uh so uh
as sasha mentioned uh it's been uh
25 years that uh
that we've been friends and professional
colleagues and so
uh you know i look in the room and i see
these old friends i'm
so happy to be here i um
he also mentioned uh that
uh i'm very systematic meaning
i got in a habit of every time i would
make a decision
to write down the criteria i would use
to make that decision
we're getting a little echo i think uh
and it's not a big room so i don't even
know if i need a mic
but um so every time i would make a
decision i would write down the criteria
i used for making those decisions
because cause effect everything happens
because of a cause
and so and the same things happen over
and over again
and so by taking the time to write them
down
and then seeing how those criteria would
have worked over a period of time i
could get perspective
and so i wrote down those principles and
as hashem mentioned
i i wrote a book called principles
which has to do which just was a
collection of the life and work
principles so the culture that we have
is very very important it was really the
most important thing in terms of
whatever success we've had
at the same time i wrote down the
economic and investment principles
so what i thought i would do today is to
share with you
what i think of my most important
economic and investment principles and
then
look at the world through the
perspective of those principles
in other words rather than just tell you
what i think i want to tell you how it
works
and then we can apply that mechanics you
can decide does it work that way
or not so are these principles
valuable because if you know the
principles
it's like it's giving it like a giving
man the fish
ability to fish rather than to just give
the fish i can tell you what i think
but if these principles are right then
you could apply them yourself
to whatever time or circumstances exist
so um i broke it down in terms of
economic principles
and investment principles because
the markets follow the economy
so in order to understand economics and
all the markets you have to
understand in order to understand the
market you have to understand the
economy
so i want to describe how
i think the economy works i think it's
like a ver
it's a perpetual motion machine and
there are four big forces
three important equilibriums and two
levers if you get this down i
think this basically everything through
my eyes
is along those lines um over a period of
time
we raise our living standards because we
learn how to do things better
we become more efficient that's called
productivity
output and that
is something that evolves over a period
of time
that is because it evolves it is not
something that
is a big thing that's we see as a big
thing but it's the most important thing
over a period of time
the big things that we see and feel
every day
are debt cycles now there's a short-term
debt cycle and there's a long-term debt
cycle
when i say a short-term debt cycle what
i mean is
what we think of is normally the
business cycle
right you have a recession you have a
weakness in the economy
when the rate of economic activity is
too low
then central banks produce credit
and credit is buying power so
you produce that credit it makes
purchases of goods services and
financial assets happen
and so the economy picks up that
cycle usually lasts seven to ten years
as the economy picks up
the demand rises relative to the
capacity as you get
later in the cycle the central bank puts
the brakes on it
they raise interest rates tighten
monetary policy
as the uh there's less slack in the
economy the unemployment rate is
low they put the brakes on it interest
rates go up
tightness and monetary policy then you
have a recession
slow up and that's the cycle right and
because
credit is buying power
by providing it it also produces debt
and debt means the obligation to pay
back
and so by its very nature it's cyclical
first comes the stimulation then comes
the paying back
which means when you when you produce
credit
you can spend more than you earn and
when you pay back
you have to spend less than you earn and
that's the nature of the cycle and i
think we're all acquainted with that
type of cycle
and with that cycle goes market cycles
which we'll talk about
that's what i mean by the short-term
debt cycle
there's also a long-term debt cycle
which is the
accumulation of all of those that those
shorter term debt cycles
because everybody wants things to go up
they want their asset prices the markets
to go up
they want employment to go up they want
everything to go up
and for that reason they
central banks over a period of time
stimulate
and they do that by normally
lowering interest rates until interest
rates hit zero
and then when interest rates hit zero
they can't do that anymore
and then we come to the need to
print money and buy financial assets
which we call quantitative easing
and when they can't do that anymore or
there are limitations
we come to the end of the long-term debt
cycle
so there's a short-term debt cycle a
long-term debt cycle and productivity
now related to all that is
politics internal politics and external
politics
in that normal cycle they're related
as we're going to see in terms of that
dynamic
the period that we're going through 2008
and 9
there was a debt cycle and interest
rates hit zero
and that's very similar to 1929 to 32
there was a debt crisis and interest
rates hit zero
and in both of those cases there was the
printing of money and the buying of
financial assets
which caused those financial asset
prices to go
up and more liquidity in the economy
and that particularly benefited
those who had financial assets and it
contributed
to the wealth gap and the
income gap as did technology
and as a result of that in the 1930s as
also happened now politics entered into
