What Ray Dalio is saying about this market
Billionaire hedge fund manager Ray Dalio has described the novel coronavirus (covid-19) as “one of those once in 100 years catastrophic events” that will hit leveraged companies the hardest, cause substantial market dislocations and potentially lead to a significant downturn.
The Founder of Bridgewater Associates, one of the world’s most prolific alternative managers with US$160 billion in assets, separated the crisis into three inter-related components: 1) the virus, 2) the economic impact of reactions to the virus, and 3) the market action.
“They all will be affected by highly emotional reactions. Individually and together they lend themselves to a giant whipsaw with big mispricings, with the off chance that it will trigger the downturn that I have been worried would happen with both the big wealth/political gap and the end of the big debt cycle (when debts are high and central banks are impotent in trying to stimulate).”
Dalio, whose views are highly sought after by investors given Bridgewater's focus on macro investing, published his comments on a LinkedIn post yesterday. In this wire, I summarise his commentary pertaining to the economy and markets.
- Markets won’t distinguish between companies
Given the toll coronavirus is having on the global supply chain, manufacturing activity and consumer spending, Dalio said businesses will “certainly” see revenues decline until the situation reverses, and while it should result in a V- or U- shaped rebound in profitability this was not a certainty. Goldman Sachs has already forecast two consecutive quarters of negative global GDP growth.
He pointed out that during the drop, the market impact on leveraged companies within the most severely affected economies would probably be significant.
“My guess is that the markets will probably not distinguish well between those which can and cannot withstand well the temporary shock and will focus more on their temporary hit to revenues than they should and underweight the credit impact—e.g., a company with plenty of cash and a big temporary economic hit will probably be exaggeratedly hit relative to one that is less economically hit but has a lot of short-term debt.”
2. Brace for more volatility (and opportunities)
Dalio is of the view that the “very unusual and fundamentally unwarranted market action” seen in recent days will continue as the situation catches some investors out.
“The markets are being, and will continue to be, affected by these sorts of market players getting squeezed and forced to make market moves because of cash-flow issues rather than because of thoughtful fundamental analysis.”
Despite this, Dalio said the shakeout has presented attractive opportunities such as some companies with good cash yields.
3. Rate-cuts won’t stimulate demand
Despite central banks including the RBA and Federal Reserve having rushed to cut rates, Dalio doesn’t believe that easier monetary policy and increased liquidity will lead to any material pickup in buying and economic activity, though they can “goose risky asset prices a bit”.
“That’s true in the U.S. In Europe and Japan, monetary policy is virtually out of gas so it’s difficult to imagine how pure monetary policy will work. In Europe, it will be interesting to see if fiscal policy stimulations can pick up in this political environment.”
He pointed out that most rate cuts have already happened via the declines in bond and note yields which is what equities and most other assets are priced off, and suggested that more effective policy than blanket rate cuts would be to provide entities facing cash crunches with liquidity.
4. Longer-term impact overshadowed by politics
While Dalio doesn't think coronavirus will have a longer-term economic impact, he can't say that for sure because of political and social instability.
“As you know, I believe that history has shown us that when a) there is a large wealth/political gap and there is a battle against populists of the left and populists of the right and b) there is an economic downturn, there are likely to be greater and more dysfunctional conflicts between the sides that undermine the effectiveness of decision making, and this is made worse when c) there are large debts and ineffective monetary policies and d) there are rising powers challenging the existing world powers.”
Dalio signed off his post with a piece of candid advice: that investors should imagine the worst-case scenario and protect themselves against it.
Like many hedge funds, Bridgewater is secretive about its portfolio positioning. However, in its 2020 Strategic Report, the manager did hint that it was looking to diversify more into developing markets, particularly emerging Asia, and that "new alpha opportunities will arise from the box that central banks find themselves in".
According to Institutional Investor, the Bridgewater Pure Alpha strategy has returned 11.5% annually over its 28-year history to 2019, while All Weather has provided 7.8% per annum since 1996.
- For another view, check out our coverage of Warren Buffett's thoughts on long-term investing during market crises
- Other perspectives can be found in my colleague Patrick Poke's write-up 'How to invest during a global pandemic'
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