bridgewater while at the Caisse back in 2002 when I was working as a portfolio analyst covering directional hedge funds (L/S Equity, global macro, CTAs and a few funds of funds). To my knowledge, the Caisse was among the first institutional investors in Canada to invest in Bridgewater but I never got to meet Ray Dalio until that trip to their offices with Gordon Fyfe.
[Note: It was Simon Wahed and Allan Schouela of McGill Capital who first brought Bridgewater to my attention back in 2002. They told me: "You need to look at these guys", which I did and came away very impressed. A few months after we invested in them, I remember making a phone call to Ron Mock at Teachers telling him to look at them. Back then, Bridgewater was managing roughly $10 billion, a sizable amount but nothing close to the behemoth it has become.]
Anyways, at the meeting with Gordon and I, Ray Dalio covered Bridgewater's All-Weather strategy which is now widely known as the "risk-parity strategy" which many funds (like AQR) have since adopted.
To be frank, that part of the meeting bored me because it was Ray selling us his baby. I much preferred when the conversation switched over to the markets and economic trends. I don't remember exactly how it went down but at one point we got onto talking about the US housing market, and I was worried about the bubble being created and how that would cause a massive dislocation, deleveraging and deflation down the road.
I was probably being a bit too aggressive with my questions and probably irritated Ray because at one point he looked at me and blurted: "Son, what's your track record?!?".
I can't remember if Bob Prince or Greg Jensen attended that meeting (one of the two attended) but I remember one of the Bridgewater representatives had this look of horror on their face, like please don't let this get out of hand. It didn't as I had the sense to shut my big yap.
At the time, I was young and proud and took it very personally and thought the guy was being a total jerk. Gordon Fyfe loved it and kept teasing me in the town car Bridgewater had arranged to drive us back to the airport: "Son, what's your track record?!? Hahaha!!".
With time, however, I realized that there was nothing personal there, that was Ray Dalio being Ray Dalio, being authentic to the values and principles he believes in. And if you aren't thick skinned and can only dish it out and not take the hits, then you're not Bridgewater material and probably not a worthy client either.
One thing I admire about Ray Dalio is he's not going to pussyfoot, coddle and blow smoke your way even if you're a large institutional client writing a big cheque. He simply doesn't care and will tell it to you like it is in your face (more like he sees it) even if it hurts your ego (that's probably why they don't put him in front of clients).
This was my long preamble to the next session going over the prince of Bridgewater's visit to Montreal.
The Prince of Bridgewater comes to Montreal
On Tuesday evening, Bob Prince, co-CIO of Bridgewater Associates, was in Montreal to discuss macro trends and Bridgewater's culture with Roland Lescure, CIO of the Caisse, at a CFA Montreal dinner event (see picture at the top, h/t Kelly Trihey).
I had emailed Roland and he was gracious enough to arrange an invitation (Roland is a very classy guy). I typically hate these events as they are long and dreadfully boring (plus the Habs were playing hockey) but I decided to put on a suit and tie and head over to the Palais des Congrès right next to the Caisse and listen to Bob Prince talk about markets, economic trends and exchange views with Roland.
And I wasn't disappointed. Bob Prince has a very sharp macro mind. I was totally engrossed with everything he was covering and he has this way of communicating complex ideas and reducing them into a simple form for everyone to understand (he's a great teacher at Bridgewater).
Having said this, even though there were many CFAs in the audience, I'm sure a lot of what Bob said totally went over their head because he is a macro genius and it's hard for a lot of people (even CFAs) to digest everything he was covering and connecting the dots to understand the bigger picture.
So what in a nutshell did Bob Prince say? Here are the main points that I jotted down:
- Higher debt and low rates will impact asset values, limit credit growth and economic growth over next decade
- Monetary policy and asset returns are skewed (so you will see bigger swings in risk assets)
- Currency swings matter a lot more in a low rate/ QE world (expect higher currency volatility)
- Low rates and low returns are here to stay (expected returns in public markets will be in low single digits over next decade)
- We are reaching an important inflection point where valuations of illiquid assets are nearing a peak at the same time where dollar liquidity dries up.
Not that they have much of a choice. Bob Prince said in this environment, you have three choices:
- Do nothing and accept the outcome
- Take more risk
- Take more efficient risk (like in illiquid assets)
Even if he's wrong, expected returns on liquid and illiquid asset classes will necessarily be lower over the next decade, so the diversification benefits of illiquid assets won't be as strong going forward.
[Note: Admittedly, this is a bit of self-serving point made by the co-CIO of the world's largest hedge fund which invests only in liquid assets. He's trying to steer investors away from illiquid to more liquid alternatives like Bridgewater but he forgets that pensions and other institutional investors have a very long investment horizon, so they can take a lot more illiquidity risk.]
During his macro presentation Bob reiterated a point made by Ray Dalio above, namely, globalization was a powerful disinflationary force but with the shift in policy, protectionism and fiscal stimulus will be reflationary which is also good for debt servicing.
During their discussion, Roland Lescure pressed him on this point, asking him is he sees runaway inflation like in the 1970s and he said "no, more like 1-2% inflation because unlike then, debt levels are much higher now and rates are at historic lows so you can't get a credit expansion which leads to growth."
Roland also covered Bridgewater's unique culture, something I've openly criticized here but to be fair, something Ray Dalio has vigorously defended on LinkedIn, addressing the negative New York Times article back in September.
Admittedly, my criticism of Bridgewater's "radical transparency" is more along philosophical grounds as my thinking on human nature and pensions was deeply shaped by Charles Taylor. Unlike the economy and financial markets, I just don't believe you can codify the way human beings can or should interact at the office, no matter how good your intentions are.
Bob however defended radical transparency stating even though it's not for everyone, it makes for "deeper relations, enhances trust and productivity."
