As Hasu mentioned, it's been 25 years and we've been friends and colleagues.
So I look out at the hall and see these old friends, and I'm very happy to be here. He also mentioned that I'm very methodical, meaning that I've always made it a habit, every time I make a decision, to write down the criteria I used to make that decision. I think there's a slight echo in the audio? And this hall isn't big, so I don't even know if I need a microphone. But every time I made a decision, I wrote down the criteria I used to make those decisions. Because cause and effect — everything happens for some reason. And so, the same things repeat over and over again.
And by taking the time to write them down and seeing how those criteria would work over time, I was able to gain perspective. And so, I wrote those principles. And as Hasu mentioned, I wrote a book called "Principles," which was a collection of life and work principles. So the culture we have is extremely important. It was truly the most important thing regarding any success we've achieved. At the same time, I wrote the economic and investment principles. So I thought I'd share with you today what I believe are my most important economic and investment principles, and then let's look at the world through the lens of those principles. In other words, instead of just telling you my opinion, I want to tell you how things work. And from there, we can apply these mechanisms. You can decide whether things work this way or not. So, are these principles valuable? Because if you know the principles, it's like teaching a man to fish rather than giving him a fish. I can tell you my opinion, but if these principles are correct, you can apply them yourself at any time or in any circumstances. I've divided them into economic principles and investment principles because markets follow the economy. So to understand the economy and all the markets, you must understand the economy first in order to understand the market. I want to describe how I believe the economy works. Consider it like a perpetual motion machine. And there are four major forces: three important balances and two levers of control. If you grasp this, I believe everything in my view follows in this context. Over time, we raise our living standards because we learn how to do things better. We become more efficient. This is called productivity. Output per hour worked. And this is something that evolves over a period of time. And because it evolves, it's not something we see as a big deal. But it's the most important thing in the long run. The big things we see and feel every day are the debt cycles. There's a short-term debt cycle and there's a long-term debt cycle. When I talk about the short-term debt cycle, I mean what we usually consider the business cycle, right? You have a recession. You have weakness in the economy. When the level of economic activity is very low, central banks create credit. And credit is purchasing power. So they produce that credit. And that makes buying goods and services and financial assets possible. And so, the economy recovers. That cycle usually lasts from 7 to 10 years. As the economy recovers, demand rises relative to productive capacity. When you get to a late stage in the cycle, the central bank puts the brakes on. They raise interest rates and tighten monetary policy. Since the economy is tightening and unemployment is low, they press on the brakes. Interest rates rise and monetary policy becomes more stringent. Then a recession occurs, a slowdown, and that's the cycle, right? And because credit is purchasing power, by providing it, it also creates debt. And debt means the obligation to repay. And so, in its very essence, it is cyclical. First comes the stimulus, then comes the repayment, which means that when you produce credit, you can spend more than you earn. And when you repay, you have to spend less than you earn. And that is the nature of the cycle. And I think we're all familiar with this type of cycle. And with that cycle come market cycles, which we'll talk about. That's what I mean by the short-term debt cycle. And there's also a long-term debt cycle, which is the accumulation of all those short-term debt cycles. Because everyone wants things to go up. They want their asset prices and their markets to rise. They want employment to rise. They want everything to rise. And for this reason, central banks, over time, stimulate, and they usually do so by cutting interest rates until they reach zero. And when interest rates reach zero, they can no longer do so. And then we reach the need to print money and buy financial assets, which is what we call quantitative easing. And when they can no longer do that, or when there are constraints, we reach the end of the long-term debt cycle. So there's a short-term debt cycle, and a long-term debt cycle, and productivity. And now, all of that is tied to policy. Domestic policy and foreign policy. And in that natural cycle, they are interconnected. And as we'll see, regarding that dynamic, the period we're going through, 2008 and 2009, there was a debt cycle, and interest rates hit zero. And this is very similar to the period from 1929 to 1932, where there was a debt crisis, and interest rates hit zero. And in both cases, money was printed and financial assets were bought, which led to a rise in those asset prices and an increase in liquidity in the economy, which benefited in particular those who own financial assets. And that contributed to widening the wealth gap and the income gap, just as technology did. And as a result, in the 1930s, as has happened now as well, politics came into the picture. So, as we see in the world now, the issue of the wealth gap is causing populism, left-wing populism and right-wing populism, and this has an effect on the markets and an effect on the economy. So, we also see a situation that is very much like the 1930s, where we see a