the picture
so as we're seeing in the world right
now that issue
of wealth gap is causing
populism populism of the left and
populism of the right
and that's having an effect on the
markets and having an effect on the
economy
so we are also seeing a situation
very much like the 30s in which
uh we're seeing a rising power
uh challenging an existing power
that's a geopolitical cycle
when a rising power in the form of china
a challenging and existing power in the
form of the united states
and if we look at histories and cycles
of those periods
there's a cycle of
conflict and peace normally
peace happens after a war because some
dominant
country wins the war nobody wants to
fight
the dominant power and you have an
extended period of
peace until there's then that particular
conflict
doesn't i'm not saying we're going to
have a military conflict or anything
like that
although you know that
always exists as a possibility so these
cycles these things have happened um
over and over again
so politics enters into can affect
the the cycles for example um
the the shift in the uh united states
to be able to create tax cut changes
help the corporate tax picture
and cause stock prices to rise okay
those are the cycles
then when i look at what's happening i
compare it to three equilibriums
and what are these three equilibriums
first that debt growth has to be in line
with the income growth that's required
to service the debt
if debt growth is faster than the income
growth that's going to service the debt
we're going to have an adjustment and
so i'm always doing the pro forma what
is the ability to service that debt
so that's what i'm watching second
equilibrium
is that the rate of economic activity
economic capacity utilization is neither
too high nor too low what that means
is if you have it pressing up too much
over an overheating economy
that's going to be the tightening of
monetary policy and a correction
and if you have it too low so that the
economy is depressed
and there's a lot of slack that's going
to cause an adjustment to bring it up
and so i'm always watching where are we
relative to that because that's a key
driver of the of these cycles and the
third
is that the projected returns of
equities
are above the projected returns of bonds
which are above the projected returns of
cash
by appropriate risk premiums in other
words the capital markets
produce the circulation of buying power
in the form of this credit coming around
and this relationship of the
cash to bond yields to stock yields and
asset classes
determines how money flows through the
economy
and a normal condition is for reasons i
won't digress into
to have cash have a lower return than
bonds that have to have a lower return
from equities
having to do with how the system works
basically central banks put cash on
deposit and people with better ideas
have to make a profit to that they use
that money to create
these other uh the level of economic
activity and
have to have higher returns and when
that's not the case the way they tighten
it
is that there are two levers so now
there are two levers monetary policy
and fiscal policy right monetary policy
then
is the means by which the brakes and the
gas are put on
and the brakes and the gas being put on
become reflected
in each of these other items so let's
say
if debt growth is too high relative to
income growth and capacity utilization
is high and strat stretched
monetary policy will be tightened
and that tightening of monetary policy
will change the projected return
of ec of cash relative to bonds and of
equities those risk premiums
and that will slow the economy down
and that will drive those cycles and
that's how
the economy is operating in these
perpetual motion kind of way
and if you you could almost picture i
literally can picture where you are in
those cycles
and what is happening and you can
anticipate what is going to happen
next from that because it's that petrol
perpetual motion machine
so that's my template in a nutshell
and if you keep thinking like where are
we now
then you um you know you can kind of
think where we are
okay so i'm just going to show you some
charts to help to convey the picture
this is uh real gdp
going back to 1900. so this is
that line is productivity right and
that's an a big inevitable force
that happens over a period of time even
the biggest economic
turbulence you know looks like a bump
in that that cycle right productivity is
a big force
betting on productivity is a big force
but what happens is that
cycle as you get later in the long-term
debt cycle
that productivity begins to slow because
there needs to be investment
and there needs to be other things and
when you activity
um when there's prosperity and so on you
get more productivity it's a self
reinforcing cycle so these
charts are just meant to show
productivity and how it's changing
over a period of time in the developed
countries and then
in china so just to give you a quick
picture here
you could see it in varying degrees bend
over as they are
later into their longer term debt cycle
this united states over the last 10
years versus
since 1980 and so in each one of those
cases you could see it declining
japan which is large later in that debt
cycle and so on
basically hardly any growth in
productivity so so
okay that's what productivity looks like
now where are we
in the short-term debt cycle of the
business cycle
this is what the cycle looks like that i
was describing
in other words um what happens from the
capital markets perspective as as
you um begin to go to higher levels of
operating rates
lower levels of unemployment central
banks begin to tighten
liquidity starts to tighten then risk
premiums start to rise okay in this
cycle we're
nine years into the cycle unemployment
rates are comparatively low
