Published in English, Ray Dalio's book Principles became one of the top business bestsellers of 2017. She is recommended by Bill Gates, Tony Robbins, Arianna Huffington, Tim Ferris. Now it is published in Russian by the publishing house MIF. The Russian-language book Principles: Life and Work by Ray Dalio was recommended by German Gref. He also wrote the preface to the Russian edition.
As a translator, I was fortunate enough to be part of the team that worked on the preparation of the Russian text. A scientific editor, literary editor, executive editor, proofreaders worked on it. And also a whole team of copyright holders, including in-house translators at Bridgewater Associates. They read the finished translation and made terminological corrections with the words: "This is a Bridgewater term, and we use it this way." It was useful: now we are sure that we have conveyed both the spirit and the letter of the original. Although sometimes the executive editor Yulia Potemkina and I argued with our American colleagues, defending our wording in order to better convey the nuances and subtleties in Russian. As they say, it was a glorious hunt! I hope you appreciate the result.
Who is Mr. Dalio?
If you know who Ray Dalio is, you have most likely already pre-ordered this book and buy it right after you leave the print shop. And if you don’t know, then here are a few words about him. Believe me, the person who is one of the 100 most influential people on the planet (according to Time) deserves it.
Ray Dalio was born and raised on Long Island in an ordinary family with an average income. He is the only son of a professional jazzman. According to Ray himself, he did not like school because there was a lot of rote cramming, and he was never able to memorize facts that could not be explained rationally (for example, phone numbers), and did not like following instructions. At the same time, he was very curious and tried to get to the bottom of it himself. (So do not rush to scold your children for school failure☺)
At the age of 12, Ray Dalio began working part-time at the fashionable Links Golf Club caddy - a boy who brings clubs and balls while playing golf. Among the players, he constantly heard talk about promotions. “Is it any wonder that with the money I was earning, I started gambling on the stock exchange,” says Ray Dalio. - My first investment was shares in Northeast Airlines. I bought them because it was the only company I had heard of that had a stock price of less than $ 5 a share. I decided that the more shares I buy, the more money I will make. Stupid strategy, but my investment has tripled. I was very lucky, but I didn't know it then. I decided that it was easy to make money by gambling on the stock exchange, and I plunged into this occupation. "
After high school, Ray entered C. W. Post College at Long Island University, where he was admitted on probation due to his low school GPA. He liked studying in college, unlike school: he learned what interested him, so he had no problems with grades. In the spring of 1971, he graduated from college as one of the best students, which gave him the opportunity to go to Harvard Business School.
Then the in-demand young specialist with an MBA degree headed the futures hedging business at the large and successful brokerage company Shearson. “Although I loved the job and my colleagues, I didn’t fit into Shearson’s corporate boundaries because of my wild temper,” says Ray Dalio. - For example, once I staged a trick that now seems very stupid to me: I brought a stripper to the California Grain & Feed Association convention, paying her to undress in front of the audience during my speech. I also punched my boss. No wonder I got fired. That being said, brokers, their clients, and even former employers liked me, and they continued to turn to me for advice. Moreover, they were willing to pay me to consult, so in 1975 I founded my own company, Bridgewater Associates. "
At that time, Ray Dalio was 26 years old, and his first office was one of the rooms of his rented three-room apartment. Hedge funds were then fairly new financial institutions that, using borrowed funds, gambled in the markets, trying to get high returns. 40 years later, Bridgewater Associates is considered the fifth most important privately held company in the United States (by Fortune) and the largest hedge fund in the world. Just think, Ray Dalio's company has made more money for their clients than any other hedge fund in the world! Ray Dalio's unique investment principles have transformed the entire industry, which is why the leading investment magazine aiCIO named him "The Steve Jobs of Investing", and Bridgewater is often called the Apple of the investment world.
A few facts about Ray Dalio:
- Ranked 54th in the Forbes World Billionaire List for 2017;
- he has four sons and a wife, Barbara, with whom he has lived for over 40 years. The wedding trip of newlyweds Ray and Barbara Dalio was Ray's business trip to the USSR in 1977, on which he took his young wife with him;
- practicing transcendental meditation twice a day since 1969;
- her deepest passion (outside of work) calls the exploration of the ocean. Recently tried ice diving in Antarctica (you remember Ray Dalio is 68 years old, right?).
What are Principles?
Our whole life is about making decisions every second how to react to this or that situation. If we are faced with something for the first time, we are forced to reflect on our actions. If the situation repeats itself from time to time, our actions become automatic, turning into a habit, and the brain saves resources for reaction.
“From my own experience, I've learned how useful it is to analyze and write down the criteria by which I make any decision,” says Ray Dalio. - So I got into the habit of doing it all the time. Over time, my set of principles began to resemble a collection of recipes for decision making. I have shared these guidelines with people at my company, Bridgewater Associates, and have offered to help test them. It is this approach and the principles on which it is based, and not at all my uniqueness, that allowed me to achieve success. "
These principles can rather be called general rules. It is important to remember that there are exceptions to any rule and none of them can replace common sense. Ray Dalio himself advises to take these principles as GPS: “The navigation system helps you get to your destination, but if you blindly follow its instructions, say, fall off a bridge, it will be your fault, not the system. Just as you can improve GPS performance by downloading updates, it is important to continually improve and supplement the guidelines by finding and discussing exceptions to them. ”
Ray Dalio's guiding principles
The main distinguishing feature of Bridgewater is its corporate culture, which is based on the principle of meritocracy of ideas - a term coined by Ray Dalio. The essence of the meritocracy of ideas is to bring together smart, independent-minded people, to allow them to openly express different points of view in order to formulate the best collective solution and resolve differences that have arisen based on the competence of the participants. To make this system work, Ray Dalio introduced the principle of radical truth and radical transparency to the company.
1. The principle of absolute honesty and utmost transparency
As the name suggests, this principle requires employees to speak "the truth and nothing but the truth." “But it’s not necessary to tell a colleague that a new haircut doesn’t suit her,” jokes Ray Dalio in one of his speeches. - Of course, we are talking about working moments. By adhering to the principle of absolute honesty in dealing with colleagues and expecting the same attitude towards yourself, you contribute to frank discussion of important issues, and not to silence them. By being completely honest, you don't have to constantly try to look good in front of others and still wonder what your coworkers think. In addition, when you express your opinion, everyone can openly appreciate the logic of your thinking. If you are well versed in the matter, it will immediately become obvious, as, indeed, in the event that you do not know the topic well. So this principle helps to maintain high quality standards. Of course, he does not insure against mistakes in the present, but, perhaps, is the only way to avoid them in the future. 
2. The principle of decision-making based on competence
It may seem that the right to speak openly on various issues and criticize any employee, regardless of rank and title, will lead to demagoguery and chaos. But in this case, Ray Dalio has "foolproof" - the principle of decision-making based on competence. It is simply impossible for every employee to participate in discussions on every issue, and besides, it is much more effective to evaluate the opinion of more professional specialists than less professional ones. This is what Ray Dalio means by “competent decision making”. If the competence of specialists is assessed correctly and consistently, you will have the fairest and most effective decision-making system. It will not only allow you to get the best result, but also preserve the collective spirit, since even employees who disagree with the decision will be able to accept it.
3. The principle of absolute open-mindedness
“My success in life is largely due to the ability to cope with what I do not know, - this is another confession of Ray Dalio. - If you objectively assess reality, then you understand how unlikely it is that your solution is always the best. Therefore, it is invaluable to know what exactly you do not know. If you know that you have blind spots, you will look for a way to get around them, but if you do not know that you are missing something, you will continue to face the same problems. "
Of course, a meritocracy of ideas isn't for everyone. But for those who get used to this system - and this is two-thirds of those who try it - it becomes so effective that they can no longer imagine any other course of action. What almost everyone likes the most about this system is the assurance that there are no double standards.
Some more practical tips from Ray Dalio:
- Don't confuse objective reality with your expectations.