rising power challenging an established power. That's a geopolitical cycle. When a rising power in the form of China challenges an established power in the form of the United States. And if we look at history and the cycles of those periods, we find a cycle of conflict and peace. Peace usually comes after war because a dominant country wins the war. No one wants to fight the dominant power, and a long period of peace passes until that particular conflict occurs. I'm not saying we're going to face a military conflict or anything like that, although that always remains a possibility. So, these cycles, and these things have happened over and over again. So, politics can affect those cycles. For example, the shift in the United States to enact tax cuts improved the corporate tax situation, which caused stock prices to rise. Okay. Those are the cycles. After that, when I look at what's happening, I compare it to three states of equilibrium. And what are these three states of equilibrium? First, debt growth must be in line with the income growth needed to service those debts. If debt growth is faster than the income allocated to service it, we'll face a correction. So I'm always assessing the capacity to service those debts. That's what I watch. The second state of equilibrium is that the rate of economic activity and the utilization of economic capacity is not too high and not too low. What that means is that if there is a lot of pressure and an overheated economy, that will lead to tightening monetary policy and a correction. But if the rate is very low, so that the economy is stagnant and has a lot of slack, that will lead to an adjustment to raise it. So I'm always watching where we are relative to that, because this is a major driver of these cycles. And the third is that the expected returns on stocks are higher than the expected returns on bonds, which in turn are higher than cash returns, in proportion to the appropriate risk premiums. In other words, capital markets produce the trading of purchasing power in the form of this credit that is traded. And this relationship between cash returns and bond returns and stock returns and asset classes determines how money flows through the economy. And the normal situation, for reasons I won't go into, is for cash to have a lower return than bonds, which should have a lower return than stocks, and this relates to how the system works. Basically, central banks put cash as deposits, and people with better ideas must make a profit from it. They use that money to create this other level of economic activity, and they must get higher returns. And when that is not the case, the way they tighten depends on two levers. So there are now two levers, monetary policy and fiscal policy, right? Monetary policy is then the means by which the brakes or the gas pedal are pressed, and this pressure is reflected on each of these other items. Let's say debt growth is very high relative to income growth, and that capacity utilization is high and monetary policy is stretched, it will be tightened, and this tightening in monetary policy will change the expected return on cash relative to bonds and stocks. Those risk premiums will lead to an economic slowdown, and that's what will drive those cycles. And so the economy works in a way that resembles perpetual motion. And you can almost picture where you are in those cycles and what's happening, and you can predict what will happen next because it's a machine that works by perpetual motion. So, this is my model in brief. And if you continue to think about where we are now, you'll be able to somewhat know where we are. Okay, I'll show you some charts to help illustrate the picture. This is real GDP since 1900. So, this line represents productivity, right? And it's a great, deterministic force that happens over a period of time. Even the biggest economic disruptions look like just a bump in that cycle, right? Productivity is a great force. Betting on productivity is a great force. But what happens is that as you move through the long-term debt cycle, that productivity starts to slow because it needs investments and other things. And when there's activity and prosperity and so on, you get more productivity. It's a self-reinforcing cycle. So these charts aim to show productivity and how it changes over time in developed countries and then in China. To give you a quick picture here, you can see it bending at varying degrees as those countries go deeper into the long-term debt cycle. This is the United States over the past ten years compared to 1980. So in each of those cases, you can see it declining. Japan, which is at a late stage in that debt cycle, hardly sees any productivity growth. So, okay, that's what productivity looks like. Now, where are we in the short-term debt cycle or the business cycle? This is what the cycle I was describing looks like. In other words, what's happening from the capital markets' point of view, as we head toward higher levels of operating rates and lower levels of unemployment, central banks start to tighten, liquidity tightens, and then risk premiums start to rise. Okay, in this cycle, we're now nine years into it, unemployment rates are relatively low, and there's a decline in the economic downturn. So it's no wonder that central banks are tightening monetary policy. And it tightens monetary policy either by raising interest rates or by reducing financial asset purchases to expand the balance sheet. This is where we are now in this cycle. Now, if you look at how markets behave in this part of the cycle, this means dividing the cycle into three parts. The early stages of the cycle, the middle stage of the cycle, and the late stage of the cycle. And this happens all over the world. In different countries. This is the United States. And this is Europe to illustrate the historical side. We're going through a period of time, and this relatively