by Preston Pysh

Ray Dalio’s Interview on Bloomberg – 16 September 2015
As many know, Billionaire Ray Dalio is one of the most gifted macro investors on the planet. When the stock market is valued at high multiples, Dalio is one of my favorite people to watch. Dalio has become famous through the years because he has side-steped every market downturn. Dalio basis his ability to avoid large market losses to his firm understanding of how credit cycles work. Dalio made a video called “How the Economic Machine Works”; if you haven’t seen the video – watch it!

So last night, Bloomberg hosted an hour-long interview with Dalio to discuss the current market conditions. These kinds of interviews are fairly rare for Dalio, so when they happen, I like to pay close attention to his emerging thoughts and positions. Here’s what he said (my writing is paraphrased and not word for word):

Question: Where are we right now with respect to equilibrium in the markets?

Dalio: The United States is in the middle of a short-term debt cycle and we are at the end of a long-term debt cycle. When in the middle of a short-term debt cycle, central banks will start to tighten their money (or credit) supply. The spreads between fixed income and equities still have margin. The equity market or stock market is providing a 3.5 – 4% return. Whereas the ten year treasury market is providing a 2.2% return. Although these margins exist between fixed income and equities, the condition has become somewhat of a steady state because rates haven’t changed in a long time. Now, if rates change, so do all of the discount cash flows that are associated with all of those assets (fixed income and equities). If rates rise, there is going to be a downward pressure on stocks or equities.

Question: Does this mean the FED can’t raise rates?

Dalio: Raising rates are dangerous because the FED can’t raise rates quickly. When we look at a bond yield curve, it represents the discount rate across all terms. If the FED raises rates, or yields, at a faster pace than what the yield curve represents, then you’ll have turmoil and downward pressure in the stock market. The concern is that the FED doesn’t have the tools like they have had in the past (in our lifetime) to adjust rates lower.

Question: So if the FED raises rates 25 basis point (or 0.25%) what impact does that have?

Dalio: So that’s a very small adjustment. That’s simply tweaking the rate. The problem is the dollar is the world’s currency. There’s a lot of dollar denominated debt. Therefore the FED acts as the US’s central bank, but also the worlds central bank. Europe, China, Japan, and other emerging companies all need an easing monetary policy.

Question: With all of these currencies having issues, how do you see things playing out with a lack of productivity?

Dalio: I see our current situation being similar to that of 1982 to 1987. Since so many foreign companies have dollar denominated debt (particularly commodity producing countries), they are effectively bidding up the value of the dollar, and they are in a self-reinforcing cycle of larger debts. The difference is that in the 1980’s the US had the capacity to lower interest rates. It’s tough to do that now.

Question: So what does a central bank do when they are at the end of the long-term debt cycle and they can’t lower rates any more?

Dalio: The risks are totally asymmetrical. You can tighten monetary policy, but why do that too early? If you keep the rates where they are at and don’t adjust them, you really don’t add much more movements on the upside. But if you move too early, there’s tremendous downside.

Question: So tell us about your opinion that the next big FED move is going to be more QE? That’s a very bold opinion, and if it’s true, is QE going to work as well as it did last time?

Dalio: QE is going to work a lot less than it did last time. We can’t have a big rate rise based on the enormous deflationary pressures that currently exist. If we raise rates, we will have a down-turn. The problem that QE creates over time is that it destroys the spreads between asset classes. QE is bond buying. It’s bond buying in order to push premiums, or prices, higher in the bond market. As the government reduces the number of bonds on the market, through the QE purchases, spreads eventually disappear because it pushes yields towards zero. As yields move in this direction and stocks/equities get closer and closer to the bond yields (zero), you have no spreads and we call that “pushing on a string”.

Question: Are we there right now?

Dalio: No we aren’t there yet in the United States. But in some countries they are there. Europe is there (where do you go from negative interest rates). Japan is there. So here’s the key. If you live in Europe or Japan where do you take your money if the yields in your domestic country are giving you no returns? You bring it to a place like the United States where our yields are, relatively high (compared to the rest of the world). As a result, you can’t have interest rates moves, so instead you have currency moves.

Question: What can the next President do to capture better productivity?

Dalio: The same thing works in all countries. What is the cost of an educated person. In Europe, people cost twice as much as a person in the United States. The other thing is the indebtedness of the country. Finally, work attitudes are important. Do people want to work to live or live to work? Those are the three main factors.

Question: What is the Ray Dalio formula for a better America?

Dalio: Or a better world. There are many factors. Are you going to be well educated? Are you going to be inefficient? There’s a 50% correlation between corruption and productivity. At the heart of the discussion is whether people are motivated to work harder because they keep their returns for themselves. I don’t want to over simplify it, because there are a lot of factors that we look at.

Question: How do you apply this concept to investing?

Dalio: I’m interested in knowing who’s going to buy and who’s going to sell and why? I go through each of the factors for each of the trades. I’ve been developing the rules since the 1980’s. After I’ve conducted each trade, I would write down the factors and the reasons why I conducted the trade. I used these factors to program a computer to conduct the trades for me. We invest in over 140 different markets.

Question: Is it tougher today with all the information or is it easier?

Dalio: I find the increased amount of data easier to invest today than before. That doesn’t mean we stop thinking.

Question: Some central bankers say if they raise rates now, then we will have ammunition during the next downturn. You seem to disagree.

Dalio: Again it’s a restrictive policy. I don’t care if they raise rates 25 basis points. What I think they are doing wrong is paying too much attention to the short-term cycle and ignoring the long-term cycle. I don’t get it. They are ignoring the fact that there is no inflation. All other countries around the world are easing, so what’s the rush, why tighten here with lack of inflation.


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