and there's less slack so you know no
surprise
central banks tighten monetary policy
and the way they tighten monetary policy
is by either raising interest rates or
lowering the purchases
of the financial assets that they buy by
expanding the balance sheet
so that's where we are in that cycle now
if you look at how markets behave in
that part of the cycle
this is breaking the cycles into three
parts
the early phases of the cycle the mid
phase of the cycle and the late phase of
the cycle
and this is across the world
different countries this is the united
states this is europe to show how the
historical so we're in a period of time
this period of time which is relatively
late in the cycle
is also associated with a period of time
where there is less attractive returns
greater vulnerability so that's largely
where we are in the cycle
interest rates have
hit their lows in some cases can't go
lower
and then we're dealing with the issue of
quantitative easing
so taking this back to uh this goes back
to 1900
this shows debt in debt to gdp ratio in
the united
states and it just shows how the cycle
that we're going through now
is very similar to the cycle that we
went into the 30s
in other words because of that debt
crisis
and interest rates hitting zero you had
the printing of money this shows the
central bank's balance sheet the
monetary base the acceleration of
printing and money
same thing happened in the 2008
financial crisis
you could see that what happens is you
have
the debt crisis you have the hitting of
zero in interest rates
they're stuck so they have to print the
money
and then we have the reaction very
similar to
1932 to 1937 in the economy picks up
1937 they start to tighten monetary
policy because they're worried that the
economy is overheating
and inflation's going to rise and they
cause
a recession that's the first time they
use the word recession
recession it was like re-depression they
used the term recession
and that was the uh the 1938
period now um i talked about debt
but there are also unfunded liabilities
that we don't call
debt which would be pension and health
care liabilities and i just wanted to
give you
a picture of what that's like that has
there's a lot of liabilities
out there um promises that have to
be kept and so the liabilities are
very large um i want you to focus then
on these the bottom charts before i put
the top charts in because i
i want to convey um as it relates to
both markets and the economy
the important um the the really
realizing that we've been really in a
golden age
of capitalism in the following sense
this chart shows how profit margins have
increased
in other words uh they've more than
doubled
since 2000. means if you didn't have an
expansion in profit margins you wouldn't
have you'd have the stock market 40
percent lower
you had an expansion in profit margins
and at the same time you had
a decrease in the form of employee
compensation
and profit margins be largely because
of a number of factors but technology
has been replacing people
and so it's made it more efficient so
that that was
an element uh also
globalization has helped um
just to show you a couple of charts
pertaining to this this
is um number the globalization pressure
movement and this is um the
capital movement and these scatter
diagrams
show um
if you go the globalization companies
that have
gone global on the margin have improved
their profit margins more
and those that are more concentrated
have improved their profit margins more
and those with
who have reduced union membership have
produced their profit margins more
and so as a result of that this has
contributed to
the growth of um the wealth gap
and the prof profit gap it's been great
for companies
but it has not been good for a certain
percentage of the population if you look
at the conditions of
the bottom 60 percent of the population
bottom 60 means the majority the
conditions have
uh have been bad there has not been
over the since 1980 any income growth
real income growth in the united states
um in a fed survey the
40 of all americans could not raise 400
in the event of an emergency
so there is a gap and with that gap
um has come this is the wealth gap that
the top um one-tenth of one percent of
the population's net worth
is almost the same as the bottom 90
percent combined
and as a result we have populism
populism of the left and populism of the
right
that was a phenomenon that developed
countries didn't used to have
and so now it is a
not only political phenomenon it's an
economic and market phenomenon
because as we come to go into the
political elections
in the number countries in europe and in
the united states
it will be really um a
a conflict over capitalism versus
socialism
or the left and the right and it's going
to become
rather extreme in both of those cases
and
that has an implication just as the
these profit margins improved
and then i and then tax rates
that's the effective corporate tax rate
and how the effective corporate tax rate
isn't
that's been fantastic so imagine you
have profit margins increasing
you have the tax rate going down
you have cheap money cheap money has
been used to
borrow to buy back stock or make mergers
that's also supportive to stock prices
and so on
many of those things will not continue
we think profit margins will go
down i think you're at the best of the
corporate tax rates
and in terms of the issue in terms of
the wealth gap so we're entering a newer
environment
including an environment which is not
going to be as conducive to the
purchasing of financial assets by
central banks
and all of that we're going from uh
headwind
from tailwinds to headwinds
and to give you a flavor of what this
political
uh situation is like and and the
polarity and the entrenchedness these
are
two charts the first they go back to
1900.
