Bridgewater is one of the biggest money managers in the world, and its founder Ray Dalio has been proved right more often than not. It managed to call the sub-prime crisis correctly slightly over a decade ago and it has consistently outperformed the market since then. Even in the ruthlessly competitive world of hedge funds it is a class act, with a long record of success.
When it takes a major position, most of its rivals quite rightly take notice. In the past couple of weeks it has emerged that Bridgewater is targeting a collapse in European stocks. Earlier in the month, it was revealed it had taken a $6.7bn short position against the continent’s largest businesses and only a week later that had grown to more than $10bn.
Fault lines reopen
That is a lot of money to wager on a fall in the market, especially as the major indices have already corrected sharply since the start of the year. Germany’s Dax has fallen by 17% since January, France’s CAC by 16%, and the Euro Stoxx 50 that covers the continent’s biggest companies by 18% (although the FTSE 100 is only off by 2%, mainly because it is so dull). Most people might well think it is time that equity prices bounced back. There are three big reasons why Bridgewater’s bet is going to pay off.
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First, Russia’s invasion of Ukraine is turning into a long, brutal war of attrition. There is no sign it is ending any time soon. Sanctions will remain in place for many years to come, hitting exports to Russia. More importantly, Europe is going to have to find a way of living without Russian oil and gas. That might be just about possible, but it will be expensive (the reason we imported it from Russia was because it was relatively cheap).
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In Germany, some form of energy rationing now looks a certainty over the coming winter, and if that includes factory closures or shortened working weeks, it will tip the country into recession. Worse, the major European economies will all have to raise defence spending, as well as paying for the arms they are shipping to Ukraine, and sooner or later pay for reconstruction as well. It will take a huge toll on the economy.
Next, inflation is about to reopen the fault lines in the single currency. We already knew from the crisis of 2011 and 2012 that the euro was dysfunctional and open to speculative attacks. European Central Bank chief Mario Draghi just about managed to paper over the cracks with printed money. But now? The reality is that the euro has never faced serious inflation before and is heading into a crisis as the ECB has to choose between controlling prices or bankrupting Italy and Greece. There have already been sharp rises in bond yields in the peripheral countries, and the ECB has promised to come up with a mysterious sounding “stabilisation tool” to control those, although there is not much detail on how it will work yet. The real test will come when interest rates start to rise next month – what happens then is anyone’s guess.
Finally, Europe’s trade deficit is soaring. Whatever their other problems, the major EU economies always managed to run a big trade surplus. That has now switched. The eurozone countries recorded a deficit of €16bn in March, and that is rising all the time. In part that reflects the cost of importing more energy. But it also reflects its declining competitiveness. That deficit will subtract from growth and at the same time put pressure on a currency that has already fallen close to parity with the dollar, but can still go down a lot more. From here on, trade is going to subtract from growth rather than help it – and that is a big change.
True, the British, American and Japanese economies are hardly in great shape either. Inflation is still dangerously high, political leaders don’t have the will to control it, and central banks are still trying to work out what level of interest rates will be needed to stop it running out of control. There will be recessions in most of the major economies. The only real question is how deep they will be. But Bridgewater is right: Europe is the weakest of all the major regions, and its economy is heading into a steep downturn – and its huge bet against Europe will prove very shrewd.
