Low, and even negative, yields offered by bonds highlight how the economics of fixed income has become ‘stupid’, and no longer makes sense to have meaningful exposure to, according to Ray Dalio.
The founder of Bridgewater Associates, made the claim in a recent edition of his weekly LinkedIn newsletter, Principled Perspectives.
In a posted called ‘Why in the world would you own bonds when...’, Dalio says the ultimate purpose of investing is to store wealth to convert into buying power later. However, the time it takes to achieve this in US, European, Japanese, and Chinese bonds has extended further and further.
‘Because you are trying to store buying power you have to take into consideration inflation. In the US, you have to wait over 500 years, and you will never get your buying power back in Europe or Japan. In fact, if you buy bonds in these countries now you will be guaranteed to have a lot less buying power in the future,’ he wrote.
‘Rather than get paid less than inflation, why not instead buy stuff – any stuff – that will equal inflation or better? We see a lot of investments that we expect to do significantly better than inflation.’
He said the issues around bond investing was exacerbated by governments and central banks issuing even more debt to cover ongoing costs and shortfalls caused by the Covid-19 pandemic.
Against this backdrop, the increased interest in Chinese bonds means there is a cycle away from the dominant market of US debt, which also provides challenges, Dalio wrote.
‘That whole set of supply-and-demand circumstances makes for a dangerous picture for bonds, cash, and currencies in the three major reserve currencies of the dollar, the euro, and the yen,’ he wrote.
‘If the new demand for these bonds falls significantly short of the new supply, which seems likely, either a) interest rates will rise and bond prices will fall or b) central banks will have to print substantial amounts of money to buy the debt assets that the free-market buyer won’t buy, which would be very reflationary (bearish for the dollar and the leading currencies who do this, relative to reflation assets).’
The challenge would be further compounded, he argued, by a scenario, albeit unlikely, of sudden selling, as there are $75tn of US assets of varying maturities. Even the most liquid market could unwind completely and it would mean many investors would have to endure terribly low returns as a result.
‘The problem is that, at current valuations, there is way too much money in these financial assets for it to be a realistic expectation that any significant percentage of that bond money can be turned into cash and exchanged for goods and services,’ he wrote.
‘If any significant amount tried to make that shift a “run on the bank”-type dynamic would ensue. When such a dynamic – which I call a “reverse wave” – occurs, there is no stopping it.’
Dalio wrote that this isn’t a completely new scenario, as there are historical precedents to follow that occur when a long-term credit/debt cycle ends.
These are normally coupled with a rush of stimulus, which causes a ‘reverse wave’, where the loanees want their money back eventually and credit/debt markets collapse.
So, what can investors do? Dalio argued that they should hold a well-diversified portfolio that has non-debt and non-dollar assets, potentially with a short cash position.
‘I also believe that assets in the mature developed reserve currency countries will underperform the Asian (including Chinese) emerging countries’ markets. I also believe that one should be mindful of tax changes and the possibility of capital controls.’
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March 16, 2021 at 04:45PM
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Ray Dalio blasts 'stupid' economics behind bond investing - Citywire Americas
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