Monday 22 October 2018

Is US hedge fund titan right to bet against eurozone?

Founder of Bridgewater Associates Ray Dalio. Photo: Larry Busacca/Getty Images for The New York Times
Founder of Bridgewater Associates Ray Dalio. Photo: Larry Busacca/Getty Images for The New York Times

Nir Kaissar

Hedge fund titan Ray Dalio is famously enigmatic, but his latest wager may be the most puzzling yet.

Bloomberg News reported on Thursday that the fund Dalio founded, Bridgewater Associates, has made a $22bn bet that many of Europe's biggest companies in the blue-chip Euro Stoxx 50 Index are poised to decline.

According to Bloomberg News, Dalio "has a checklist to identify the best time to sell stocks: a strong economy, close to full employment and rising interest rates."

It's an old idea. Economic fortunes are reliably cyclical, even if no one can precisely predict the turns. Booms tend to be followed by busts, and vice versa, and stock prices often go along for the ride.

By that measure, it seems like a precarious time for US stocks. The US's real GDP has grown for eight consecutive years, by 2.2pc annually from 2010 to 2017. Unemployment has declined to 4.1pc from 10pc in late 2009. And the yield on the 10-year US Treasury is up to 2.9pc from 2.1pc in September - an increase of nearly 40pc.

The problem with Dalio's checklist, however, is that stock prices take their cue from companies' fundamentals, not the economy. Yes, companies' collective fortunes often reflect those of the broader economy, but not always. And when the two diverge, the relationship between economic results and stock prices breaks down, too.

US companies have done even better than the US economy in recent years. Earnings per share for the S&P 500 Index have grown by 9.7pc a year from 2010 to 2017, or real growth of 8pc. That's more than double the long-term earnings growth of 4pc a year since 1871, and four times the real growth rate of 2pc, according to data compiled by Yale professor Robert Shiller. It's no surprise that the S&P 500 is up 11.6pc annually over the last eight years through 2017.

Given the recent performance of US companies, Dalio's checklist of economic bellwethers might understate the risks to US stockholders.

Consider, by contrast, how France and Germany have fared over the same time.

The two European powerhouses dominate the Euro Stoxx 50 Index. Their companies account for 34 of the stocks in the index and 67pc of its market capitalisation in euro.

France and Germany's growth rates have rivalled those of the US since 2010.

Like those in the US, Germany's economic results check the boxes on Dalio's list. Its real GDP grew by 1.9pc a year from 2010 to 2017. Its unemployment rate has declined to 5.8pc from 8.6pc in early 2010 and is even lower now than it was before the 2008 financial crisis. And the yield on its 10-year government bond has nearly tripled to 0.9pc since December.

France's success has been more modest, but it, too, checks the boxes.

Here's the disconnect, however: Unlike US companies, those in the Euro Stoxx 50 have performed horribly. Their revenue declined 1.3pc annually from 2010 to 2017.

Not surprisingly, stock prices have gone nowhere. The Euro Stoxx 50 is up just 2.1pc annually from 2010 to 2017 in euro. That's well below its annual growth of 5.3pc from 1987 to 2009, the earliest year for which numbers are available.

As Bloomberg News points out, information about Bridgewater's short bets on US stocks isn't available. It's possible that Dalio's scepticism is directed at US stocks rather than European ones and that Bridgewater is betting that a US bear market would drag down Europe, too. It's a legitimate concern. During the previous two downturns in 2000 and 2008, stocks sold off around the world.

But if Dalio thinks that Europe's economic numbers are concerning for its stocks, he may want to add a few more data points to that checklist. (Bloomberg)

Bloomberg

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