- Don't worry about what people think of you, rather worry about achieving your goals.
- Don't overestimate the short-term effects over the long-term ones.
- Don't let pain get in the way of progress. There is no result without pain.
- You can only blame yourself for a bad result.
What will be your principles?
Using the classification from Joseph Campbell's The Thousand Faced Hero, which, incidentally, Ray Dalio calls a must-read for everyone, he himself is now in the Return of the Gift stage: “I am talking about these principles because now I am at that stage of life when I want to help others to become successful more than to become more successful myself. These principles have helped me and many other people tremendously, and therefore I am sharing them. Decide for yourself how valuable they are to you and how you will apply them.
Your principles can be anything you like, the main thing is that they are authentic, that is, reflect your character and values. The worst thing that could be is falsehood. Ask yourself what you want, find examples of people who have achieved a goal, analyze the causal patterns that helped them in this, and then try to apply them in such a way as to achieve your own goal. "
The founder of the hedge fund Bridgewater, the billionaire who is called "Steve Jobs from investing" by the media, shared management secrets, said what he considers the main quality of an employee and why he does not trust computers
Ray Dalio (Photo: Andrey Lyubimov / RBC)
Who is Ray Dalio?
Coming from a family of New York jazz musician, Ray Dalio started investing as a teenager when he bought shares in Northeast Airlines for $ 300. After completing an MBA from Harvard Business School, he worked at the New York Stock Exchange, and in 1975 founded his own company, Bridgewater Associates, which innovated in asset management. Bridgewater is now one of the largest hedge funds on the planet, and Dalio is one of the top 100 richest people in the world. The assets that the company manages are estimated at $ 160 billion (at the end of 2017), Dalio's own fortune is $ 18 billion. The 69-year-old billionaire, who is called "Steve Jobs from investing" by the American media, is also widely known for his charitable activities. At the end of August, his book "Principles" was published in Russian translation.
"You will not be able to endure people whose values you do not respect all your life."
- Mr. Dalio, what are the main qualities that helped you to achieve success?
- Curiosity, courage, adventurism. Everything that I have in life I owe not to my knowledge, but rather to my ability to work with what I don’t know. I like to build theories and then put them into practice. At the same time, I am always afraid to make mistakes, and this makes me ask for help from other people who are able to figure out what I do not understand.
- You are a very rich man. What does money mean to you?
- Money was an accidental purchase in a game that I have been playing all my life. I have a passion for doing something new. When I was 12, I started trading on the stock exchange. Buying and selling stocks is pure play. Feels like it's about the same as "falling in love" with chess. At the age of 26, when I realized that I wanted to work for myself, money began to mean freedom of choice for me, the opportunity to be my own boss. Then, when I had a family, they became a guarantee of safety for my loved ones. A little later, money turned into an opportunity to influence other people. Until now, this is the most important thing that money can give me. I am not one of those who like luxury, and have always feared that wealth might spoil me. My parents were not very wealthy, and a humble childhood taught me to value the most important things in life - relationships with people and family. But I will not deny that I managed to make a lot of money, and now I can spend some of it to help society. In 2011, I took the so-called Giving Oath (an initiative proposed by Bill Gates and Warren Buffett - RBK), promising to donate at least half of their fortune to charities such as the fight against polio. Philanthropy brings incomparable pleasure.
- Can you name the most important lessons that life has taught you?
- Here are two formulas that I managed to derive. First: "The key to success is dreams combined with a sober assessment of what reality is, as well as the knowledge of how to overcome this reality, and the determination to do it." Everyone has their own goals in life, but in order to achieve them, you first need to define your principles in order to clearly understand what is really important and what is not. At the same time, your principles should be very realistic, they should work. The second formula is: "Pain plus thinking about it equals progress." Pain always shows that something is wrong. If you can quickly figure out what it is and fix the problem, you are moving in the right direction.
- In your book, you write: "The right person in the right place is the key to success." How do you recruit employees, what qualities do you pay attention to?
- Every employee has three “dimensions”: his values, abilities and skills. Values are what a person considers most important in life. Abilities are features of thinking: for example, someone is creative, someone is accurate, someone is good at math. Natural abilities differ from person to person. Skills are something that can be learned: for example, you can learn programming, a foreign language, the basics of journalism. Headhunters in most companies hire people primarily for their skills. At the same time, they pay some - not too much - attention to the candidates' abilities and no attention to their values. For me, everything is exactly the opposite: values come first, then abilities and, finally, skills.
- Why are values so important?
- When you recruit people to work on a common task, it is important for you to know how they will behave when you are not following them. Are they going in the same direction that you yourself want to go? Business is often like a battle, and in battle, skills and abilities are not as important as a person's principles and strength of character. Interpersonal relationships are built on common values, and deep, sincere relationships with people are the most important thing that a leader can have. If an employee works just for a salary, you actually treat him as equipment, and he also perceives himself as a cog in a big car. Of those who work for a salary, you cannot create a strong team. In addition, in order to achieve your goals, you must feel the joy of working with people. Work is a big part of life. Who do you want to spend this part of your life with? Probably with people you treat like your family or your friends. You will not be able to put up with people whose values you do not respect all your life.
"Democracy is a bad system"
- It is important for a manager to get the best answers to his questions, wherever those answers come from. And if your self-esteem and adherence to your own ingrained beliefs are on the way to a better answer, it's a tragedy! The ego easily becomes an obstacle to making better decisions.
- How is the decision-making process organized at Bridgewater Associates?
- We have a meritocracy of ideas in our company - this is a system in which the best ideas win. It is rather complicated, I will try to explain the essence in a nutshell. Typically, companies have one of two types of governance. Some are autocratic - all decisions are made by the boss, and the rest obey his orders. In others, democracy: everyone has one vote, and decisions are made by majority vote. In my opinion, both systems are bad. Autocracy means that all the best thoughts are in the boss's mind, but in reality this is often not the case. And how can such a boss manage to lead people if he only knows how to give orders? Democracy is a bad system: it assumes that all people are equally capable of making decisions, which they are not.
At Bridgewater Associates, we assess the ability of each individual employee to make the right decisions on a variety of subjects. Those who come up with good ideas more often than others receive a higher voice weight than other employees. Such scoring allows not to abandon the system of collective discussion, but at the same time not to slip into the principle of "one person, one vote": when voting, the opinion of more talented employees will affect decision-making more than the opinion of those who rarely come up with good ideas. At the same time, the final decision is still made by the manager, so it is always clear who is responsible.
- Are your subordinates allowed to criticize you?
- I encourage them to do it! Good communication with people is the basis of productive work. If you suppress criticism, you prevent employees from coming up with good ideas and cause them to accumulate resentment, which ultimately leads to rebellion. In addition, unwillingness to listen to criticism will lead to the fact that you simply do not recognize what problems the company has. But you need to see all the difficulties in time and eliminate them as soon as possible.
- You call yourself a supporter of "radical transparency": at Bridgewater Associates you fight secret meetings of managers and strive to convey information about the real state of affairs to employees. Why is transparency so important?
- Because transparency gives an understanding of what is really happening and what people really think. It also serves as the basis of trust: a person himself draws conclusions about the position of the company, and does not decide whether to trust the speeches of the management. A high level of understanding of what is happening allows people to overcome differences and get rid of the struggle within the company of various parties that pursue their own interests.
Employees at Bridgewater Associates (Photo: Bridgewater Associates)
"You have very few entrepreneurs in Russia"
- What is good leadership? How should a leader organize the processes in the company in order to achieve the growth of his business?
- If a person leads the company well, it means that he leads people where they want to go. You cannot force employees to work under pressure, it will not give a good result. You need them to be with you, mind and heart. This means that, first of all, the leader must understand what the people themselves want, and for this he needs to build reliable communication with them - to find out what they believe in, what they consider to be fair. The ability to hear people is the main quality of a leader.
- Name the most common shortcomings that prevent entrepreneurs from building a business.