He gave an example of how they are all sitting in Ray's office talking about something and all of a sudden someone says something about Peter (just an example). Ray will immediately call Peter and tell him they are talking about him and ask if he wants to participate in the discussion as it pertains to him.
Now, if Ray called me and said "Leo, we're talking about you, want to come join", I'd probably say "have fun but stop wasting my time as I am immersed in markets". But that's me, I hate office politics, he said/ she said nonsense.
Still, I understand Bridgewater's principles, many of which are critically important for any organization that wants to learn from its mistakes and grow in the right direction. And unlike others, Ray Dalio will call you a slimy weasel to your face even if it hurts your feelings (call it tough love or refreshing honesty with zero tolerance for hypocrisy).
On this, Roland asked Bob about the iPad app where employees evaluate each other and give a point system. Bob said it's very accurate about him as his weaknesses are that he has "a tough time holding people accountable and often hears only what he wants to hear" (yup, I get that criticism a lot). On the flip side, people at Bridgewater learn a lot from Bob and value his wisdom and experience.
One thing I really liked was listening to Bob describe how Bridgewater measures success and compensates employees based on "the expected utility of what they've accomplished" not the results of what they produced. He said one year where they were up big and employees were happy, "Ray was horrified."
Bob explained it this way: "What if someone had invented something incredible which doesn't have an immediate payoff but will have a huge payoff in the future, how do you properly compensate someone like that?".
It's a great point because working at the large pensions, I often found that too much emphasis was being placed on front office portfolio managers who deliver the P & L and not enough emphasis was place on back, middle office, finance and good old researchers whose work isn't appreciated to the extent it should be.
The portfolio managers are "kings" and everyone else is there to serve them, which used to piss me off because behind every great portfolio manager there is a great team of people working to help them achieve their success.
Also, any portfolio manager can be lucky on any given year, how did he or she make their money, did they have a clear process, did they understand the risks they took, was it well thought out and based on good research, are they good and inspiring leaders? These are the critical questions.
During the Q&A, Bob addressed a few questions, I will try to summarize below:
- There are great opportunities in emerging markets but there will be winners (India) and losers (Brazil?) so investors need to tread carefully (read my recent comment on Trump and emerging markets).
- Bob said China is addressing its debt problems but one of the biggest macro events that went virtually unnoticed last December was when "China stopped pegging of the USD and moved to pegging to the USD and a basket of currencies, giving it a lot more flexibility in terms of monetary policy."
- On turnover, he said it's high (30%) during the first twelve to eighteen months but once employees pass that mark, it drops down significantly (Bridgewater isn't for everyone).
- He said they are worried about Canada's high personal debt levels and how it will negatively impact the housing market here.
- He reiterated the point that while globalization was disinflationary and dollar bearish, protectionism and fiscal stimulus are reflationary and dollar bullish.
All this to say I respectfully disagree with Ray Dalio, Bob Prince and the folks at Bridgewater which is why I recommended investors sell the Trump rally, buy bonds on the recent backup in yields and proceed cautiously on emerging markets as the US dollar strengthens and could wreak a deflationary tsunami in Asia which will find its way on this side of the Atlantic.
Unlike Ray Dalio and others, I just don't see the end of the bond bull market and I'm convinced we have not seen the secular low in long bond yields as global deflation risks are not fading, they are gathering steam and if Trump's administration isn't careful, deflation will hit America too.
This is why I continue to be long the greenback and would take profits or even short emerging market (EEM), Chinese (FXI), Metal & Mining (XME) and Energy (XLE) shares on any strength. And despite huge volatility, I remain long biotech shares (IBB and equally weighted XBI) and keep finding gems in this sector by examining closely the holdings of top biotech funds.
And in a deflationary, ZIRP & NIRP world, I still maintain nominal bonds (TLT), not gold, will remain the ultimate diversifier and Financials (XLF) will struggle for a long time if a debt deflation cycle hits the world (ultra low or negative rates for years aren't good for financials).
As far as Ultilities (XLU), REITs (IYR), Consumer Staples (XLP), and other dividend plays (DVY), they have gotten hit lately partly because of a backup in yields but mostly because they ran up too much as everyone chased yield (be careful, high dividend doesn't mean less risk!). Interestingly, however, high yield credit (HYG) continues to make new highs which bodes well for risk assets.
I better stop here because I can hear Ray Dalio screaming at his computer in Connecticut: "Son, what's your track record?"
It's not bad Ray and maybe one day we can meet again and I can cover Bridgewater a little more closely n a separate blog comment.
I reached out to Brian Lawlor at Bridgewater to ask him if they can share Bob's presentation. I haven't heard anything yet and truth be told, I really hope CFA Montreal posts this event and other upcoming events on its website here.
I was glad to attend this event, thank Roland Lescure who did a great job asking Bob Prince good questions and was glad I shook hands with Bob and Brian at the end of the evening.
I couldn't cover everything here but I will leave you with this, one thing that really struck me is how smart and nice Bob Prince is and what a tremendous asset he is at Bridgewater. He spoke highly of all his colleagues including Ray, Greg and Karen "KT", his trusted research associate.
Roland is right, Bridgewater is the "biggest and best hedge fund" and a big reason behind that success is obviously Ray Dalio but also Bob Prince, Greg Jensen and thousands of hard working employees who are navigating through a radically transparent culture, contributing to Bridgewater's success.
Below, Ray Dalio recently spoke with Andrew Ross Sorkin of CNBC sharing his thoughts on markets. I also embedded an older presentation where Ray discussed Bridgewater's culture.
If I receive feedback or new material, I will update this comment. As always, please remember to show your appreciation by subscribing or donating to this blog under my picture on the top right-hand side. Thank you and that's my track record!! -:)