The stock market struck a fairly upbeat tone through most of 2018, despite a host of gails and headwinds. Confidence remained fairly high, despite the Federal Reserve continually plugging away at its program of tightening monetary policy (even global trade conflicts heated up). For a while, the bull market, though running flat through most of the year, seemed remarkably resilient.
Then everything changed in December. The Fed followed through with a rate hike, despite pressure not only from big financial actors, but also from the president of the United States himself. The decision sparked a firestorm of volatility, sending shockwaves of fear through once-imperturbable markets. The possibility of a near-term economic downturn or recession was suddenly a common topic of discussion in investing circles once again.
But just because the market outlook is darkening does not mean investors should despair. Ray Dalio (Trades, Portfolio), the billionaire boss of Bridgewater Associates, has shared his thoughts on what investors can do to weather the approaching economic storm.
Recession looms
While much of the market was buffeted badly in the final quarter of 2018, not everyone was taken by surprise. Indeed, Bridgewater, the world’s largest hedge fund manager, bet on end-of-year turmoil and profited handsomely. Its flagship Pure Alpha Fund, which runs a global macro strategy, turned in its best performance in years, handily beating the market (and pretty much all the other hedge funds).
But Dalio is worried about a looming recession. In September, he opined that the current economic cycle was in its “seventh inning” and that upside “looks limited” in light of that fact.
Time to start thinking defensively
Dalio’s outlook has only darkened in the months since. In January, he observed “significant risk” of recession striking by 2020, as we discussed in a recent research note. He is not alone. Other leading traders have echoed Dalio’s concerns in recent weeks.
Dalio is calling on investors to be “more defensive” in their trades and investment allocation decisions. That should be obvious enough. But, thankfully, Dalio has more to offer us than mere generalized bromides.
The “all weather” portfolio
Dalio offered an interesting take on how ordinary investors can build an “all weather” portfolio designed to perform well in both good times and bad:
“You can immunize yourself from the cycle by holding a balanced portfolio of assets ... When you look at most portfolios, they have a very strong bias to do well in good times and bad in bad times.”
The key, according to Dalio, is to strike a better balance. He outlined the recommended composition of this portfolio in a few places. It is fairly simple and straightforward:
- 30% stocks.
- 40% long-term U.S. bonds.
- 15% intermediate U.S. bonds.
- 7.5% gold.
- 7.5% other commodities.
In essence, this portfolio offers diversification, as well as a number of established and well-understood hedges that do well in times of economic trouble. We have discussed the value of gold in hedging against crisis, for example.
Defense at the expense of offense
Dalio’s recommended portfolio allocation is definitely highly defensive. Indeed, compared to the traditional 60-40 mix of stocks and bonds, it is downright radically so. But that is the trade-off being proposed by this portfolio.
Dalio offers a portfolio allocation strategy that is “all weather” insofar as it will perform with stable regularity across most economic conditions. But it does so at a cost. Specifically, it will offer only muted performance during times of real upward momentum, such as has prevailed over the past decade.
For investors with capital preservation as their overriding concern, the opportunity cost of this portfolio allocation strategy may be worth paying. But for investors with an eye toward finding value, it looks a little too skittish.
Verdict
The “all weather” portfolio is something worth thinking about, and might be worth emulating in part in these particularly uncertain times, but it is not the path to market-beating returns on a sustained basis. But, if you are an active investor looking to beat the market on a long-run basis, this portfolio is not going to cut it.
Still, Bridgewater kept its head above water in spite of turmoil and volatility in 2018. That might be reason enough to give serious consideration to Dalio’s advice when it comes to surviving recessions. That said, Bridgewater’s success in 2018 came from playing an active global macro strategy, not by adopting a defensive crouch.
Dalio’s specific advice on portfolio allocation may not apply to everyone, and there will likely actually be an increase in potential value play opportunities in the face of heightened market anxiety, but his words are still worth considering, no matter your situation or approach to investment strategy.
Disclosure: No positions.