late period of the cycle is also associated with a period that has less attractive returns. With greater exposure to risk. This is largely where we are in the cycle. Interest rates have reached their lowest levels and in some cases cannot go any lower, and we are dealing with the issue of quantitative easing. Going back to 1900, this shows the debt-to-GDP ratio in the United States, and it shows how the cycle we're in now is very much like the cycle we went through in the 1930s. In other words, because of that debt crisis, and interest rates hitting zero, money had to be printed. This shows the central bank's balance sheet. The monetary base, and the acceleration of money printing. The same thing happened in the 2008 financial crisis. You can see that what's happening is a debt crisis, and interest rates hitting zero. They're stuck. So they have to print money, and then we see the reaction. And it's very similar to the period from 1932 to 1937. With the economy recovering in 1937, they started tightening monetary policy because they were worried about the economy overheating and inflation rising, which caused a recession. That was the first time they used the word recession. The recession was more like a "mini-depression," they used the term recession and that was the period of 1938. Now, I've talked about debt, but there are also unfunded liabilities that we don't call debt, which are pension and healthcare liabilities, and I just wanted to give you a picture of what they look like. There are a lot of existing liabilities, promises that must be kept, and so these liabilities are very large. I want you to focus on these bottom charts before I put up the top charts, because I want to illustrate the importance of realizing that we have already lived in a golden age of capitalism with regard to the markets and the economy. This chart shows how profit margins have risen. In other words, they have more than doubled since 2000. This means that if there had been no expansion in profit margins, the value of the stock market would have been 40% lower. We've seen an expansion in profit margins and along with that a decline in the share of employee compensation, and that's for several reasons, but technology replaced labor and made work more efficient, so that was one of the factors. Also, globalization helped with that. Just to show you a few charts related to this matter. This represents the pressures of globalization, and this represents global capital movement. And these charts show that companies that have expanded globally have improved their profit margins more. And companies that are more focused on the market have improved their profit margins more. And those who have reduced union membership have achieved higher profit margins. And as a result, this contributed to widening the wealth gap. And the profit gap as well. It was great for corporations, but it wasn't good for a certain percentage of the population. If you look at the circumstances of the poorest 60% of the population, that percentage means the majority. Their circumstances were bad. There has been no growth in real income in the United States since 1980. And according to a Federal Reserve survey, 40% of Americans cannot come up with $400 in an emergency. So there's a gap, and with this gap came the wealth gap, where the net worth of the top 0.1% of the population is roughly equal to the net worth of the bottom 90% combined. And as a result, we now have populism. Populism from the left and populism from the right. It was a phenomenon that developed countries were not used to before. And now it's not just a political phenomenon, but an economic and market phenomenon. Because as we approach political elections in a number of countries in Europe and the United States, it will really be a struggle between capitalism and socialism, or between the left and the right. And this struggle will take an extreme course in both cases. And this has its consequences. Just as these profit margins improved, then came tax rates. And this is the actual tax rate on corporations, and how this rate was great. Imagine then that profit margins are rising, tax rates are falling, with cheap liquidity available. Cheap money was used to borrow in order to buy back shares or do mergers. And this also supports stock prices and so on. A lot of this will not continue. We believe profit margins will fall. And I think we've reached the peak of corporate tax rates, especially regarding the issue of the wealth gap. So we're entering a new environment, including an environment that will not be helpful for buying financial assets from central banks and others. We're moving from a period of tailwinds to headwinds. And to give you an idea of the nature of this political situation and the state of polarization and entrenchment. These are two charts. Both go back to 1900. The first chart, the red one, shows how much Republican conservatives... a survey on economic conservatism. They are more conservative than they have ever been. As for the Democrats, the chart shows how liberal they are regarding policies. And they are more liberal than they have ever been. So politicians have not seen greater polarization than we see today. And this shows how committed voters are to party lines. In other words, Republicans stick to Republican views, and Democrats stick to Democratic views. And this shows the rooted conflict we are experiencing. This is in the United States. And this phenomenon is not limited to the United States alone. It is a European phenomenon just as much. We are approaching elections in Europe, and we await European elections, as we will also see changes in the political landscape. And there will be a greater trend toward political extremism. For example, in the United Kingdom, I think it is likely that Jeremy Corbyn will come to power, which will affect capital flows. So we are entering a new period of