“The biggest problem with entrepreneurs is that they don’t know how to deal with failure. To build a solid business, you need to think differently and be right at the same time. Entrepreneurs try to be the first to do something that hasn't happened yet, they constantly experiment, and failure is a natural part of this process. The ability not to give up, but to learn quickly from mistakes is a rare quality among entrepreneurs. The second problem is the lack of determination to turn your vision into reality. It is obvious that an entrepreneur must be a person, “burn” with his dream. But at the same time, he must be a practitioner: after all, his work is mostly very daily, routine. Especially at the beginning of the journey: after all, an entrepreneur usually starts building a business with almost no money and no track record that could quickly attract investors. Therefore, he must make his dream a reality as quickly as possible, showing that he can make money on it. Very few people succeed in being both a dreamer and a practitioner.
- Do Russian entrepreneurs have the same disadvantages as all others?
- No I do not think so. Both the attitude towards business and the realities of entrepreneurship in Russia are very different from most other countries. You have very few entrepreneurs in Russia. Why? What hinders business in Russia and how can you make more entrepreneurs? These are very important questions, because the answer to them determines whether you can revive your economy. In my opinion, there are five main criteria that determine the development of the economy. Does the country have a good and relatively inexpensive education system? How big is a country's external debt - countries that have little debt can grow faster. What does a country have with natural resources? Do you have a well-developed capital market so that entrepreneurs can easily attract investment? And the last criterion: how good is the business climate in the country and what kind of work culture is it?
Countries where it is easy to register and start a business, where the law works well and there is little corruption, and where corruption is low, manage to make sure that hard work and human ingenuity are generously rewarded. Russia does not have a developed capital market, and it also has tangible problems with the business climate - many of them dating back to the Soviet era. You must solve these problems for your economy to grow. However, when I think about how far Russia has come from the point where it was in the 1990s, I begin to believe that your country has good prospects.
"The development of artificial intelligence reduces the uniqueness of man as a species"
- Today, many decisions in the financial sector are made using artificial intelligence (AI). When is AI useful and when not?
- Artificial intelligence is a very complex term, so I would like to give a more precise definition. This is the most common name for the algorithms that computers use to make decisions. People come up with these algorithms, and in essence they are no different from any other decision-making method. Everything that a person can express in words can be formulated as a set of some equations. How efficiently the algorithms work depends only on how good the equations themselves, invented by a specific person, are.
Another form of artificial intelligence is machine learning. Everything is structured differently here: you enter a huge amount of data into a computer, and it itself compiles algorithms for you. The key question in machine learning is whether an algorithm that has worked well in the past will perform well in the future. Machine learning works well if you have a large sample of examples that the computer learns from and the rules of the game that never change - like in chess, where computers have no equal. But in the world we live in, any situation can change, and the future can be radically different from the past. When the rules of the game change, it becomes much more difficult for machine learning to make the right decisions. And then the next question arises: do you understand how your algorithms work or not? If reality is changing rapidly, and you do not have a clear understanding of exactly how your computer makes decisions, artificial intelligence becomes simply dangerous: you have nothing left but a blind faith in its infallibility.
“Today, many people fear that robots will steal their jobs. Should we be afraid of this?
- This is one of the biggest problems of our time. First of all, the displacement of people by robots will multiply the income gap between the rich and the poor. A lot of people will begin to feel their worthlessness. The development of artificial intelligence reduces the uniqueness of humans as a species. Previously, people were mainly engaged in manual labor. Then the machines surpassed them in this, but people still had the privilege - after all, they could think. Now machines are pushing people more and more into the field, which he believed belonged only to him - they learn to think. What can we counter this? You can't just stop the development of artificial intelligence, because robots increase productivity, and this is what companies and consumers want. If you really want to solve this problem, you need to figure out how to develop people who find themselves out of work so that they feel useful. And at the same time, figure out how to deal with a sharp difference in income.
- How about the idea of universal basic income? This concept is increasingly discussed in connection with the loss of jobs due to robots.
- This idea has its strengths and weaknesses. The strengths are that along with money, people have a choice: imagine that you are not trying to help people through social programs, but simply write them a check, and they themselves decide what to spend it on. If a person understands his needs well, he uses this money more profitably than the state would do. In addition, by cutting ineffective social programs, you will save a lot on officials' salaries. The main question, therefore, is whether people themselves can wisely spend the money you give them. What if you shut down an education program for children and just give their parents money to go to school - and they take that money and say their children don't need any education? I am convinced that universal basic income should not be at the expense of good social programs, should not be turned into simple unemployment benefits. Society needs to develop people, give them a meaning of existence, and not just money.
- Which new technologies are worth investing in, and which are nothing more than bubbles? For example, is it worth investing in cryptocurrencies?
“We’ll never know if we don’t experiment with them. In the past, many ideas that I didn't believe in ended up firing. For example, bottled water: when I was little, clean water was everywhere, and it was hard to believe that anyone would buy water in plastic bottles. I believe that natural selection of business ideas, trial and error, is the only way to know what will work and what will not.
Ray Dalio has occupied honorary positions in the Forbes ratings for more than a dozen years. Since 2011, his capital has never gone down. How honesty, adherence and discipline have helped raise billions of dollars.
- FULL NAME: Raymond Dalio (Ray Dalio).
- Date of Birth: 08/08/1949 Jackson Heights, Queens County, New York, USA.
- Nationality: Italian by father, American by mother.
- Education: BA, Long Island University, MBA from Harvard Business School (HBS).
- Business start date / age: 1975, 26 years old.
- Startup activity: investment company Bridgewater Associates.
- Current activity: the largest hedge fund Bridgewater Associates.
- Current state: Forbes $ 17.7 billion, April 2018.
- Social networks: https://www.youtube.com/user/Bridgewater a YouTube channel, which is filled personally by the investor. Billionaire Twitter Profile @RayDalio.
The largest number of world famous investors and large billionaires was donated to the world by America during periods of crisis for the country. One of these is Ray Dalio, a billionaire, investor and world-renowned economic guru who made his first fortune at the age of 12.
Brief biography of billionaire Ray Dalio
Ray Dalio was born on August 08, 1949 in Queens County, New York, USA, the son of jazz musician Marino Dalio and housewife Anne Dalio and was the only child of his parents.
A brief biography of Ray Dalio and family history tells that the father of the investor is Italian, who emigrated to the states during the crisis, who made his living playing the clarinet and saxophone in Manhattan clubs, including Capacabane. Mother - Native American, was engaged in raising her son.
At the age of 12, Ray worked part-time on the courses at a golf club, where he first heard from the club's players about promotions and investing. In those days, many talked about the stock markets, which interested the young man, he quickly realized that this way you can increase your capital. As soon as Dalio collected $ 300, he made the decision to make his first investment.
“The only thing I liked was spending money, so I handed out newspapers, cleaned snow, carried golf clubs and mowed lawns. At 12 years old. " R. Dalio about his first work.
Being attentive and consistent, the future billionaire quickly determined which strategy would help him not to burn out, but, on the contrary, to increase the amount of savings. The first criterion for choosing a company in which the money will be invested was the value of the shares, the price per unit should not exceed $ 5. The second parameter that played a role was the popularity of the chosen enterprise, despite the low cost of the acquisition.
“The stock I bought was selected based on what I heard about the company and knew it was priced at less than $ 5. So, as it seemed to me, I could make a big profit. " R. Dalio on the first investment.
Fig. 1. Dalio with friends at the dawn of his career.
Source: best-investor.ru
Based on these fundamental principles, he invested money in Northeast Airlines stock, and through the subsequent takeover of the company, this brought three times the profit.
By the end of high school, the novice investor already had a list of good and bad deals, experience in the market, and a fortune of several thousand dollars.
Looking at the degrees Dalio received, his vision of economics and the desire to write educational articles, many come to the conclusion that the businessman has been interested in studying all his life and devoted a lot of time to it. But, as the investor himself admits, in high school he despised studies and spent more time learning things interesting to him.
