what is discounted in the curve [SB here: for your client not immersed in our financial language, this is the yield difference between shorter-term vs. longer-term bonds].

  • So (right now) we have about 50 bps (1/2 of 1%) of Fed tightening over the next three years already priced into the curve. [SB: meaning the market is pricing in a 50 bps point Fed Funds rate hike.]
  • That affects all asset prices because all asset prices are affected by interest rates. It’s the discount rate for the present value of the future cash flows.
  • So if there is a change in those interest rates relative to discount, not only does it affect the bond market it affects the equity market. That has a wealth effect.
  • It is a risky thing to raise interest rates more than is already discounted in the curve particularly when the duration of assets have lengthened. [SB: investors have gone into longer-dated bond funds to increase their yields, when rates rise, longer-dated maturities suffer loss more than shorter-dated maturities.]
  • Sorkin asks, “When Jamie Dimon says the Fed should raise interest rates, you think that is wrong.”  Dalio answers:

    • That’s right. It is wrong.
    • At this stage, the risks are so asymmetric.
    • Look, there is no doubt that you can slow the world economy, the U.S. economy. Tightening (central bankers raising interest rates) will work.
    • When you look at the inflation pressures (and this is a global thing) and you look at the demographics, all of those means that the risks are so much more on the downside.
    • If you have a downturn and you don’t have that power… we’ve (most of us alive) never been in a world like this.

    Asked about the impact of Brexit, here are a few other comments I found important:

    • I think that populism, the wealth gap, the nationalism, the impatience – all of is a global phenomenon.
    • It is similar to the late 1930’s, and that concerns me.

    Sorkin asked, “As an investor, what do you do about it?”

    • Dalio smiles and says, “Well, that’s a complicated question.” But adds, “You diversify.  You have a whole bunch of uncorrelated investments bets.  And then you understand it (the situation) as best you can.”

    10-21-00

    You can watch the 32-minute discussion here.

    As a hedge fund manager, Dalio tries to stay six months or six days ahead of what is happening.  If someone tells you they know how this is going to play out, take the information in with a high degree of skepticism.

    We can know if player “A” does this, then “X” is likely to happen and if player “B” does that, then “Y” is a probable outcome, but we just don’t know who is going to what and when.

    Beautiful or ugly?  A or B?

    The differences between how deleveragings are resolved depend on the amounts and paces of 1) debt reduction, 2) austerity, 3) transferring wealth from the haves to the have-nots and 4) debt monetization.  What we are saying is that beautiful ones balance these well and ugly ones don’t and what we will show below is how.

    There are many important players in the game and many complicated moving parts.  Brexit comes to mind.  Putin’s actions are another.

    Recognize where we are in the cycle.  In my mind, debt is the issue.  History can teach us a great deal about human behavior and also show us potential solutions.  Yet the outcome is dependent upon a number of diverse players with diverse interests.

    Our job as advisors and money managers is to do our best to stay one or two steps in front of the “beautiful” or the “ugly.”  Unfortunately, at this moment in time, the risks are asymmetrically skewed to the ugly.

    My notes above covered about two-thirds of the 32-minute CNBC Delivering Alpha Conference interview.  I encourage you to watch the full video.

    Dalio says, “We’re in a situation where central banks want to drive you out of cash and out of bonds.”  He called it a dangerous situation, as central banks run out of assets to buy and push investors into riskier assets.  He believes raising interest rates is risky as it’s not priced into the yield curve.  In sum, “There’s only so much you can squeeze out of a debt cycle and we’re there, globally.”

    Dalio suggests broad diversification.  Note his fund was up 13% in 2008.  He thinks we are nearing but not yet at a tipping point.  Beautiful or ugly?  I’m praying for beautiful but have a close eye on ugly.

    Grab a coffee.  If you’re inclined, take a look at the section called “An In-Depth Look at Deleveragings,” which is contained in Economic Principles (see link below).  Also, you’ll find the most recent Trade Signals charts.

    I hope you find this week’s post helpful.  And please share this piece with a friend if you feel they may find it useful.  Wishing you the very best.

    ? If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ?

    Included in this week’s On My Radar:

    • “An In-Depth Look at Deleveragings” (from Economic Principles, Ray Dalio and Bridgewater Associates)
    • Trade Signals – Extreme Pessimism (S/T Bullish), Equity and HY Trends Bullish, Zweig Bond Model Bearish… No Sign of U.S. Recession (10-19-2016)

    “An In-Depth Look at Deleveragings” (from Economic Principles, Ray Dalio and Bridgewater Associates)

    Last week I wrote, “What troubles me most is the amount of debt and leverage that exists here, there and everywhere… a massive overabundance of debt.”  There are some pretty good charts and you can find that post here.

    So what can we do about it?  The following can serve as a road map for what we need to keep On Our Radars:

    The deleveraging process reduces debt/income ratios.  When debt burdens become too large, deleveragings must happen.  These deleveragings can be well managed or badly managed.

    Some have been very ugly (causing great economic pain, social upheaval and sometimes wars, while failing to bring down the debt/income ratio), while others have been quite beautiful (causing orderly adjustments to healthy production-consumption balances in debt/income ratios).

    In this study, we are going to review the mechanics of deleveragings by showing how a number of past deleveragings transpired in order to convey that some are ugly and some are beautiful.  What you will see is that beautiful deleveragings are well balanced and ugly ones are badly imbalanced.

    The differences between how deleveragings are resolved depend on the amounts and paces of 1) debt reduction, 2) austerity, 3) transferring wealth from the haves to the have-nots and 4) debt monetization.  What we are saying is that beautiful ones balance these well and ugly ones don’t and what we will show below is how.

    Source: Economic Principles, p. 23.  Consider coming back to the entire report from time to time.  There is so much data to digest but nonetheless important.


    Trade Signals – Extreme Pessimism (S/T Bullish), Equity and HY Trends Bullish, Zweig Bond Model Bearish… No Sign of U.S. Recession (10-19-2016)

    S&P 500 Index — 2,147 (10-19-16)

    Posted each Wednesday, Trade Signals looks at several of my favorite stock, investor sentiment and bond market indicators.  It is my weekly risk management dashboard, designed to keep me better in sync with the major technical trends.  I hope you find the

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