time. Where we are in a somewhat late stage of the economic cycle. Central banks now have less capacity than they previously had for monetary easing. And we are witnessing this wave of populism in the electoral cycle. So this is the status quo in general. If you look at Europe, you can assess a country's capacity for easing by looking at the level of interest rates relative to zero, and how much quantitative easing can be carried out and its marginal effects. Let's say, for example, in the United States, it goes down from 2.5% to zero and you're done. But in Europe, you're already at the zero level. And in Europe, there are constraints and caps at 33% on certain types of debt that they have reached and cannot exceed unless some kind of agreement is reached, and it is politically difficult to reach an agreement. So this will be a problem for the European Central Bank in terms of its ability to stimulate. And Japan is in a somewhat similar situation with these negative interest rates, or slightly more negative interest rates, and less capacity to stimulate. So this is the status quo with regard to the markets and the economy within the model I presented to you at the beginning. Okay. Um, regarding the rising power challenging the established power, China will be an influential power in the world we live in for the rest of our lives. And it will become increasingly influential in globalization and so on. So this just shows where the United States and China stand in terms of relative output. This is what I think is likely with regard to the market value of stocks and the share of outstanding debt securities. In other words, Chinese markets are large and becoming larger, more liquid, and more efficient. And they will play an important role, as will the Chinese economy in the environment we live in. Not only in the form of trade, but also in the form of geopolitics as a whole, especially that which is reflected through technology. If you look at history and what made countries succeed or fail, you will find that it was driven in particular by technology. So, I wanted to spend the past several months researching the rise and fall of global reserve currencies. And to do that, I need to track the path of each of these reserve currencies. There's the US dollar, and before it was the British pound, and before it was the Dutch guilder. And as a result, I needed to understand a number of things about the economies that made them reserve currencies. How did they become reserve currencies? How did they lose their status as reserve currencies? And that led me to track and study a number of factors. I love compiling statistics and numbers to form indices. So these are the six main factors by which you can judge a country's power. You know, power is a somewhat vague thing. You can have economic power, or military power, or power in different ways. But this is what I came up with when I researched each of these four cases. Here's the Dutch cycle, and the British cycle, and the American cycle, and the Chinese cycle reflected in this dynamic. And what you can see in this classic cycle is that it starts with innovation, meaning technology and education and competitiveness, especially new technology. And new technology, like 5G technology today, and the issues surrounding Huawei and other technology companies. If you have technology, it works on both the economic and military fronts. And so, there's always new technology. In the case of the Dutch, it was the ability to build ships that could go anywhere in the world. They took those ships, and because the Europeans were expert at fighting due to their constant conflicts, they put cannons on the ships, and set out for the rest of the world and captured half of world trade. Can you imagine that? And when they set out with half of world trade, they brought their currency, the Dutch guilder, right? And so, they brought the currency. And when they bring the currency, it becomes a global reserve currency. And in order to be able to go out into the world, they must have an army to support that. And so, these cycles continue. And if you look at that, the red line represents China and the blue line represents the United States in terms of the average of these things. And they go back to 1500. And one of the things you can see there is that the Chinese were usually in first or second place, even though the world was a different size back then, you know? Those were very distant places. We now live in a somewhat one world. So, this is the place, these are the economic principles. I think we are in a late stage of the economic cycle, relatively late. I would say we are in the seventh inning of the business cycle. There is relative tightening in monetary policy. We have less capacity, we have greater polarization, and we have a position where we will face political issues. And these political issues will become market issues, because as we start to think, "Will this be a move to the right or to the left?" it will affect capital flows. Okay, this is my list of investment principles. The model through which I look. First, theoretical value equals the present value of future cash flows. In other words, every investment is a lump sum paid in exchange for a future cash flow. So when we think about the value of something, we look at those expected cash flows and discount them at an interest rate. That is the theoretical value. But the actual value at which it will be traded will equal the total amount of spending. If you calculate the total amount of dollars spent on something divided by the quantity of goods sold. So I always look at how much will be spent, and the motivations of the spenders, and what quantity will be sold. I try to estimate total spending divided by quantity to estimate the price. Okay, number three is that asset classes will outperform cash in the long run. I've explained that this is required, otherwise the