Ray Dalio and his team at Bridgewater Associates are famously one of the few hedge funds that called — and profited from — the 2008 financial crisis. More recently, he labelled Bitcoin a bubble not only months before it popped, but before the great rally of Christmas 2017 had begun.
Yet despite the warning of an impending downturn for the past two years, Dalio recently admitted that he was blindsided by the recent crash, missing out on opportunities as the coronavirus pandemic swept the globe and brought down markets down with it.
During this time Bridgewater Associates’ flagship macro Pure Alpha fund initially lost 20% as the market tumbled, before making up to $4bn shorting European firms.
Pure Alpha fund's initial loss
Bridgewater’s downturn indicators
Previously, Dalio has explained that Bridgewater Associates was able to successfully predict the 2008 financial crisis by studying past debt crises and depressions. It included looking at everything from the Great Depression to the hyperinflation in Germany following the First World War to create a “depression gauge”.
The two main things Bridgewater looks for are debt growing faster than income and interest rates reaching zero or close to zero. The first of these sets the scene for a debt squeeze while the second means policymakers have little room to reduce the high debt burden, stimulate the economy and prevent a downturn.
“The key is that a depression, in our view is not the same as a long and large recession but is rather a different phenomenon entirely,” Bridgewater Associates wrote in 2002.
“Normal economic linkages are maintained in recessions, but break down during depressions… In both [the US in the 1930s and Japan’s current deflationary depression] monetary policy (falling interest rates) failed to stimulate economic growth or financial markets, leading to an unmanaged economic contraction in which central bank control is very limited,” the firm explains.
Dalio says the Bridgewater’s crisis indicators started flashing in 2002. At this time the risk of a depression reached over 25% — the rebound in stocks from the dot-com bubble began to take hold as a result of big rate cuts, which stimulated borrowing and spending. By 2006, the firm was convinced a bursting of the bubble was imminent. In July 2007, as markets made a minor correction, Bridgewater said an all-out crash were imminent.
By mid-2008, the markets were in freefall and banks lost over $500bn. That year, Pure Alpha gained 8.7% after fees. Investors poured money into the firm, cementing Bridgewater’s position as the world’s biggest hedge fund.
Amount lost by banks in mid-2008
Yet, even as the coronavirus took hold earlier this year, Dalio seemed, initially at least, unfazed. On 12 February he said that the virus “probably had a bit of an exaggerated effect on the pricing of assets because of the temporary nature of that, so I would expect more of a rebound”.
By mid-March, Bridgewater’s Pure Alpha fund was down 20% for the year. By 15 March It had lost 13%, building on an 8% drop in February, an inside source told the Financial Times.
Dalio then responded to the publication.
“We did not know how to navigate the virus and chose not to because we didn't think we had an edge in trading it. So, we stayed in our positions and in retrospect we should have cut all risk. We’re disappointed because we should have made money rather than lost money in this move the way we did in 2008,” he said.
“We did not know how to navigate the virus and chose not to because we didn't think we had an edge in trading it. So, we stayed in our positions and in retrospect we should have cut all risk” - Ray Dalio
Part of the problem, it seems, is that there was very little in the history books to look to for the current crisis.
At the close of 2008, Dalio had told investors: "Since I believe that a big common mistake that caused many investors problems in 2008 was not having a broad enough perspective, I believe that one of the most important lessons for those who did badly in 2008 is to have a ‘timeless and universal investment’ perspective, which means to broaden your perspective to understand what happened in long-ago times (eg, in the 1930s) and faraway places (like Japan and Latin America)".
This time around, however, Dalio lamented “the extremely rare nature of the circumstances."
The fund wasn’t caught napping for long, however. Before the end of March, Bridgewater Associates had reportedly netted a cool $4bn from $14bn-worth of short positions it had previously taken on European companies.
Furthermore, Dalio has now switched to the position that the global economy and companies are in real trouble, predicting that US companies alone could lose up to a staggering $4tn as a result of the pandemic.
US companies' predicted loss due to coronavirus, according to Ray Dalio
"There will also be individuals who have very big losses and individuals who can't afford the shock they're going to have," he told CNBC, adding that with the US Federal Reserve and other global monetary policymakers already having cut rates, there’s little more they can do.
Dalio’s depression gauge may well be flashing red.
“Long-term interest rates hitting the hard 0% floor means that virtually all asset classes go down because the positive effects of interest rates falling won't exist (at least not much),” Dalio recently wrote on LinkedIn. “Hitting this 0% floor also means that virtually all the reserve country central banks' interest rate stimulation tools (including cutting them and yield curve guidance) won't work.”
If Dalio’s risk radar is once again working, then this could once again be a keen indicator of further upheaval to come.