Bridgewater's Ray Dalio at the World Economic Forum in Davos: Liquidity Will Flow into Risk Assets - Goldman Sachs Gr (NYSE:GS)

Last Friday, Ray Dalio, one of the world's foremost investors, participated in a Bloomberg debate at the World Economic Forum in Davos, Switzerland. While most of Wall Street was focused on the epic verbal throw-down between Carl Icahn and Bill Ackman, which occurred live on CNBC, Dalio's commentary at the debate may have been overlooked. His outlook on the economy and markets for 2013, however, was extremely illuminating. Interestingly, Dalio's view mirrored that of Appaloosa Management's founder David Tepper who gave Bloomberg a

wide-ranging, exclusive interview

last Tuesday. Tepper and Dalio are both at the very apex of the hedge fund universe and among the most respected market minds in the world. Tepper founded Appaloosa in 1993 and the firm has grown into one of the largest and most successful hedge funds in history. In the process, the University of Pittsburgh and Goldman Sachs

alumnus has become a billionaire many times over. In his Bloomberg Television interview, Tepper was unequivocally bullish on the U.S. stock market. Among the factors he cited was a low earnings multiple for the S&P 500, combined with a flood of liquidity from global central banks and unattractive yields in fixed income. He said that the gap between equity valuations and the valuation of the bond market was the biggest he has ever seen. "There's never been this big of a gap in the history of my life at least." With growth running at 2% to 3% and the economy seemingly on solid, if not spectacular footing, Tepper argued that the excess liquidity in the financial system will flow into equities and other risk assets. He said that there will be a great shift of both new money and old money into stocks. The new money will be generated by incremental savings and traditional capital formation while the old money Tepper refers to is currently allocated in fixed income. In combination, these two sources of liquidity amount to a mountain of cash looking for a home with the best risk-adjusted return potential. According to Tepper, stocks are the obvious choice because of low historical valuations and a dearth of attractive alternatives in the current interest rate environment. In addition to this dynamic, Tepper was extremely upbeat about the forward-looking prospects for the economy. The hedge fund manager told Bloomberg Television's Stephanie Ruhle that "this country is on the verge of just an explosion of greatness." Based in Westport, Connecticut, Bridgewater Associates was founded by Ray Dalio in 1975. Over the years, the hedge fund has become one of the most powerful and influential investors on the planet. Dalio's firm currently manages approximately $130 billion in global investments, making it the largest hedge fund in existence today. In the world of alternative investments, Ray Dalio's success is nearly unprecedented. His comments at Davos paralleled Tepper's arguments in some significant respects. Speaking about current economic conditions, he said "what's happened now is that because of all the money that has been added to the system, there is a great deal of liquidity in the world. So there is money in corporations, in households. Liquidity is all over the place, a lot of it." Like Tepper, Dalio sees a great shift in capital flows occurring this year. Particularly, he said that the transition will occur "later in the year and beyond." His reasoning for this shift also mirrors the thesis laid out on Bloomberg Television by David Tepper last week. He said, "The returns of cash are terrible. So as a result of that, what we have is a lot of money in a place -- and it needed to go there to make up for the contraction in credit -- but a lot of money is getting a very bad return. That, in this particular year, in my opinion, will shift. And the complexion of the world will change as that money goes from cash into other things." According to Dalio, another catalyst for this transition in capital flows is the containment of the European sovereign debt crisis. He said that currently, "the imbalances of Europe have largely been rectified. They have been rectified because the amount of borrowing is now consistent with the ability to fund that. And so the tail risks were taken off the table and that less risky environment is going to create that kind of a shift I think." Dalio and Tepper not only share a similar view of current conditions, but their conclusions are also largely the same. They both see huge amounts of liquidity in the system, a lessening of downside risks, and poor returns on cash and fixed income investments. In this environment, they conclude that money will flow into risk assets. Dalio called the present situation "a bubble in liquidity" and like Tepper, he doesn't like bonds. He said, "there is too much liquidity and so bonds are a poor investment, they will have a poor return. Cash will have an even worse return, that's assured." Therefore, Dalio thinks that the risk markets will see huge inflows in the back half of 2013 and into 2014. Although the Bridgewater founder said that he thinks the main theme for 2013 will be transition and that it might not be a memorable year from a historic perspective, his outlook certainly appears to be very bullish over the next couple of years. He said, "I think the shift of the cash, that massive amount of cash will be what will be a game changer...into stocks, into everything. It will mean more purchases of goods and services and financial assets. It will be into equities, it will be into real estate, it will be into gold, it will be into a lot of...just basically everything." The entire transcript of Ray Dalio's comments from the Bloomberg debate at Davos are below, courtesy of

