Bridgewater Associates: Its All Macro - May 2004
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Bridgewater Associates: Its All Macro - May 2004

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Bridgewater Associates: Collection of Writings (1999-2012)

Bridgewater Associates: Collection of Writings (1999-2012)

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Bridgewater Associates: Its All Macro - May 2004 Bridgewater Associates: Its All Macro - May 2004 Document Transcript

  • Bridgewater® Daily Observations May 7, 2004 © 2004 Bridgewater Associates, Inc. (203) 226-3030 Ray Dalio Amit Srivastava It’s All Macro Revised 3/10/2006 There are very few markets (betas) or managers’ performance numbers (alphas) that are not dominated by changes in the macro picture. That is because almost all pricing reflects expected future conditions, so prices change as a function of changing expectations. For example, by comparing nominal Treasury bond yields with inflation-indexed bond yields, we can see the “discounted” inflation rates for each of the next several years; by comparing nominal bond yields to earnings yields, we can calculate the discounted earnings growth rate; by looking at credit spreads, we can calculate the discounted rate of credit problems, etc., etc., etc. In most countries, these pictures are painted in incredible detail – e.g., by sector, by company, and by date. The biggest drivers of market returns are changes in discounted real growth and discounted inflation rates. At the most macro level, our estimated discounted world real growth index (GDP-weighted for the world) is shown in the chart below and conveys four major swings (two down and two up) since 1997. Discounted Real Growth Index -30 -20 -10 0 10 20 30 40 50 60 97 98 99 00 01 02 03 04 Bridgewater ® Daily Observations is protected by copyright. No part of the Bridgewater ® Daily Observations can be duplicated or redistributed without prior consent from Bridgewater Associates. Copying or redistribution of The Bridgewater ® Daily Observations is in violation of the U.S. Federal copyright law (T 17,U.S. code). 1 Bridgewater ® Daily Observations 05/07/2004
  • The next chart shows our estimated discounted world inflation index (GDP-weighted for the world). Discounted World Inflation Index 0 20 40 60 80 100 120 Apr-97 Aug-97 Dec-97 Apr-98 Aug-98 Dec-98 Apr-99 Aug-99 Dec-99 Apr-00 Aug-00 Dec-00 Apr-01 Aug-01 Dec-01 Apr-02 Aug-02 Dec-02 Apr-03 Aug-03 Dec-03 Apr-04 Most market movements reflected these shifting expectations, and these shifts resulted primarily from how economic stats came out relative to expectations. For example, since early 2003, stats reflecting growth around the world (especially in the U.S.) came out stronger than expected, which caused equities to rally, credit spreads to narrow, and bond yields to rise globally. These market changes were further supported by increases in expected inflation rates. Similarly, the relative performances of each country’s markets were highly correlated with differences in their economic conditions. As mentioned, these types of changes also occurred at micro levels (e.g., by stock and bond sectors and by companies), based on their changing discounted conditions. To convey this picture, the following charts reflect how these shifting growth and inflation expectations drove the movement for some of the U.S. markets. Below, the first chart shows the S&P 500 rising, the second chart shows the Baa credit spreads narrowing, and the third chart shows the US 10-year yields since early 2003. US Stocks (ln) 6.6 6.7 6.8 6.9 7.0 7.1 7.2 7.3 7.4 97 98 99 00 01 02 03 04 2 Bridgewater ® Daily Observations 05/07/2004
  • Credit Spreads (inverted) 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 97 98 99 00 01 02 03 04 US Bond Yield 3% 4% 5% 6% 7% 8% 97 98 99 00 01 02 03 04 The directions of the markets will continue to be largely driven by how events (most importantly growth and inflation) turn out relative to what is discounted. Right now: * In the U.S., real and nominal short rates and bond yields are very low, there is a big tightening built into the curve (1 1/2% over the next year), and even after the tightening that’s priced in, interest rates out in late 2005 look low. Also, the discounted real growth rate in the U.S. is still pretty low, though we see high real growth in the pipeline, so it looks to us that stocks will perform moderately well, T-bonds will perform moderately poorly, and credit spreads will be pretty stable. This situation is likely to prevail until late this year at which time the positive correlations between stocks and bonds will return, both bonds and stocks will start to decline, and credit spreads will widen. Further, we expect the dollar’s weakness to return and accelerate late this year, which will further support these trends. We believe that mid to late 2005 will be a very difficult period for these markets. * In Europe, real and nominal short rates and bond yields are low, there a modest tightening (about ½% over the next year) built into the curve, and even after the tightening that’s priced in, interest rates out in late 2005 look a bit low. However, the discounted real growth rate in Europe is very low, and the growth that we see in the pipeline isn’t strong. Further, we expect the euro to rise, all of which makes the European bond market attractive relative to the U.S. market and the 3 Bridgewater ® Daily Observations 05/07/2004
  • European equity market modestly attractive compared to the U.S. (because it’s cheaper, but it will have slower earnings growth and a rising currency). We expect the 2005 outlook for European markets to be similar to the U.S., though we expect conditions won’t be as bad for Euroland bonds than as for US bonds. * In Japan, the obvious bets are gone. Back about 18 months ago, earnings and dividend yields had risen above bond yields, discounting significant negative growth, and bond yields got extremely low. At the same time, growth in the pipeline was strong, making stocks very attractive relative to bonds. This has all changed, however, so that stocks now look only slightly cheap, and bonds look only slightly expensive, especially in light of expected currency changes. * In Emerging Countries, especially those in Asia, we expect much more tightening to occur than is discounted, especially via them allowing their currencies to appreciate, as their economies grow much faster than desired, and their balance of payments positions remain strong. While their bond and stock markets will do moderately well, this de-facto tightening will significantly slow these moves and will change the wealth shift to the currency. Bridgewater Daily Observations is prepared by and is the property of Bridgewater Associates, Inc. and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives or tolerances of any of the recipients. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This report is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. Bridgewater research is based primarily upon proprietary analysis of current public information from sources that Bridgewater considers reliable, but it do not assume responsibility for the accuracy of the data. The views expressed herein are solely those of Bridgewater as of the date of this report and are subject to change without notice. The views represent Bridgewater's outright views in these specific markets, but not all markets that Bridgewater trades. Bridgewater may have a significant financial interest in one or more of the positions and/or securities or derivatives discussed. Those responsible for preparing this report receive compensation based upon various factors, including, among other things, the quality of their work and firm revenues. 4 Bridgewater ® Daily Observations 05/07/2004