the first chart which is the red chart
shows
um how conservative the republicans are
survey
surveyed economically conservative so
the they're more conservative than they
have ever been
the democrats it shows how liberal they
are
in terms of policies and they're more
liberal than they have ever been
so the two have not had greater polarity
than we have today in politics
and this shows how much is
the votes cast along party lines in
other words republicans sticking with
republicans and democrats sticking with
democrats and so it shows the entrenched
conflict that we're having this is in
the united states
this is not just a united states
phenomenon it is a european phenomenon
as as much we're going to be going into
elections
in uh europe and then
for the european elections and then
we're also going to have
changes in politics and there's going to
be more movement
to political extremes for example in the
uk i think it's likely that
um jeremy corbyn will be um in power
which will have an effect on capital
flows
so we're entering a period of time
in which we're late rather late in the
cycle
central banks have less power than they
used to to ease
and we're having this populism
in an election cycle so that's kind of
the lay of the land
if you look at europe uh you can you can
judge the
capacity of a country to ease by looking
at the level of interest rates relative
to zero
and the amount of quantitative easing
that can take place and its marginal
effects so let's say in the united
states you go from two and a half
percent to zero
and you're done in europe you're at zero
and in europe there are limitations
caps at 33 of certain types of debt
that they have hit that they can't go
beyond unless there's
some sort of an agreement and
politically very difficult to have an
agreement so in
in europe is going to be a problem for
the ecb
in terms of being able to have uh the
ability to stimulate
and japan is in a position somewhat
similar with these
negative interest rates slightly
negative interest rates farther and
a lesser ability to stimulate
so that's the lay of the land
i think in terms of markets and economy
within the template that i showed you
for
to begin with okay um
in terms of um the rising power
challenging existing power uh
china will be an important influence
in the world that we're operating in
um for the rest of our lifetimes it'll
become an
increasing influence in in that
globalization and so on
um so this just shows
uh where they are in united states and
china in relative output this is what i
believe
that what's likely in terms of equity
market cap
and share of debt securities outstanding
in other words the european
the chinese markets are big
and becoming bigger and more liquid and
more
effective and they're going to play an
important role as will the chinese
economy
in the environment we're in not only in
the form of trade
but also in the form of you know the the
whole
geopolitics particularly reflected
through technology if you look at
history
and what caused countries to succeed and
fail
it was um particularly led by technology
so um i've been uh
over the last several months
wanting to research the rise and
declines of world reserve currencies
and in order to do that i have to watch
the arc of each one of these reserve
currencies
there's the us dollar before that there
was the british pound before that there
was the dutch gilder
and as a result of that i needed to
understand
uh a number of things about the
economies
that i um that made them reserve
currency how did they become reserve
currencies how did they lose their
reserve currency status
and that led me to uh watch
um a number of factors and studying
those
um and i i love putting together
statistics and numbers
to put together indices so uh
these are the six main factors
uh that you can judge a country's power
by
you know power's a a vague thing
you can have economic power you can have
military power you can have power in
different ways
but this is the uh when i
uh went to each one of these four
cases here's the dutch cycle here's the
british cycle here's the u.s cycle
here's the chinese cycle
and reflected in these this dynamic
and uh what you can see this classic
cycle is first
it's innovation meaning technology
education and competitiveness mostly a
new technology
and the new technology like the 5g
technology today
and the issues pertaining to huawei and
other technology companies
if you have technology it works uh both
economically and militarily and so
there's always a new technology in the
case of the dutch
it was the ability to build ships that
can go anywhere around the world
and they took those ships and they put
and because the
europeans were experts in fighting
because they was fought with each other
they took the guns they put them on the
ships and they go out to the rest of the
world
and they accounted for half of world
trade
can you imagine that and when they go
out there with half of world trade
they're bringing their money the dutch
gilder
okay so they bring the money and when
they have bring the money it becomes a
world reserve currency
