Capital ultimately backs capital. While politicians might make the headlines, it’s the bond markets that keep the score – and governments forgetting this cast-iron rule ultimately pay the price.
With US President Donald Trump overturning the 80-year world order, it has never been more imperative for Australia – including financial institutions – to nurture a better understanding of the Middle Kingdom.
Hedge fund manager sees troubled waters ahead
Renowned US hedge fund Bridgewater Associates is tipping a messy market transition as inflation and interest rate changes wash through the global financial system this year.
Bridgewater, founded by Ray Dalio (photo at top), warns that while extraordinary COVID-era global monetary stimulus measures have finally kick-started the real economy, investors remain overly optimistic about the prospects for a seamless withdrawal of central bank largesse.
“Given the inertia in the system, it is unlikely that the current level of nominal spending growth and its impacts on inflation can be contained without aggressive monetary tightening in the very near term,” the Bridgewater analysis says.
“In contrast to this unfolding story, the markets are discounting a smooth reversion to the prior decades’ low level of inflation, without the need for aggressive policy action-that it will mostly just naturally happen on its own. We see a coming clash between what is about to transpire and what is now being discounted.”
Current market conditions have served up “two unique risks” that investors have not experienced for four decades, including the potential for an inflation-driven collapse in asset prices and, monetary policy mistakes leading to sharp hikes later down the track.
“Because there is such a big difference between what is discounted and what we think is likely, we see the potential for large market moves, which of course implies significant risks from holding assets, as well as significant alpha opportunity from price change,” the paper says.
However, the macro-style hedge fund says the monetary trends will play out differently across the world with a broad split between Asia (especially China) and developed economies.
“With bond yields still having room to fall, inflation still relatively low, and policy makers facing pressure to ease, Chinese assets remain attractive relative to cash, with the differences in conditions versus the West creating a high likelihood of continued diversification,” Bridgewater says.
“By contrast, we have grown significantly less bullish on assets versus cash across the developed world in aggregate, with significant differences across countries.”
Earlier in January, Bob Prince, Bridgewater co chief investment officer, noted the “four major forces” that the manager believes underpin equity markets – changes in discounted growth, discounted inflation, discount rates, and risk premiums – were all pointing to softer share returns.
In an article titled ‘The Archetypical Equity Cycle and the Anatomy of a Bear Market‘, Prince says the data shows “the macro environment that we are headed into is far less supportive than what has existed over the past couple of years.
Like many hedge funds, the storied Bridgewater, founded by Ray Dalio, has experienced a tough decade as easy money conditions lifted equity indices ever-higher. But the group’s flagship Pure Alpha Fund II turned in a 7.8 per cent return in December last year, boosting annual performance to over 8 per cent. Currently, Bridgewater manages about US$150 billion in total.
Bridgewater named Nir Bar Dea and Mark Bertolini as co-CEOs at the beginning of this year to replace to replace the outgoing, David McCormick, who is widely tipped to seek a US senate seat in Pennsylvania under Republican colours.