“I was not inspired by the need to remember what other people want from me. Besides, I had no idea why I needed it and where I was going. ”- Rei Dalio about his studies.
How Bridgewater came about, the success story of Ray Dalio
Dalio began his career while studying at the University by trading commodity futures on the New York Stock Exchange. In 1972, he persuaded the director of Merrill Lynch to hire him as an assistant and very quickly became a director of futures trading, since he was one of the few in the United States who knew anything about them. However, the company quickly fell apart.
Later, a young talented financier was hired as director of commodity investments at Dominick & Dominick LLC, from which he was fired for a fight with his boss and a scandalous speech at a congress of agrarians, where a naked girl was hired by him instead of Ray. A year after his dismissal, the investor worked at Shearson Hayden Stone as a broker and futures trader, after which his department was disbanded, and the talented young man was again unemployed.
Against the background of the financial crisis and accumulated knowledge, the future billionaire decides not to go to hired work anymore. Bridgewater Associates founded his foundation in 1975 when he was 26 years old. The young investor wanted to break into the market and conquer it, which in the end he succeeded. The company's first headquarters were located in Ray's two-room apartment in Manhattan. Dalio's business began by luring the bulk of clients from the previous place of work, the entrepreneur tried to never lose contacts with the right people.
Fig. 2. Ray Dalio gives an interview in a country house.
Source: fastsalttimes.com
At the beginning of the company's journey, the main activity was focused on consulting and working for several large clients who passed from the former employer of the billionaire. But after a while, grateful partners began to recommend the promising financier to their friends, and Dalio's client portfolio began to grow, adding key clients to him. Thus, a contract was signed with McDonald’s, which became a reliable support for the company for a long time and made it possible to achieve new heights faster.
How the Dalio Foundation developed
Work in this mode continued for Bridgewater Associates until 1981, when the billionaire and his family moved to Connecticut, where the foundation settled. In 1985, Dalio turned his views towards pension funds and signed the first contract with a division of the World Bank, 4 years later, Kodak with a similar structure appeared among clients. The billionaire still remains attached to such investors.
As the company has grown, its investment portfolio has grown and Dalio is introducing a new investment strategy, Global marco. The system is based on the analysis of many criteria, and the investments themselves are placed all over the world. The billionaire's company has always been famous for its high-quality management of client finances, minimization of currency risks, and even during the crisis, it made a profit. All this was achieved due to the knowledge of Ray himself, who analyzed all the indicators and events, compared them and eventually developed a whole model to prevent the negative influence of external circumstances.
The economist's ideal finance allocation model involves an investment of 55% in government bonds (of this volume about 75% in long-term and 25% in medium-term), 30% goes to companies included in the S&P 500, and the remaining 15% is intended for commodity investments. , precious metals, etc. This diversification of the portfolio allows you to quickly respond to changes in the market and quickly transfer investments from one segment to another.
Pure alpha
Since 1991, Dalio launched the Pure Alpha fund, which plays on the excess over the market average. It was the billionaire who first singled out this strategy and was able to apply it to the benefit of his clients' portfolios. The profitability of a hedge fund averages 18% per annum and is practically unchanged from the moment it entered the market.
Later, two more funds appeared in Bridgewater Associates: All-weather and Pure Alpha Major Markets. The emergence of directions occurred in 2011 and allows Dalio to serve those customer segments that were not previously considered, as the All-weather fund was created for the mass market and has reduced interest and commissions.
Ray Dalio is often referred to as the Steve Jobs of financial markets for his innovative approaches and self-developed investment schemes.
The company on the eve of the 2008 crisis and now
The focus of all Bridgewater and its employees is on the analysis of market performance and fluctuations. From his youth, Dalio himself was accustomed to finding and analyzing large amounts of information, which allowed him to competently manage not only his own, but also client's finances. Back in 2006, Ray's team began to predict the fall of the US economy due to the excess of the cost of debt service over income and the failure of the real estate market. And this time the billionaire was right.
“I don't always know which side the coin will fall on. At these moments, I try to do everything so that there are no negative consequences for me in any of the cases. In other words, I don't make random decisions. My bets are always limited to the things that I'm sure of. " R. Dalio on risk and rates.
The billionaire has repeatedly tried to warn big banks and other investors about the impending fall in markets, but he was never heard. As a result of the 2008 crisis, many companies still suffered large losses, except for funds led by an economist. Pure Alpha yielded 9.5% that year without losing a cent.
Fig. 3. Ray Dalio is interviewed by CNBC.
Source: Fortune
After another 2 years, continuing to operate as before and without changing the chosen strategies, Bridgewater increased its profitability up to 45%. This growth has allowed it to outpace the giants combined: Amazon, Yahoo, Google and eBay.
When the market shook again in 2011 and other hedge fund participants lost more than 4%, Bridgewater re-earned its clients and founder a 23% return. For 2012 and 2013, the company's earnings exceeded all that ever occurred in its segment.
From then until today, Bridgewater has always been at the forefront of its industry. The hedge fund in 2017 posted a total profit of $ 49.7 billion, the best in the world. In second place after him is only George Soros's hedge with a profitability of $ 43.9 billion. Such a gap can be considered quite large.
Ray Dalio's personal philosophy
Having in his genes the inheritance of the musician's father, Dalio himself was fond of music from his youth. In the years that fell on the graduation of the young men of high school, the Beatles were especially popular.
When Ray was 19, his favorite band went to India in search of inspiration. They brought the culture of transcendental meditation, which the future billionaire became interested in in the future. By the way, from that time on, he never deviated from practice and recognized that it was the use of techniques that helped him to clear his mind, see the most beneficial solutions to certain situations and create the existing success story of Ray Dalio.
In addition to meditations, the life of an investor tirelessly follows the principles formulated by him, which he applies not only in work, but also in private life. Its main tenets are radical openness and transparency of activities; inside the company and in its interaction with clients, concealment of information, squabbles and shadow operations, and dissent are prohibited. All activities of the billionaire and his team are based on straightforwardness, business purity and personal qualities. For which he was often accused of rudeness and rudeness. For example, in 2017, Dalio provoked the outrage of Italians when he expressed his opinion about the hopelessness of Italy and the eurozone.
He tried to predict what trends are expected in the market, as well as what assets are the most promising.
Here are the main theses and conclusions from his article.
How the paradigm shift happens... In the world of finance, there are long periods (about 10 years) during which markets function within certain relationships. Dalio calls these relationships "paradigms." They lead to the fact that most people adapt to them and, ultimately, project today's logic onto all processes in the future. As a result, the paradigm changes, and markets begin to work in diametrically opposite ways.
Example. Low rates provide favorable borrowing conditions. Debt is growing, borrowed funds are also used to purchase investment assets. This leads to an increase in their prices and it seems that borrowing and buying these investment assets will always be profitable.
But this cannot last forever. The potential return on assets decreases as prices rise. Debt service costs gradually increase relative to income, cash flow decreases and debtors have problems with loans. As a result, we will see a reduction in lending, a decrease in spending on goods, services and investment assets. There will be a paradigm shift.
The very process of changing the paradigm turns out to be quite painful for investors who fall prey to popular solutions. This seriously affects their welfare. The last paradigm shift was the 2008-2009 financial crisis.
Understanding the nature of the changes to come is critical to investor success. It is necessary to structure your investment portfolio so that it is largely protected from new risks.
Part I: How Paradigms Work
Usually, market consensus is formed on the basis of recent events (in the last few years), rather than on the basis of the most likely development scenarios. It follows that investors do not anticipate a paradigm shift and expect the existing market conditions to continue. As a result, we get quite impressive market and economic changes.
As a rule, the paradigm change takes place once every ten years - for example, the 1920s were “roaring,” the 1930s plunged into a “depression,” the 1970s became inflationary, the 1980s were disinflationary, and so on. It is noteworthy that now are the last months of the decade since the crisis of 2008-2009. and it is rather curious to try to imagine what the new paradigm will be in the 20s.
