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Ray Dalio thinks the bull market has two years left – is he right?

Ray Dalio thinks the bull market has two years left – is he right?

 

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Yesterday, billionaire Ray Dalio went on TV and predicted that the economic cycle we are currently in, and which is now well into its ninth year, is in the “seventh inning” of its run. He also suggested that investors should start thinking about becoming more defensive in the stock market and that he sees market risk increasing as time progresses. At the beginning of the year, that might not have sounded like such a crazy opinion to some, but right now it seems to be going against the grain of a lot of other forecasts I’ve seen other analysts and so-called experts I’ve seen making, who seem to think that stock valuations generally aren’t that high and the market’s volatility this year should give it room to extend its long-term upward trend even further into the future.

Who is Ray Dalio, and why would his opinion carry any weight? Dalio is the founder of Bridgewater Associates, the investment firm that became the largest hedge fund in the world in 2005 and at last count has more than $160 billion in assets under management. Dalio also made news in 2007 when he predicted the oncoming global financial crisis in 2007. He’s currently ranked among the top 100 richest men in the world, with a net worth that is estimated at more than $17 billion. Not too bad for a guy who started Bridgewater in 1975 out of his apartment!

My own belief about the market, and the economy is essentially unchanged from what I have written about for more than two years now; the market has been very extended for a very long time now, and even with the correction we witnessed in the beginning of the year, remains that way. It is true that the market’s volatility this year has created a lot of pockets where good value can be had, and that is encouraging to see. It is also true that the economy continues to show impressive strength, helped in part by presidential policies like last year’s tax bill that have enabled the economy, and the market, to extend itself into the longest run of prosperity in history.



The contrarian in me tends to agree with Mr. Dalio’s suggestion that investors would be wise at this stage of the game to start thinking in more conservative, even defensive terms about the investments they’re willing to make. That’s because of a simple fact; all markets and economies move in cycles, from expansion to contraction, and back again. Analysts and experts, me included, like to try to predict how long a given cycle is going to last, and it is true that those predictions are really nothing more than that person’s individual guess based on imperfect information; but even if you can’t really predict when a certain cycle is going to end, the truth is that at some point it will. It’s a fact that has proven itself over hundreds of years of market activity all over the world. There is no amount of financial, political or social engineering that can ensure expansion never ends.

Thinking in more conservative, or even defensive terms can be taken in a lot of different ways. To some, that means closing out of existing positions, increasing cash, and waiting for the inevitable. For some of these folks, it means getting out of all long positions and hoarding cash until the market has dropped and starts to go back up again. The problem with that logic is that is smart people like Mr. Dalio are right, you would have to willing to play a very long waiting game.

Think about it: historically speaking, most bear markets last a year and a half to two years on average, which means that if the market really does have about two more years to follow its unprecedented run, the super-conservative approach would force you to pull out of the market and be ready to wait for four more years until you start to put your money to work for you again. That’s a long time to wait, and if you simply leave your money in cash – or even go ahead and take whatever you can get from conservative, interest-bearing instruments like Treasury bonds, CD’s or savings accounts, which remain very near to historical lows, despite the last couple of years’ worth of Fed rate increases – that’s a lot of lost opportunity.



I prefer to think in a somewhat more moderated fashion. For me, it’s a mistake to take everything out of the market and start sitting cash, even if the market is at or near all-time highs, because if there does remain upside to be had, I want to keep my money working for me as much as possible. The longer the market extends itself, however, the more I want to be very careful about how I approach and plan my investments, and how much of my capital I’m willing to actually invest at any given time.

I write a lot about value investing, and when I highlight a stock, I usually look at it from a strictly value-oriented perspective. That’s because I think value investing is the best way to maintain the ability to identify and take advantage of good long-term opportunities in the stock market no matter what the market’s current condition is. If the market is nearing all-time highs, or making new ones, identifying undervalued stocks usually means finding stocks that most investors aren’t paying attention to, but that should have healthy upside the market will eventually have to pay attention to. If the market and the economy reverses, value stocks are still a better place to be because they’ve already been beaten down before the rest of the market started dropping. That usually means that they’re less at risk to see the kind of extreme drops in price to which stocks that have followed the broad market to extreme highs are going to be subject.



The longer a bull market lasts, the more selective I try to be about the stocks I pay attention to; and if I do decide to take a position, the more conservative my plan about how much money I’ll put into that position is going to be. That’s because I want to limit my initial risk in the event that a reversal does actually happen, and I want to maintain my financial flexibility to make adjustments and changes as conditions seem appropriate.

The truth is that there are other risks that are increasingly coming into play. Trade tensions between the U.S., Canada, Europe, and of course China are still not done playing themselves out. I think that if the U.S. manages to convince its partners to come to terms, it will probably help the economy continue to grow and extend into the two-year timeframe that Mr. Dalio has predicted; but I also think that it could force the Fed to start increasing the pace of its interest rate increases, and that is something that investors would almost certainly react negatively to. 

The risk of over-inflating the economy is that when the end comes, it won’t simply contract, but actually deflate, something that could force the economy to reverse much more sharply and severely than most people would be able to predict or prepare for. That’s what happened in 2008, when the financial “bubble” burst; it was very much like an over-inflated balloon that pops, because there is no way to re-inflate it. The only solution is to find another balloon. That’s why the smart thing under current conditions is to be very careful about new trades, and work only with very conservative position sizing rules.


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