“The economics of investing in bonds (and most financial assets) has become stupid”. That’s the latest message from Ray Dalio, one of the world’s most successful hedge fund managers.
Dalio is the founder of Bridgewater Associates, which is one of the most successful hedge fund groups in the world. That doesn’t mean Dalio gets everything right any more than Warren Buffett gets everything right. But it does indicate that his opinion is worth at least a listen.
So what’s he suggesting instead?
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The bond bull market might already be over
The bond bull market of the past 40 years may well be over. The real (after-inflation) yield that you can get on bonds is the lowest ever right now, says Dalio. If you buy most developed-world sovereign bonds then “you will be guaranteed to have a lot less buying power in the future”.
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The big risk now is that the world owns a great deal of this debt, just at the time when it’s more overpriced than ever before. This is all part of a very long cycle, notes Dalio, which has been driven to its climax by the efforts of governments to spend their way out of the Covid-19 recession.
Moreover, there’s another cycle at play – that of today’s superpower, the US, being challenged by a rising power, China. It’s the fact that the US has been top dog for such a long time that has “allowed the US to overborrow for decades”. US dollar bonds account for “over a third of global bond holdings”. A long way behind that, you have euro-denominated bonds.
Today however, China is on the rise as a competing superpower. And increasingly, big international investors are starting to put some money into Chinese bonds. Not much – “only about 6% of allocations in global portfolios” – but it’s a start.
This reflects a lot of different factors, including the fact that Chinese bonds yield more. But it’s also because the Chinese financial system is developing, and because the clear long-term desire of the Chinese authorities is to internationalise the yuan, and turn it into a reserve currency.
To my mind, that has interesting political ramifications beyond the whole “rise of empires” thing. Can China really internationalise the currency while maintaining the level of control over the economy and its own population that it desires? I’m not sure. That’s probably one reason why it’s so keen on digitising the yuan as well. But this is all a separate story for another day.
In any case, Dalio makes the point that we’ve got all of these big issues coming to a head right now. There are a limited number of ways for central banks and politicians to manage it. And that will have a big impact on investors.
So what can you invest in now?
Now, it’s worth bearing in mind that plenty of people thought that Japanese government bonds couldn’t go any lower in the 1990s and 2000s, and they did. So, while high-conviction pieces like this can be very compelling reads, you have to remember that lots of confident forecasts end up going nowhere.
But given where we are right now, I also think it’s a mistake to dismiss what seem like extreme views. It’s very difficult for us to see how far we’ve already come in terms of what would have seemed “unthinkable” at the start of this century. Central banks printing money? Unthinkable. Governments sending money direct to individuals? Unthinkable.
What’s the next “unthinkable” thing that will happen? Well, one very obvious option is for central banks to ignore inflation and instead use their money-printing and regulatory powers to hold yields on debt down, while the owners of said debt pay a huge inflation tax.
There is also, says Dalio, the risk of capital controls (in other words, you won’t be able to send your money around the world as easily because it’ll be needed at home) and also much higher taxes. He’s writing for a US audience primarily, but it’s easy to see all of these things applying to most developed economies - potentially.
So what on earth can you invest in at this point? Dalio concludes that “a well-diversified portfolio of non-debt and non-dollar assets along with a short cash position is preferable to a traditional stock/bond mix that is heavily skewed to US dollars”.
What does that mean? Overall, Dalio is saying that you shouldn’t have as much exposure to bonds as might once have been deemed traditional. He’s also arguing that US investors shouldn’t have as much exposure to the US dollar as they probably do.
For UK-based and private investors, this take isn’t quite as helpful. Dalio isn’t keen on cash because he thinks it’ll be devalued. To my mind though, all private investors need cash because of the “optionality” (that’s a fancy word for flexibility) it gives you. So I wouldn’t worry about that too much.
In terms of bonds, as I’ve said before, no one gets everything right. But it’s certainly not a good time to be “overweight” them in your portfolio.
In the “real” assets side of things – we are keen on UK stocks right now because they’re cheap relative to the rest of the developed world. I’d also still be keen to hold some money in gold – despite the risks of capital controls – because we’re not there yet (and it’s worth noting that unlike the US in the 1930s, the UK has never made owning gold illegal)
Also note that Dalio is specifically bullish on Asian emerging countries versus “assets in the mature developed reserve currency countries”. We have an in-depth piece on one very specific and dynamic emerging Asian country – Vietnam – and how to invest in it, in the current issue of MoneyWeek magazine.
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