Each decade had its own distinctive features, although within each decade there were rather long periods (from 1 to 3 years) when the markets behaved in exactly the opposite way to the rest of the years.
The largest economic and market fluctuations took place during a paradigm shift, when the principles of "equilibrium" that had been in force for a decade were violated.
Balance principles:
1) The increase in debt corresponds to the increase in income required to service this debt;
2) The growth rate of the economy is not too high, because it will lead to an unacceptable jump in inflation and inefficiency, and not too low, because low activity in the economy will lead to shock and political change;
3) The projected yield on cash is lower than the projected yield on bonds, which in turn is below the projected yield on stocks and other higher-risk assets. The absence of these patterns will impede effective growth of lending and lead to a slowdown in economic growth and its decline.
At the end of each decade, most investors expected the next decade to be similar to the previous one. However, due to the process of kinks described above, leading to changes and increased waviness, the following decades were more opposite than similar to the previous ones. Because of these shifts, the movements in the markets were significant and led to the redistribution of wealth in the world.
Theories about how to invest have changed frequently. They usually relied on patterns observed in previous years. These retrospective theories were most popular at the end of the paradigm and ended up as a completely inappropriate investment guide for the next decade.
Using these tables, you can get an idea of the dynamics of economic indicators, asset returns for each decade, both in nominal and real terms; monetary and credit ratios and debt growth rates for each decade.
Part II: When to expect a paradigm shift and where to invest
The main conditions that characterize the situation in which we find ourselves since 2009:
1) Central banks cut interest rates and implement quantitative easing (QE), which means they print money and buy financial assets. These methods will soon be exhausted.
Quantitative easing has been a powerful stimulus since 2009. It has boosted asset prices both directly from actual asset purchases and indirectly, as lower interest rates spurred debt-financed share buybacks and acquisitions.
The chart below shows the changes in the interest rate and QE in the US since 1920. Here you can see that this happened twice, in 1931-45. and in 2008-14.
The next three graphs show the dynamics of the US dollar, euro and yen since 1960. When interest rates reached 0%, money printing began in all these countries. The ECB ended its QE program at the end of 2018 while the Bank of Japan is still increasing the money supply.
Today, all of the world's key central banks are again turning to these forms of mitigation, as economic growth slows and inflation remains below target levels.
2) There was a wave of share buybacks, mergers, acquisitions, direct investments and venture capital investments. These investments, financed by cheap money and loans, stimulated the rise in the prices of investment assets. This increased the well-being of those who had the opportunity to buy them. The rich got richer. As a result, anti-capitalist sentiment is on the rise.
3) Profits have grown rapidly thanks to advances in automation and globalization that have reduced labor costs.
The chart below to the left shows this rise.
It is unlikely that such growth rates will be sustainable. Profitability is likely to decline soon.
4) The tax reform has resulted in increased value of shares. However, further tax cuts are unlikely. On the contrary, there is a high probability that it will be raised again, especially if the Democrats come to power.
The chart below shows estimates of what would have happened to the S&P 500 if none of the above had happened.
A paradigm shift could occur in the next few years when:
A) The real interest rate will be so low that investors with debt will not want to hold it and will start switching to other assets
The effectiveness of quantitative easing and rate cuts will exhaust itself, as the profitability of risky financial instruments approaches the profitability of the cash. This means that there will be less and less buyers for them. As a result, the Central Bank will have to apply other forms of mitigation. The most obvious: currency depreciation and growing budget deficits.
B) at the same time, a greater need for money to fund the liabilities will contribute to the “big squeeze”.
The huge amounts of money invested in low-yield instruments will not be enough to fund the liabilities. They just won't be able to generate adequate income. To finance their expenses, the owners will have to sell the principal of the debt, which will result in a decrease in the capital stock.
This will happen simultaneously with the exacerbation of internal (mainly between socialists and capitalists) and external conflicts.
In such a reality, storing capital in cash and bonds will no longer be safe. Real and nominal bond yields will be low. But the central banks will buy most of them to keep interest rates down. In other words, the new paradigm will be characterized by large debt monetization.
Thus, it is worth considering what investments will work well in a reflationary system with large debt obligations, significant internal and external conflicts?
Most people now think that the best "risky investments" are investments like stocks, real estate lending, and venture capital. But, in Ray Dalio's opinion, those assets that benefit when the value of money depreciates and when significant internal and international conflicts take place will feel better.
Most investors underestimate such assets. An indirect confirmation of this is the current low share of precious metals in the portfolios of large investors. For this reason, to reduce risks and increase profitability, Dalio suggests considering adding gold to his portfolio.
Ray Dalio is an American businessman, billionaire, founder of the investment company Bridgewater Associates. Ray published another article today, which may be of interest to all investors. Read the adapted translation:
One of my investment guidelines:
Determine the paradigm you are in, study whether it is stable and if it is not stable, then what exactly, then visualize how the paradigm shift will occur when it changes.
In my 50 or so years as a global macroinvestor, I have noticed that there have been relatively long periods (about 10 years) during which markets and market relations function in a certain way (which I call a “paradigm”), most people adapt to this over time. , and ultimately extrapolate the current logic to all processes, which leads to a shift in the balance and ultimately a transition to new paradigms, in which markets often act in the opposite way in relation to how they acted during the previous paradigm.
Identifying and tactically navigating these paradigm shifts (which we are trying to do in our Pure Alpha fund) and / or structuring our portfolio in a way that is largely immune to them (which we are trying to do with our All Weather portfolios). is critical to success as an investor.
How paradigm changes take place
There are always large unstable forces driving the paradigm. They continue to act long enough for people to believe that their effect will never end, although they obviously must cease their effect.
Such a classic force is the volatile debt growth rate that supports the purchase of investment assets; this leads to higher asset prices, which leads people to believe that it is a good thing to borrow and buy these investment assets.
But this cannot last forever, because the entities that borrow and buy these assets will exhaust their borrowing capacity, while debt service costs rise in relation to their income, which puts pressure on their cash flows. When this happens, there is a paradigm shift. Debtors begin to have credit problems, therefore, lending and spending on goods, services, and investment assets decrease, so that they decrease in a self-reinforcing dynamic that looks more like the opposite than similar to the previous paradigm. This continues until this trend also becomes excessive, which reverses it, I will not delve into this phenomenon, it is explained in my book "Principles of Navigating Debt Crises You Can Get for Free".
Another classic example that comes to mind is that long periods of low volatility tend to lead to high volatility because people adjust to such low volatility that it forces them to do things (such as borrowing more money than they would take if the volatility was higher), which expose them to risk in an environment of greater volatility, which leads to a self-reinforcing surge in volatility.
There are many classic examples like this that repeat over time, and I won't go into them now. However, I want to emphasize that understanding what types of paradigms exist and how they can change is essential for consistent investment. Because any particular approach to investing - for example, investing in any asset class, investing using any investment style - experiences a time when it performs so badly that it could lead you to ruin.
With a paradigm shift, most people find themselves overly slow to do something too popular, and they do suffer losses. On the other hand, if you are discerning enough to understand these changes, you can navigate well and protect yourself from them. The 2008-2009 financial crisis, which was the last major paradigm shift, was one such period. This was because the rate of debt growth was volatile, just as it was during the 1929-32 change period. As we studied such periods, we saw that we were moving towards a different paradigm because what was happening was volatile, so we got a good understanding of the crisis when most of the investors suffered.
I think now is a good time:
1) look at past paradigms and paradigm shifts, and
2) focus on the paradigm in which we are and how it can change, because we have been in the current one for a long time and are probably close to changing it. To do this, I wrote this report in two parts: 1. "The Paradigm Shift Over the Last 100 Years" and 2. "The Coming Paradigm Shift." They are attached. If you have time to read both of them, I suggest you start with “paradigm shifts over the past 100 years” because it will give you a good understanding of this moment and will give you a story that got us to where we are, which will help. put us in context. There is also an appendix with longer descriptions of each of the decades from the 1920s to the present for those looking to investigate the phenomenon in more detail.