and in order to go out in the world they
have to have a military
to support that and so these cycles go
on
and if you look at that this is the red
line is china and
the blue line is in the united states in
terms of the averages of these things
and it goes back to 1500 and one of the
things you could see
there is the chinese have typically been
number one or number two although the
world was a different size then you know
those were all very far away places we
now have
one sort of world so
that's where that those are the economic
principles so i think we're late in the
business cycle
relatively late um i would say the
seventh inning
of the business cycle there is a
relatively tightening and monetary
policy
we have less capacity and we are
we have greater polarity and we have
um a situation in which we're going to
have political issues
and those political issues will be
market issues
because as as we start to think
will this be a movement to the right or
a movement to the left
that will affect capital flows
so these are my list of investment
principles
the template that i look first the
theoretical
theoretical value equals the present
value of future cash flows in other
words every investment
is a lump sum payment for a future cash
flow
so when we think what is something worth
we look at those projected cash flows
and we discount it with an interest rate
that's the theoretical value
the actual value that it will trade at
will
equal the total amount of spending
if i calculate total amount of dollars
spending on something divided by the
quantity of goods sold
so i'm always looking at who how much is
going to be spent
and what are the motivations of the
spenders and what are the and
how much of it is going to be quantity i
try to estimate
what the total spending is divided by
the quantity to estimate the price
okay number three is that asset classes
will outperform cash over the long term
i explained that
it's required otherwise the gears come
the economy comes to a halt and that the
outperformance of
asset classes over cash that beta
cannot be very positive for too long
because if it was it would be easy
if it was positive you just buy borrow
cash and you buy the long things and you
make a lot of money
it ha comes with big bumps along the way
and that assets
are priced to discount future
expectations most importantly inflation
growth risk premiums and discount rates
and i'm going to get
into that in a minute and then every
investment
is a return stream what i mean is every
day you can market to the market you
know what it's like
and so the key is to be able to put
together portfolios of return streams
so that they balance well as hashing was
saying
i would say whatever success that i've
had in life
or that bridgewater has had has to do
with knowing how to deal with our not
knowing
more than anything we know because what
you don't know
is a lot and if and you can reduce your
risk by a lot more than you could reduce
your return by knowing how to diversify
well
so so diversification can reduce risk
more than it reduces return
so it improves the return to risk ratios
and then i say that there i'm sorry if
i'm getting technical but there are two
types of return streams
there is a beta return stream and an
alpha return stream
and what i mean by a beta return stream
is that there is an intrinsic
reason that that asset class will behave
in a certain way that you will
know in other words if growth rises
faster than discounted
and interest rates don't rise much you
know that that stocks are going to go up
so there is environmental so you can
structure that alpha is a zero-sum game
in other words for me to produce alpha i
have to be uh
outperform i have to take money away
from somebody else it's a zero-sum
game like poker at a poker table so
so they can be either alphas of betas
and the key
to good investing is to create good
portfolios of good return streams
and then in order to balance these you
have to risk balance them
in other words if somebody might think
if i put 50
of my dollars in stocks and 50 percent
of my dollars in bonds
that i have my diversification but not
so because
the volatility of stocks is greater than
the twi is twice the volatility of bonds
and because of that you have to risk
balance them and
then the holy grail of investing is to
find 15 or more
good uncorrelated return streams i'll
get into that in a minute
and then as hashem mentioned then
systemizing decision rules is is
critical
and those rules should be timeless and
universal what i mean is
as i said i write down the criteria we
write down the criteria for
investing and then we take those
criteria and we test them through all
periods of time
and all countries timeless
and universal because if something
happened in one time
and your process is not working in that
time
then it must be that you haven't
explained the differences
and so by forcing ourselves to try to
make those rules
timeless and universal it then becomes
the
you know the the standard that we
operate by so all the rules that we're
operating them by are
timeless and universal i'll just pass
through some
