Ray Dalio’s Short-Bet Puzzle Is Missing Some Pieces

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 $22 billion bet that many of Europe’s biggest companies in the blue-chip Euro Stoxx 50 Index are poised to decline.

Bridgewater didn’t respond to Bloomberg’s request for comment, so Dalio’s motivation is not entirely clear. But according to Bloomberg News’ Brandon Kochkodin, 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 U.S. stocks. The U.S.’s real GDP has grown for eight consecutive years, by 2.2 percent annually from 2010 to 2017. Unemployment has declined to 4.1 percent from 10 percent in late 2009. And the yield on the 10-year U.S. Treasury is up to 2.9 percent from 2.1 percent in September — an increase of nearly 40 percent.

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.

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Slumbering Bear Holds a Lot of Answers

It has been almost nine years since the last U.S. bear market, as defined by a 20 percent or more decline in the S&P 500 Index. That’s the second-longest stretch without one since 1928, according to Yardeni Research Inc. Only the period from December 1987 to March 2000 was longer.

That’s a long time for questions to pile up that can only be answered by the next downturn. Here are some of the most burning ones:

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For Hedge Funds, the Bear Can’t Come Too Soon

No one is more eager for the next bear market than long-short hedge funds.

Long-shorts had a good year in 2017. The HFRI Equity Hedge Total Index — an index of long-short equity hedge funds — returned 13.5 percent last year, its best performance since 2013.

But as my Bloomberg View colleague Barry Ritholtz pointed out last week, it wasn’t good enough. The equity hedge index trailed the S&P 500 Index by 8.4 percentage points last year, including dividends. It was the ninth consecutive year that long-short hedge funds trailed the broader market, and the S&P 500 outpaced the equity hedge index by a stunning 8.1 percentage points annually over that period.

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Hedge Funds Have a Performance Problem

Hedge funds have had a tough go of it lately. The HFRI Fund Weighted Composite Index – an equal-weighted index of hedge funds – was down 1.1 percent in 2015, and is down another 2.3 percent through February of this year.

It’s not just your workaday hedge funds that have stumbled – the supernovas are burning less brightly, too. Greenlight Capital was down 20 percent in 2015. Hedge funds at Citadel, Blackstone, and Millenium have seen declines this year. And, well, Bill Ackman and Pershing Square’s Valeant debacle.

Granted, every investment has its ups and downs, but investors who dismiss hedge funds’ recent woes as an ordinary cyclical downturn are missing the larger and more worrisome picture.

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