On Paradigm Shifts 1920-2019 By Ray Dalio

I do a lot of reading of articles and opinions in the financial markets because I have a love of the markets as well as strong desire to continue incorporating the many lessons of the market into my investing. Perhaps the biggest lesson I have learned is that markets are driven by extremes in investor psychology (think of high/low PE ratios) cycling above and below the long term trendline of economic growth. According, I keep a close eye on both behavioral economics and investor psychology.

There are many analysts and commentators who believe that both equity and bond prices have reached unsustainable levels. I agree with them, but what we believe does not really matter to the market. It is the state of collective investor psychology which matters and investor beliefs can be both long lasting and fickle. It is when investor psychology takes an investment paradigm to the point where it becomes unsustainable, and then hits the panic button, that the paradigm changes. Wiley E. Coyote comes to mind.

Ray Dalio, the founder and CEO of Bridgewater, is one of the richest guys on the planet because he has done a much better job than most of us in dissecting what makes markets and investor psychology tick, then putting that information into strategies which drive Bridgewater's investments.

Ray started publishing articles about the credit markets and credit cycles a year or two ago. His How The Economic Machine Works resonated with me because I have long believed that it is the credit markets which alternately feed and starve the economy over long periods of time. These cycles of credit excess and starvation lead the direction of the equity markets. I keep a close eye on the state of credit markets.

I've spent some time studying Ray Dalio's most recent piece Paradigm Shifts which he posted on LinkedIn. Since it can not be annotated or printed from LinkedIn, I copied it to Google Docs where I could study and annotate it. The article is a very useful guide in thinking about the decade ahead. 

I believe it's important to have a general road map for the next decade because prices of equities and bonds have stretched to the point where virtually all of the future returns have been brought forward into the present. Ray shows us that this is not the first time this has happened even though the current paradigm is the most extreme. He also provides some clues regarding the probabilities of what comes next.

As I look ahead, I don't know when the coming paradigm shift will occur, nor do I have any guarantees regarding which assets will do well and which assets will do poorly. I do think it is safe to say that assets are going to be repriced and Ray probably has as good or better handle on the repricing than most.

It is my belief that any investment strategy which is to survive from one paradigm to another must be self-adapting, must utilize a broad basket of potential investments, and must navigate the changes while maintaining investor confidence in managing volatility. This forms an integral part of the design behind the Tactical Adaptive Global Strategy. The fund basket, consisting of 24 funds, is the broadest tactical basket of which I am aware. Adaptive Dynamic Momentum, which underlies the fund selection process, is the only tactical method I know of which is capable of dynamically-adapting to changes in cyclical characteristics within market sectors. The Strategy's historical volatility during the full market cycle beginning in October 2007 is very low.

My deep concerns regarding the coming paradigm shift is the reason why the majority of our personal investments are managed using Tactical Asset Allocation. Also worthy of mention, in light of the article, is the fact that we have maintained an 8% position in the Sprott Physical Gold Trust (PHYS), without market timing. for two years now.

Ray's piece is a long read but then, 10 years is a long time.

Here is a link to my annotated copy of Paradigm Shifts which is downloadable and printable.

Earl Adamy

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A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

 

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.