Hedge fund manager, Bridgewater, has warned Western economies remain well out of kilter with some painful re-weightings ahead to restore balance.
In a new paper, Bridgewater says the three main economic metrics of spending, debt and risk premium have strayed far from their respective counterpoints of capacity, income growth and historical return above cash in the US, UK and Europe, particularly.
“These economies remain quite far from equilibrium for similar reasons, and this is leading to big policy shifts and high market volatility,” the Bridgewater report says. “Furthermore, despite aggressive policy action, they have not moved much closer to equilibrium. On the margin, the nature of the disequilibrium has shifted from too much inflation to not enough growth, with the risk premiums on assets falling relative to cash.”
According to the macro-analysis, the Western economies have fallen into a “bearish disequilibrium” phase featuring too-high inflation and nominal spending mixed with too-low unemployment and real growth.
“Of course, a weaker real growth rate is required to resolve the other imbalances, but that is a form of disequilibrium on its own, illustrating the challenge of having to create one disequilibrium in order to resolve another, and then iterating back and forth as policy makers try to bring all of them in line,” the paper says.
While central banks are currently trying to restore order by boosting cash rates, the path to more evenly balanced economies may take some time with considerable volatility ahead.
“Looking directly at corporate profits shows a bit more progress toward equilibrium, but we estimate corporate profits need to fall roughly 20% and are currently down a bit less than 10%,” the paper says. “More pain is needed to raise unemployment, reduce wages, and moderate inflation.”
Bridgewater favours cash in most developed economies but is overweight risk assets in Asia “because they are either closer to equilibrium or are in disequilibriums that favor an expansion of liquidity that makes cash unattractive in relation to assets”.
Authored by Bridgewater co chief investment officers Bob Prince, Greg Jensen and Karen Karniol-Tambour, the report says while monetary tightening in the West has lifted real cash rates neither growth nor risk premiums have yet to adjust.
“That is likely what comes next.”
Meanwhile, Bridgewater founder (and former chief), Ray Dalio, suggests the world is poised for momentous change as five fundamental influences crest at another historical peak.
“… four of these five big forces (i.e., the financial one, the internal conflict one, the external conflict one, and the acts of nature one) appear more likely to be painful disrupters to the world order. The fifth one—human inventiveness/technology—is likely to be a big disruptor, though it’s difficult to say in what ways,” Dalio says.
“When these forces come together in the magnitudes that we are now seeing, history has shown that it is likely that we experience seismic shifts in financial orders, domestic orders, and world orders.”
And there’s probably a hedge fund for that.