Part I: Paradigm Shifts Over the Past 100 Years
History has taught us that there are always paradigms and paradigm shifts, and that understanding and positioning ourselves in them is critical to the well-being of the investor and beyond. The purpose of this article is to show you market and economic paradigms and their shifts over the past 100 years, to show you how they work. In the accompanying article, “The Paradigm Shift,” I explain my thoughts on what might lie ahead.
Due to the limitations of time and space, I will focus only on events in the United States, because there will be enough of them to give you the point of view that I would like to convey. However, at some point I will show you them in all significant countries, just as I did for large debt crises in the Principles for Overcoming Large Debt Crises, because I believe that understanding all of them is necessary in order to to have a timeless and universal understanding of how markets and economies work.
How paradigms and paradigm shifts work
As you know, market prices reflect the expectations of the future; as such, they paint fairly detailed pictures of what will happen on the basis of the consensus expectation of the future. Markets then move based on how events occur in relation to those expectations. As a result, knowing the markets well requires being more precise about what will happen than the consensus that is built into the price. It's a game. This is why understanding these paradigms and paradigm shifts is so important.
I have found that the consensus point of view is more influenced by what has happened relatively recently (that is, over the past few years) than what is most likely. The consensus is inclined to believe that existing paradigms will persist, and it does not foresee paradigm shifts, which is why we have such large market and economic swings. Changes most often lead to the fact that markets and economies behave in the opposite way, rather than analogous to how they behaved in the previous paradigm.
What follows is my description of paradigms and paradigm shifts in the United States over the past 100 years. It involves a combination of fact and subjective interpretation, because when faced with the choice of sharing or ignoring these subjective thoughts, I felt it would be better to include them.
Naturally, my degree of closeness to this experience influences the quality of my descriptions. Since my direct experience began in the early 1960s, my observations of recent years are most striking. Although my understanding of markets and economics, dating back to the 1920s, was less vivid, it is still quite good, both because of my intense study of this, and because of my conversations with people from my parents' generation who survived this period. As for the times before the 1920s, My understanding comes only from studying the big market and economic movements, so it is less good, although it exists.
For the past year, I have studied economic and market movements in major countries since about AD 1500, which has given me a superficial understanding of them. From this point of view, I can confidently say that at all times I have studied the same big events happening over and over again for essentially the same reasons. I am not saying that they are exactly the same, or that important changes did not happen, because they certainly did (for example, how central banks came into being and changed). What I'm talking about is that big paradigm shifts have always happened and are happening for roughly the same reasons.
To show them, I have divided history into decades, starting in the 1920s, because they fit well enough with paradigm shifts for me to convey the picture. Not always perfectly aligned, paradigm shifts tended to occur in about ten-year periods - for example, the 1920s were “roaring,” the 1930s were “depressed,” the 1970s were inflationary, the 1980s were deflationary etc.
Also, I find that looking at a 10-year time frame helps to put things like this in perspective. It also matches well with the fact that we are in the last months of this decade, so it's an interesting exercise for the mind to start imagining what the 20th of the 21st century will be like, this is my goal, not a focus on what it will happen in any quarter or year.
Before briefly describing each of these decades, I want to make a few points that you should pay attention to when discussing each of them.
1) An increase in debt, corresponding to an increase in income required to service the debt;
2) The operating level of the economy is neither too high (because it will lead to unacceptable inflation and inefficiency) nor too low (because economically lower levels of activity will lead to unacceptable damage and political change); as well as
3) The projected cash yields are lower than the projected bond yields, which are lower than the projected returns on stocks and the projected returns on other “risky assets” (because the absence of these spreads will impede effective growth in credit and other forms of capital that will lead to a slowdown or fall in the economy, while while wide spreads will lead to its acceleration).
Each decade had its own distinctive characteristics, although throughout the decades there were long periods (for example, from 1 to 3 years), which had almost completely opposite characteristics of what characterized the decade. To successfully cope with these changes, one would need to successfully calculate entries and exits, or decay (i.e., buy more when prices fell and sell more when prices rose), or have a balanced portfolio that would hold relatively stable over time. different periods. The worst thing would be to go with the flow (sell after a price decrease and buy after a price increase).
Large economic and market movements experienced large fluctuations, which were caused by the sequence of actions and reactions from politicians, investors, business owners and workers. In the process of shifting the balance in economic conditions and market values, the seeds of change germinated. For example, the same debt that financed surplus in economic activity and supported market prices created obligations that could not be met, which contributed to further declines. Likewise, the more extreme economic conditions became, the more decisive were the actions of politicians to change them. For these reasons, during these 10 decades, we have seen large economic and market fluctuations around "equilibrium" levels. The equilibria I'm talking about are the three that I specified in my template:
At the end of each decade, most investors expected the next decade to be similar to the previous one, but due to the previously described inflectional process, the following decades were more opposite than similar to those that preceded them. As a result, market movements due to these paradigm changes tend to be very large and unexpected and cause large changes in states.
Every major asset class has had great and terrible decades, so long that any investor who concentrates most of their wealth on a single investment has lost almost everything at one point or another.
Theories about how to invest have changed frequently, usually based on explanations of how to proceed in the past few years, even if it didn't make sense. These retrospective theories tended to be strongest at the end of the paradigm period and proved to be terrible investment guidelines for the next decade, so they were highly disruptive. This is why it is so important to see the full spectrum of past paradigms and paradigm shifts and structure your investment approach so that it works well for all of them. The worst thing to do, especially at the end of the paradigm, is to build your portfolio around what has worked well in the previous 10 years, but this is typical.
It is for these reasons that we invest the way we invest, which is why we have created a balanced All Weather portfolio designed to provide relatively stable returns with good diversification and created a Pure Alpha portfolio for tactical moves.
Below I have summarized the picture of the dynamics of each decade with a very brief description and several tables that show the returns on asset classes, interest rates, and economic activity for each decade over the past nine years. Using these tables, you can get an idea of the dynamics for each decade, which I will then look at in more detail and show the market movements in the appendix to this report.
1920s= "Roaring": from boom to explosive bubble. It all started with a recession in the economy, and the markets did not take this into account, as stock returns were significantly higher than bond yields, resulting in rapid growth, which was financed by accelerating debt growth over a decade, so stocks rallied very well. By the end of the decade, markets ignored the acceleration in economic growth and ended in a classic bubble (that is, high-price purchases of stocks and other assets financed by debt) that burst in 1929, the last year of the decade.
1930s= depression.This decade was for the most part the opposite of the 1920s. It began with an explosive reaction to high levels of debt and markets that discount relatively high rate increases. This debt crisis and slump in economic activity led to an economic depression that led to aggressive monetary easing by the Fed, which consisted of severing the bond with gold, interest rates hitting 0%, printing a lot of money, and devaluing the dollar.
This was accompanied by increases in gold prices, stock prices and commodity prices from 1932 to 1937. As monetary policy led to higher asset prices and because money was not going into the real economy, the wealth gap widened, conflict arose between socialists and capitalists, and there was an increase in populism and nationalism around the world.
In 1937, the Fed and fiscal policy were tightened slightly, and the stock market and economy fell. At the same time, geopolitical conflicts intensified between the developing Axis countries: Germany, Italy and Japan and the allied countries - Great Britain, France and China, which ultimately led to an all-out war in Europe in 1939, and the United States began a war in Asia in 1941.
For the decade as a whole, stocks did poorly, with an early debt crisis that was largely managed through defaults, guarantees, and debt monetization, along with a lot of tax incentives.
1940s= war post-war economy and markets were under classical military rule. Governments around the world borrowed heavily and printed significant amounts of money to stimulate private sector employment to support war and military employment. While production was strong, much of what was produced was used and destroyed during the war, so classical rates of growth and unemployment are misleading. However, this war production got the US out of the crisis after the Great Depression.
