If I have a to choose a side in the Great Rotation debate that’s now being waged across thousands of television segments, chief strategist notes, newsletters, blog posts and articles, then I choose to side with Ray Dalio of Bridgewater, also known as one of the the most brilliant global macro investors in history.
What Ray Dalio understands – that many in the chattering classes do not – is that the rotation is not just a bonds-to-stocks phenomenon. It is a cash-to-everything story predicated on the positive feedback loop of returns elsewhere and the relatively destructive long-term returns on cash and super-short-term fixed income.
And so for these purposes, when we say bonds-to-stocks, we’re referring to the treasury maturities that have been substituted for cash, cash itself at banks, money market funds, maturing CDs, corporate balance sheet cash, mattress cash, short-term bond funds that cannot mathematically compete with constant inflation above 2% and on and on. This broader description of what is left to be rotated represents a wicked assload of assets (yes, that’s a technical term I learned at MIT).
And while I am in agreement with Dalio, I will tell you with whom I am in disagreement with:
1. Any journalist who writes articles on the topic just to be interesting, provocative, clickable (hey, it’s the hot topic!) or worse – who seeks to frighten people for the sake of pageviews.
2. Analysts or strategists who work at asset management firms in which bonds represent 90 cents of every dollar in AUM. Imagine hearing Nathans come out and admit that burgers are superior to frankfurters (and of course they are). GMAFB, never gonna happen. El-Erian is telling us that he doesn’t see the rotation happening at PIMCO. With all due respect, you won’t – PIMCO is not exactly the first destination for new inflow dollars to equity funds.
3. Short-term traders who don’t speak with clients. Sorry guys, in most matters of tape-reading and such I’ll take your word for it…but you must truly be plugged into the mindset of wealthy investors to understand the anxiety with which they are now starting to view massively overgrown cash piles. This isn’t about the trade of the week – this is about the purchasing power of their life’s savings and it is hard to understand the intensity of these concerns from a distance.
Anyway, Dalio’s take is simple – it is the “Bubble of Cash” that is unsustainable (and lots of that cash bubble is engaged in areas within the bond market). The blog Santangel’s Review has the full transcript of his comments during the Bloomberg panel at Davos last week. I cherry-pick the key phrases, emphasis is mine:
So when we’ve added money, we’ve made up for credit and that’s been fine. What’s happened now is that because of all the money that has been added to the system, there is a great deal of liquidity in the world. So there is money in corporations, in households. Liquidity is all over the place, a lot of it. And it has gone there because of monetary policy and it has also gone there seeking safety.
That is changing on the margin. The returns of cash are terrible. So as a result of that, what we have is a lot of money in a place — and it needed to go there to make up for the contraction in credit — but a lot of money that is getting a very bad return. That, in this particular year, in my opinion, will shift. And the complexion of the world will change as that money goes from cash into other things.
Now each region is very different, each set of circumstances. But the landscape will change I think particularly later in the year and beyond as those people who put their money there are receiving this bad return and feel an environment of safety [now] because the imbalances of Europe have largely been rectified. They have been rectified because the amount of borrowing is now consistent with the ability to fund that. And so the tail risks were taken off the table and that less risky environment is going to create that kind of a shift I think.”
“There is a lot of liquidity, but the most fundamental laws of economics is you can’t have debt rise faster than income. You can’t have income rise faster than productivity and the long term growth will be dependent on productivity. And we have these cycles around productivity growth because of debt cycles. We don’t have a credit bubble because of the production of too much credit, but we do have a bubble in liquidity.
There is too much liquidity and so bonds are a poor investment, they will have a poor return. Cash will have an even worse return, that’s assured. And that’s a bubble. Too much money in there. So the cash bubble exists, but we are reaching an equilibrium in terms of the debt growth.”
Ray sees what I see. There is too much liquidity in liquidity, too much of a safety premium in safety. And money sitting in so-called “safe assets” is beginning to find that things are not quite so safe there either. He talks about this becoming a full-blown phenomenon sometime later, in the second half of this year. He has studied asset markets through every single boom and bust cycle throughout human history, in every geographic location and under every conceivable economic variable. I’d listen to what he has to say on the topic, even if you disagree with his (and my) conclusion.
To just refer to bonds vs stocks instead of cash and bonds vs stocks is to miss the entire premise of the rotation debate to begin with. Everyone who manages and allocates portfolios in real life understands this even as many journos and analysts do not.
Transcript of Ray Dalio’s Comments at Davos (Santangel’s Review)
Fund Flows and the Positive Feedback Loop (TRB)
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