Ray Dalio has been painting a bleak picture of late. In a recent interview with MarketWatch, the Bridgewater Associates founder said that the world would change in “shocking ways” over the next five years.
Capitalism, Dalio says, is in crisis. Not only is the enormous COVID-19 debt expected to halt US economic growth, but the resulting fallout could see the world turn its back on the dollar. This would reduce the country’s clout and, with it, the American standard of living.
Dalio also thinks that the most bitterly contested election in US history could make things even worse, no matter who wins. “I look at it mechanically, like a doctor looking at a disease,” he told the publication.
It’s no wonder Dalio is morose. Bridgewater Associates lost $25bn throughout March and April, according to Bloomberg, after Dalio’s legendary quant modelling strategy misread the coronavirus pandemic.
Bridgewater Associates’ fabled flagship fund, Pure Alpha II, has fallen 18.6% year-to-date through August. As a result, investors have deserted Dalio, taking with them $3.5bn in the first seven months of the year, according to analysis by Fortune.
Amount Bridgewater Associates lost throughout March and April
A bleak outlook for Dalio
In July, Dalio lost a three-year tribunal against two former Bridgewater Associates staff members that had accused him of revealing trade secrets. He was also pulled into another personal dispute when former CEO Eileen Murray accused him of deferring her compensation because of gender discrimination. During the month, Dalio laid off several dozen workers — an unusually large cut for the firm.
Of course, Dalio is no stranger to voicing his thoughts but, given his firm’s underperformance this year, those thoughts have turned increasingly negative. His frustration is understandable. After all, the Pure Alpha II fund previously returned an average 11.1% annually since its inception in 1975 to 2018.
He shrugged off the fund’s first annual loss of 0.5% in 20 years in 2019, but now he seems downright gloomy.
“The United States’ relative position in the world, which was dominant in almost all these categories at the beginning of this world order in 1945, has declined and is exhibiting real signs that should raise worries,” he told MarketWatch in September.
“It is running a deficit to the rest of the world that is financed by borrowing money so we are producing liabilities.”
“The United States’ relative position in the world, which was dominant in almost all these categories at the beginning of this world order in 1945, has declined and is exhibiting real signs that should raise worries” - Ray Dalio
Dalio warned that if the US doesn’t force increased productivity then it will lose its ability to borrow in the future.
How the US government ultimately pays for that deficit is one of three factors Dalio believes will shape the coming months and years in the markets, with the other two being the probability of a messily contested US election and China’s dominance.
“Printing money is the most expedient, least well-understood, and most common big way of restructuring debts,” Dalio wrote in the latest chapter of his upcoming book The Changing World Order. “It’s like playing Monopoly in a way where the banker can make more money and redistribute it to everyone when too many of the players are going broke and getting angry.”
The deficit will be huge whether Trump or Biden wins the election. However, one of them does need to win it, and Dalio believes it needs to be an obvious victory.
“The worst-case scenario could be a situation in which we don’t have a clear winner of the elections and we don’t have a clear process for getting at the winner of that election. If there’s continued conflict… you could start to see bad things happen,” he told Bloomberg.
“The worst-case scenario could be a situation in which we don’t have a clear winner of the elections and we don’t have a clear process for getting at the winner of that election. If there’s continued conflict… you could start to see bad things happen” - Ray Dalio
He’s no less pessimistic about the rise of China, either. “There are five kinds of war and we’re in four of those: there’s a trade war, a technology war, a geopolitical war, there’s the beginning of a capital war, and then there’s the question of a military war. Having watched these things over a period of time and having close contact with the situation, we don’t internationally have a rule-based system.”
The importance of diversification
Despite Dalio’s bleak outlook, he thinks the answer for investors is straightforward. “We have to realise we’re in a period of great risk and the most important thing is to know how to diversify well, to diversify by asset class to achieve balance, to diversify by country and to diversify by currency,” he told Bloomberg, adding that it’s important to know how to balance between assets classes like gold and inflation-indexed bonds.
“Diversification doesn't cost you anything. Because when your asset classes are going to — if you balance them right — have approximately equal expected risk-adjusted returns, you can balance them, because they all compete with each other … Diversification is a wonderful, mechanical, good way to reduce risk without reducing expected return.”
“Diversification is a wonderful, mechanical, good way to reduce risk without reducing expected return” - Ray Dalio
Dalio’s strong investment conviction gives a sense of reassurance. He is, after all, someone who can point to 20 years of high returns — a record which suggests Bridgewater Associates’ performance will likely return to its previous strength again.
“We had a bad year so far,” he admitted, adding: “Over the last 20 years, we’ve never had any significant downturn — nothing, they were all positive years — but we knew that there would come a day.”
“I don’t have a problem with my clients because we have something like $140bn worth of clients who have faith in us otherwise they wouldn’t hand us their money. We’re the largest hedge fund for a reason.”