Monetary policy was very easily tailored to accommodate loans and pay off debts in the post-war period. In particular, monetary policy remained supportive as interest rates were held down and fiscal policy caused large budget deficits during the war and then after the war to foster recovery overseas (the Marshall Plan). As a result, stocks, bonds, and commodities rallied over this period, with commodities beginning to rally early in the war, and stocks rallying later in the war (when an Allied victory looked more likely).
The pictures of what happened in other countries, especially those that lost the war, were radically different and worthy of a separate description. After the war, the United States was the leading power, and the dollar was the world's reserve currency, linked to gold, while other currencies were linked to the dollar. This period is an excellent time to demonstrate 1) the power and mechanisms of central banks to hold interest rates in the face of significant budget deficits, and 2) the actions of markets during times of war.
1950s = Post-war reconstruction. In the 1950s, after two decades of depression and war, most people were financially conservative, preferring safety to risk. Markets mirrored this in actual pricing in negative earnings growth rates with very high risk premium (for example, the S & P500 dividend yield in 1950 was 6.8% and was more than 3 times the 1.9% yield on 10-year bonds) ... What happened in the 50s was exactly the opposite of what happened before. The post-war recovery was strong (averaging 4% real growth per year over a decade), thanks in part to continued stimulus policies. As a result, the promotions felt great.
Since the government did not run into significant deficits, the public debt burden (public debt as a percentage of revenues) fell, while the level of private debt was in line with the rise in income, so the rise in debt was in line with the rise in revenue. The decade ended financially strong, with prices reflecting relatively modest growth and low inflation. The 1950s and 1960s were also a period when middle-class workers were in high demand and prosperous.
1960s = From boom to money crash. The first half of the decade was increasingly financed by a debt boom that led to balance of payments problems in the second half, leading to a big paradigm shift in ending the Bretton Woods monetary system.
In the first half of the decade, markets started out with weak growth, but then there was a rapid rise in assets until 1966. Back then, most of them looked at the last 15 years of high stock market returns and were very optimistic. However, because debt and economic growth were too rapid, leading to higher inflation, the Fed's monetary policy was tightened (for example, the yield curve inverted for the first time since 1929). This led to a real (i.e. inflation-adjusted) peak in the stock market.
In the second half of the 1960s, debt grew faster than income, and inflation began to rise amid a slowdown in economic growth, followed by an economic recession at the end of the decade. Towards the end of the 60s, the problem of the US balance of payments began to manifest itself more clearly in the reduction of gold reserves, so it became clear that the Fed would have to choose between two bad alternatives, namely: a) too tight monetary policy, which would lead to a too weak economy, or b) too strong domestic stimulus to keep the dollar rate and inflation. This led to a major paradigm shift from the monetary system and the beginning of the decade of stagflation in the 1970s, which was the opposite of the decade of the 1960s.
1970s = low growth and high inflation (i.e. stagflation) .In the beginning of the decade, there was a high level of indebtedness, the problem of the balance of payments and the gold standard, which was abolished in 1971. As a result, the promise to convert money into gold was broken, and money began to be printed.
To ease the debt burden, the dollar was devalued to reduce external deficits, growth was slow, inflation accelerated, inflation defenders did well, while stocks and bonds performed poorly for a decade. In inflation, inflation expectations, and interest rates, two large phases occurred: the first from 1970 to 1973 and the second and larger from 1977 to 1980-81. At the end of the decade, markets discounted very high inflation and low growth, which was roughly the opposite of what was discounted at the end of the previous decade. Paul Volcker was appointed in August 1979.
1980s = high growth and falling inflation (i.e. deflation). The decade began with markets discounting high inflation and slow growth, but the decade was characterized by falling inflation and rapid growth, so inflation-hedging assets were depressed and stocks and bonds flourished. The paradigm shift came at the beginning of the decade when tight monetary conditions imposed by Paul Volcker triggered deflationary pressures, severe economic downturns, and a debt crisis in which emerging markets were unable to service their debt obligations to US banks. This process was well organized, so banks were provided with adequate liquidity, and debts were not written off in a way that would cause irreparable damage to bank capital. However, this led to a deficit in dollars and capital flows, which pushed the dollar up and created deflationary pressures that allowed interest rates to fall while the gains were strong, which was great for stocks and bond prices. As a result, it was a great period for deflationary growth and high returns on equity and bond investments.
1990s = from boom to explosive bubble. The decade began with a recession, the first Gulf War, monetary easing, relatively fast debt-financed economic growth and rising stock prices; it ended in a tech / dot-com bubble (that is, debt-financed high-price purchases of “tech” stocks and other financial assets) that looked like a 1950s bubble in the late 1960s. This dot-com bubble burst just after the end of the decade, at the same time as the 9/11 attacks followed by the very costly wars in Iraq and Afghanistan.
2000-10 = from boom to explosive bubble. This decade was the most similar to the 1920s, with a large debt bubble leading to the 2008-2009 debt / economic crisis, which was similar to the 1929-32 debt crisis. In both cases, they drove interest rates down to 0% and led central banks to print a lot of money and buy financial assets. The paradigm shift took place in 2008-09 when quantitative easing began while interest rates were held at or near 0%. The decade began with very high discounting gains (such as in equities) during the dot-com bubble, and was followed by the lowest real growth rate in any of those nine decades (1.8%), which was close to the level of the 30s. As a result, stocks have had the worst performance in decades since the 1930s. In this decade, as in the 1930s, interest rates fell to 0%, the Fed printed a lot of money as a way of easing with 0% interest rates, the dollar fell, and gold and T-bonds were the best investments. Debt levels remained very high at the end of the decade, but markets did not account for the slow growth.
2010-now= reflation. The transition to a new paradigm that also bottomed out markets and economies occurred in late 2008 / early 2009, when risk premiums were extremely high, interest rates hit 0% and central banks began aggressive quantitative easing ('money printing' ). And purchases of financial assets). Investors took money from the sale of their financial assets to central banks and bought other financial assets, which raised the prices of financial assets and lowered risk premiums and expected returns across all asset classes. As in the period 1932-37, this led to a significant increase in the prices of financial assets, which benefited those who had financial assets as opposed to those who did not, which widened the wealth gap. At the same time, technological automation and businesses that globalize production in lower-cost countries have put pressure on wages, especially for middle- and low-income groups, while most of the high incomes. Growth was slow and inflation remained low. Stocks were up consistently, driven by continued rate cuts (for example, due to central bank stimulus), high profit margins (due in part to automation curbing wage growth) and, more recently, tax cuts. Meanwhile, widening wealth and income gaps have fueled a global rise in populism. Asset prices are now relatively high, price increases remain moderately high and inflation remains low.
The following tables show: a) growth and inflation rates that were discounted at the beginning of each decade, b) growth, inflation, and other statistics for each decade, c) asset class returns in both nominal and real terms, and d ) monetary and credit ratios and debt growth rates for each decade:
Part 2: The Paradigm Shift
The main forces behind the paradigm in which we have been operating since 2009 are:
1. Central banks lower interest rates and implement quantitative easing (ie, print money and buy financial assets) in ways that are unsustainable.
Easing in this way has become a strong stimulus since 2009, with only minor tightening leading to "market tantrums". This boosted asset prices both directly (from actual asset purchases) and indirectly (as lower interest rates raised P / Es and led to debt-financed share buybacks and acquisitions). This form of easing is approaching its limits because interest rates cannot be cut much more and quantitative easing is having less and less impact on the economy and markets as the money pumped in increasingly ends up in the hands of investors who buy other investments with it, which increases the prices of assets and reduces their future nominal and real returns and their returns relative to cash (that is, their risk premium).
The expected returns and risk premiums for non-monetary assets are declining, so there is less incentive to buy them, so it will become increasingly difficult to push their prices up. At the same time, central banks, which are more involved in printing money and buying assets, will generate increasingly negative real and nominal returns, which will lead to the fact that investors will increasingly prefer alternative forms of money (for example, gold) or other ...