Santangel's Review

(The times that he was speaking are denoted prior to the questions). The full 50-minute video of the Bloomberg panel can be seen

here

8 minutes, 40 seconds: Are you concerned about inflation if you look at the way that we have all this cheap liquidity out there?“I think the economy works like a machine and I think it's important to understand how the machine works in order to answer that question. So if there is a transaction, you could pay with money or you can pay with credit. If you have money, that is making up for a contraction in credit. It's not inflationary because the total amount spent in comparison to the total number of goods sold will determine the price.So when we've added money, we've made up for credit and that's been fine. What's happened now is that because of all the money that has been added to the system, there is a great deal of liquidity in the world. So there is money in corporations, in households. Liquidity is all over the place, a lot of it. And it has gone there because of monetary policy and it has also gone there seeking safety.That is changing on the margin. The returns of cash are terrible. So as a result of that, what we have is a lot of money in a place — and it needed to go there to make up for the contraction in credit — but a lot of money that is getting a very bad return. That, in this particular year, in my opinion, will shift. And the complexion of the world will change as that money goes from cash into other things.Now each region is very different, each set of circumstances. But the landscape will change I think particularly later in the year and beyond as those people who put their money there are receiving this bad return and feel an environment of safety [now] because the imbalances of Europe have largely been rectified. They have been rectified because the amount of borrowing is now consistent with the ability to fund that. And so the tail risks were taken off the table and that less risky environment is going to create that kind of a shift I think.”

11 minutes: Do you think we are seeing a credit bubble? “There is a lot of liquidity, but the most fundamental laws of economics is you can't have debt rise faster than income. You can't have income rise faster than productivity and the long term growth will be dependent on productivity. And we have these cycles around productivity growth because of debt cycles. We don't have a credit bubble because of the production of too much credit, but we do have a bubble in liquidity.There is too much liquidity and so bonds are a poor investment, they will have a poor return. Cash will have an even worse return, that's assured. And that's a bubble. Too much money in there. So the cash bubble exists, but we are reaching an equilibrium in terms of the debt growth.”20 minutes, 20 seconds: (in response to another speaker's comment)

“I think it is important to understand the adjustment that is happening is not just central banks feel there was a funding gap, the amount of money that can be lent and the amount of money that needed to be borrowed, there was a gap. And the central banks needed to come in and help fill that gap.What's happened in the adjustment is that the amount of money that is being lent and borrowed has fallen a lot and with that depressions have historically occurred. So it is important to realize that when we go back to normalcy, normalcy [will not be] like the past. In other words those countries can't spend the way that they have spent before. Equilibrium means a depressed economy. And what that means is the fundamental law is that we can't raise debt faster than income from now on. And if we can't raise debt faster than income we have to have a low debt growth and the issue will come to productivity.So the shift of the discussion is going to change. The shift of the discussion is now going to change in the economics of how do you become competitive. And so competition will be the discussion and I won't go on there, but there are clear benchmarks for discussion about productivity and ultimately you can only spend what you produce.If you use the measures …literally what does it cost to have an educated person in France, the United States and China? Look at those comparisons and the cost of an educated person in these countries is multiples of the cost of an educated person in China and so when it comes down to it, there are going to be very big social questions. It's going to be values of life. How long is vacation? How much savings? Very much quality of life types of questions. How much will there transfers of wealth? Productivity is going to be the question. There are clear benchmarks of productivity. I won't go on, but we have a list of those things that correlate with 90 percent correlation with the outcome of the growth rate the next ten years. They are like a health index. If you look at that health index, you can go down that and compare it and those are going to be the drivers. Productivity, because the debt cycle will no longer be the main driver.”27 minutes, 10 seconds: Ray are you concerned about currency wars? “I'm not particularly concerned about currency wars. I also think central banks will play a much lesser role going forward. I think the ECB's balance sheet will gradually taper off. The same thing with the U.S. So I think they will naturally recede. I think that their next move will be, as described, a move from liquidity to the purchases and then we have a shift. So I don't think that is the issue. I think the shift of the cash, that massive amount of cash will be what will be a game changer…into stocks, into everything. It will mean more purchases of goods and services and financial assets. It will be into equities, it will be into real estate, it will be into gold, it will be into a lot of….just basically everything.”39 minutes, 20 seconds: Audience question – What are your views on the Fed's ability to shrink its balance sheet before it creates an inflation problem?“Again I think it's important to think of the economy as operating like a machine and everything is a transaction. So the amount of spending is what matters. Now spending can mean money or it can mean credit. If credit is picking up then money can decrease and so spending is the thing that matters. When it picks up, it will be incumbent on the central banks to reduce the amount of money so that the amount of spending is consistent with the productivity growth rate. And so I believe that that can be done as long as there is balance. As long as debt doesn't rise faster than income, income doesn't rise faster than productivity, and productivity then grows at a decent pace. That's what matters.”49 minutes, 25 seconds: Closing remarks“I think it is very difficult to talk about the world as a whole because conditions are very different. I think in the U.S., it's a transition year. It's one of those years that will go down in history as one you won't even remember. It's a transition in between cycles as we move from one to the other. I think in Europe, what we have achieved is the debt creation has been brought down to a level that is funding and that is a depression-like condition and that will now be an environment in which social pressures and political pressures will be difficult. And the importance there is not to have a pick-up in debt relative to income again and deal with it through productivity. I think in China they are in the other side of the cycle. The other side of the cycle is that debt is rising too fast relative to income and that is something that is the opposite side of the cycle and they will have to deal with it. So I think that those conditions are a landscape. They are transitions for all those countries.”

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