charts so this going back to 1975
think of this as the rolling returns of
asset classes okay what you can see
is that all of the asset classes there
have some times that are good sometimes
that are bad
on average they're above zero but they
all have periods of down
and inevitably what happens is that
investors most
investors love the asset classes
that did well they
the biggest mistakes of most investors
is that they
think that the investment that did well
is a good investment
rather than it's a more expensive
investment
and so like so here we we have
here's eq whoops
you know here's equities recently done
well here's commodities
done very poorly then here but here's
equities
right done very poorly in that period of
time so the key
as hashim was saying is balance
how to do that so you can break the
drivers
of asset class returns into a few
categories
this is true for any asset class and
it's true for all asset classes
there are two main things that drive it
in terms of
that's inflation and growth and if
basically if you tell me that
inflation's going to be higher than
expected
and growth be higher than expected um i
would know what to invest in
higher than discounted and if it's you
say it's lower i'll know what to invest
in and
most people here would so those become
the two
main drivers they can rise or that
decline
and then there are discount rates and
risk premiums
discount rates mean the inch as i told
you
the interest rate affects all asset
classes
because the interest rate is the
discount rate
that you use to compare the cash flow so
you raise the interest rate
and that's negative for all asset
classes and then you have
when you strip all that risk premiums
out and if you
and that equals the following this shows
what happened in history in relationship
to that context
the top chart shows a growth
assets relative to uh
strong and assets that you hold if you
had a
falling growth environment assets that
you'd have a rising fault
aggregate with inflation then it shows
what the discount rate is and then it
shows what the risk premium which was
the residual of that
and that's what we have all-weather
return all-weather return
it all rather is a
[Music]
our optimally diversified portfolio
okay uh what i'm going to skip this
chart what it's meant to show
basically is that how diversification
can substantially improve your risk
to return ratio i want to turn
uh to this chart so this is what i
believe the holy grail of investing is
if you can do this you will make a
fortune
you'll be very successful and it's
simple really
maybe not simple to pull off but simple
concept
if you can get 10
good uncorrelated investments
five good uncorrelated investments
15 good uncorrelated investments
you can substantially improve the return
to risk ratio
and this just shows how it works and why
diversification
is more important than
being good even in picking the best
investments
and most people think give me the best
investment and let me put all my money
in what i think is the best investment
wrong the best find your best
10 uncorrelated investments and put your
money in that
and you're going to do a lot better and
this just gives you an example
so this is the standard deviation let's
call it the risk
of 10 percent and just imagine
i put in an asset i'll use a simple
example that has 10 percent return and
10
standard deviation uh so let's say it's
10
return 10 standard deviation and let's
say i
put in a second investment that is six
sixty percent correlated with that
third fourth
fifth and sixth and so on this is how my
risk in my portfolio would change that
means like if you have a diversified
portfolio
of stocks average stock is about 60
correlated with average other stocks
and you can put in a hundred you can put
in a thousand
and you are not going to materially
reduce your risk relative to putting
in you know just five to ten and you
could see that that'll lower your risk
by
10 or 15 percent if you have an
uncorrelated
return stream and you can get actually
better than uncorrelated because you
could have negatively correlated but
let's say i put in
an uncorrelated return stream this is
how the line goes
so you could see like at five you've
more than cut your risk in half
five uncorrelated return streams if you
have down to 15 you're going to reduce
your risk by
nearly 80 percent that means you've
improved your return to risk ratio by a
factor
of five
so you can reduce your risk a lot
without
reducing your return and that is the key
to it
right so when i look at this
i think that um there are two types of
assets what's your strategic asset
allocation mix what is your
beta in other words what portfolio do
you normally have
and in my opinion it should be highly
diversified
but with along those lines in terms of
like half and growth half inflation
rising or declining and then alphas
you have to have a lot of different
alphas like in our case we have
you know well over 100 different types
of alphas about 130 different kinds
of markets actually in terms of trading
so
that's it thank you for your patience
let's have a conversation about it