As these forms of mitigation (i.e., lower interest rates and QE) stop working well and the problem of too much debt and non-debt liabilities (such as pension and medical obligations) remains, other forms of mitigation (the most obvious are currency depreciation and fiscal deficits) will become more and more likely.
Think of it this way: One person's debts are another's assets. Monetary policy moves back and forth between a) helping debtors at the expense of creditors (by keeping real interest rates low, which creates bad returns for creditors and good relief for debtors) and b) helping creditors at the expense of debtors ( by supporting real increases in interest rates, which create good returns for creditors and painful costs for debtors). By looking at who has what assets and liabilities, asking yourself who the central bank should help the most, and figuring out what they are most likely to do given the instruments they have, you can get the most likely change in monetary policy. , which are the main drivers of the paradigm shift.
It seems to me obvious that now they should help debtors in relation to creditors. At the same time, it seems to me that the weakening forces of this paradigm (that is, lower interest rates and quantitative easing) will have an increasingly weakening effect. For this reason, I believe that debt monetization and currency depreciation will ultimately be chosen, which will reduce the value of money and real profitability for lenders. Then we look at how long lenders will allow central banks to generate negative real returns before they go into other assets.
To be clear, I am not saying that this shift will happen immediately. I say that I think this is coming and will have a big impact on what the next paradigm looks like.
The chart below shows the change in interest rate and QE in the US since 1920, so you can see what happened two times - in 1931-45 and in 2008-14.
The next three charts show the US dollar, euro and yen since 1960. As you can see, when interest rates hit 0%, money printing started in all these countries. The ECB ended its QE program at the end of 2018 while the Bank of Japan is still increasing the money supply. Now all three central banks are turning to these forms of easing again as growth slows and inflation remains below target:
2. There was a wave of share buybacks, mergers, acquisitions, and private and venture capital investments, which were funded both by cheap money and loans, and a huge amount of cash that was introduced into the system.
This has resulted in higher prices for stocks and other assets and lower future returns. It also made the money almost worthless. (I'll explain more about why this is so and why it is unsustainable at the moment.) Rising investment asset prices have benefited those with investment assets far more than those who do not, widening the wealth gap. which creates anti-capitalist sentiment in politics and increasing pressure to transfer most of the printed money into the hands of non-investor / capitalist.
3. Profits have grown rapidly thanks to advances in automation and globalization that have lowered labor costs.
The chart below shows this growth. It is unlikely that this rate of growth in profitability will be sustained, and there is a high likelihood that margins will decline in the future. Since this increased share of the pie destined for capitalists was achieved through a decrease in the share of the pie sent to workers, this widened the wealth gap and led to increased talk of corporate action against workers.
4. The corporate tax cut has made stocks more valuable because they generate more profits.
The latest decline resulted in a one-off rise in share prices. Such cuts will not continue, and there is a strong likelihood that they will be reversed, especially if Democrats gain more power.
It was the big tailwinds that kept stock prices up. The chart below shows our estimates of what would have happened to the S&P 500 if none of this volatile had happened.
Paradigm shift
There is a saying in the markets that "the one who lives by the crystal ball is destined to have frosted glass." While I'm not sure exactly when and how the paradigm shift will occur, I will share my thoughts on it. I think it is very likely that this will happen over the next few years,
1) central banks run out of incentives to stimulate markets and the economy while the economy is weak and
2) there will be a huge amount of debt and - non-debt obligations (for example, pensions and health care), which will grow and cannot be financed from current income.
In other words, I think the paradigm we are in is likely to end when
a) the real interest rate will be reduced so low that the investors holding the debt will not want to hold it and will begin to move on to something they deem best and
b) at the same time, a large need for money to finance the liabilities will contribute to "great pressure". At this point, there will not be enough money to meet the needs for it, so there must be some combination of monetization discounts, currency depreciation and significant tax increases, and these circumstances are likely to increase conflicts between the capitalist haves and the socialist have-nots. Most likely, during this time, debt holders will receive very low or negative nominal and real gains in weakening currencies, which will actually be a wealth tax.
Right now, about $ 13 trillion in investor money is being held in debt at zero or negative interest rates. This means that these investments are useless to generate income (unless they are funded by obligations that have even more negative interest rates). Thus, these investments can be considered at best safe places to hold the principal.
So far, investors have been happy with the rate / yield cut as investors are focusing more on price increases as a result of falling interest rates than on falling future yield rates. The diagram below helps to demonstrate this. When interest rates fall (right side of the chart), it drives up the value of assets (left side of the chart), which creates the illusion that the investment is providing good returns, when in reality, returns are only future returns. "Present value effect". As a result, future earnings will be lower.
This will end when interest rates hit their bottoms (just below 0%), when the perceived return on risky assets is reduced to a level close to the expected cash return, and when the demand for money to pay for debt, pensions and health care increases. While there is still little incentive to get a little more from current value and a little more from declining risk premiums, there are not many.
At the same time, the fulfillment of obligations will come sooner or later, so it is unlikely that there will be enough money in the system to fulfill these obligations. Then there will probably be a battle for
1) how many of these promises will not be fulfilled (which will anger those who are the owners of the debt),
2) how many of them will be offset by higher taxes (which will make the rich poorer, which will make them angry)
3) how satisfied they will be due to much larger discounts in monetization (which will lead to a decrease in the value of money and a decrease in real return on investment, which will harm those who have investments), especially those who have debts).
The charts below show the wave of commitments that is hitting the US.
History has shown us, and logic tells us, that there is no limit to the ability of central banks to hold nominal and real interest rates through their purchases, flooding the world with more money, and that it is the lender who suffers from low returns.
In other words:
Huge amounts of investments with low returns will not be enough to finance the liabilities, even though the volumes look very large. This is because these volumes do not provide adequate income. In fact, most of them will not generate any income, so they are useless for this purpose. They simply provide a “safe” place to store capital assets.
As a result, in order to finance their expenses, their owners will have to sell the principal amount of the debt, which will reduce the fixed capital, so that they will either a) need higher and higher returns on declining capital (which they have no chance of getting) or b) them you will have to speed up the process of spending capital until you run out of money.
This will happen simultaneously with increased internal conflicts (mainly between socialists and capitalists) about how to divide the domestic economy pie, and exacerbation of external conflicts (mainly between countries about how to divide both the global economic pie and global influence).
In such a world, keeping money and bonds would no longer be safe. Bondholders will clamor for debt monetization, and governments are likely to continue printing money to pay off their debts with devalued money.
This is the simplest and least controversial way to reduce the debt burden without raising taxes. My guess is that bonds will provide poor real and nominal yields for those who hold them, but that will not lead to significant price drops and higher interest rates because I think central banks are most likely to buy most of them. to lower interest rates and keep prices higher.
In other words, I suspect that the new paradigm will be characterized by massive debt monetization, which will be most similar to those that occurred during the war years of the 1940s.
Thus, the big question to ponder at this time is which investments will perform well in the face of reflation, accompanied by demands for repayment of large obligations and significant internal conflict between capitalists and socialists, as well as external conflicts. This is also a good time to ask what the next best currency or store of wealth will be when most reserve currency central banks want to devalue their fiat currencies.
Nowadays, most people believe that the best “risky investments” will still be in stocks, lending real estate, and venture capital, and this is especially true when central banks are refering. As a result, the world entered large long leverage, holding assets with low real and nominal expected returns, which also provide historically low returns relative to cash returns (due to the huge amount of money that has been pumped into the hands of investors by central banks and due to other economic forces that force companies to hold large amounts of cash).
I think that they are unlikely to be good real returnable investments, and that the best investors will be those who understand when the value of money starts to depreciate and defensive assets such as gold begin to rise.
In addition, for reasons that I will explain in the near future, most investors underestimate such assets, which means that if they just wanted a more balanced portfolio to reduce risk, they would have more of this kind. For this reason, I believe it would be beneficial to both reduce risk and increase profitability in order to consider adding gold to your portfolio. I'll post an explanation shortly about why I believe gold is an effective portfolio diversifier.