economy would stop working. And that asset classes outperforming cash, i.e., "beta," cannot stay positive for a very long time, because if it did, it would be easy. If it were positive, you would simply borrow cash and buy long-term assets and make a lot of money. But it comes with big volatility along the way. And that assets are priced to discount future expectations. And most importantly, inflation, and growth, and risk premiums, and discount rates. I'll get to that in a moment. Then, that every investment is a return stream. What I mean is that you can evaluate the market daily and know its condition. So the key is the ability to assemble portfolios of return streams that balance well, as Hasu was saying. Or I would say that any success I've achieved in my life or that Bridgewater has achieved is about knowing how to deal with what we don't know, more than anything else we do know. Because what you don't know is a lot. And you can reduce your risk by a lot more than you might reduce your returns if you know how to diversify your investments well. So diversification can reduce risk by more than it reduces returns. Which improves your return-to-risk ratios. Then I say, and I apologize if I'm speaking in technical language, that there are two types of return streams. There are beta return streams and alpha return streams. And what I mean by a beta return stream is that there is a fundamental reason that makes that asset class behave in a certain way that you can predict. In other words, if the economy grows faster than expected and interest rates don't rise much, you know that stocks will rise. So there are environmental circumstances that allow you to structure that. Alpha is a zero-sum game. In other words, in order for me to earn alpha returns, I have to outperform, meaning I have to take money from someone else. It's a zero-sum game, just like a poker game at a casino table. So returns can be alpha or beta, and the key to good investing is building good portfolios of good return streams. And then in order to balance these returns, you have to balance their risks. In other words, some people might think that if they invest 50% of their money in stocks and 50% in bonds, they have achieved diversification, but that's not true because stock volatility is double bond volatility. And because of that, you have to balance the risks between them. Then, the holy grail of investing is finding 15 or more uncorrelated good return streams. I'll talk about that in a moment. Then, as Asha mentioned, setting systematic decision rules is essential. And those rules must be timeless and universal. What I mean is, as I said, I write investment criteria, and we write those criteria. Then we take those criteria and test them across all time periods and in all countries, they are timeless and universal. Because if something happens at a particular time and your process wasn't effective at that time, that definitely means you haven't explained the differences. And so, by committing ourselves to making those rules timeless and universal, they become the standard by which we operate. So all the rules we operate by are timeless and universal. I'll walk you through some charts. So this takes us back to 1975, think of this as varying returns for asset classes. Okay, what you can see is that all asset classes go through good times and sometimes bad times. On average, their value is above zero, but they all go through periods of doubt. And what inevitably happens is that investors, most investors, love asset classes that have performed well. The biggest mistake most investors make is believing that an investment that has performed well is a good investment, rather than being a more expensive investment. And so, okay, here we have, hello. As you know, these are stocks. They've performed well recently. These are commodities. No, they've performed terribly. Then here, but these are stocks, right? They performed terribly in that time period. So the key, as Hasu was saying, is balance. How can this be done? You can break down 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 them, and they are inflation and growth. And if you simply tell me that inflation will be higher than expected and growth higher than expected, I'll know what to invest in. Higher than the discounted expectations. And if you say it's lower, I'll know what to invest in more than most people here know. So these become the two main drivers. They can go up or down, and there are also discount rates and risk premiums. Discount rates mean, as I told you, that the interest rate affects all asset classes because the interest rate is the discount rate you use to compare cash flow. So if you raise the interest rate, that's negative for all asset classes. And when you exclude all those risk premiums. And if you do that, the result equals the following. This shows what happened in history with respect to this context. The top chart shows growth assets relative to strong assets, and the assets you hold if the growth environment is declining, and the assets you own when growth is rising, and the same applies to inflation. Then it shows what the discount rate is, and after that it shows the risk premium that was the remainder of that, and this is what we have in "All-Weather." "All-Weather," "All-Weather" is our optimally diversified portfolio. Okay. I'm going to skip this chart. What it aims to show simply is how diversification can greatly improve the risk-to-return ratio. I wanted to move to this chart. So, this is what I believe is the holy grail of investing. If you can do this, you'll make a fortune. You'll be extremely successful. And it's really quite simple. Maybe it's not easy to execute, but it's a simple concept. Um, if you can get 10 good uncorrelated investments, five good uncorrelated investments, 15 good uncorrelated investments, you can greatly improve your return-to-risk ratio. And this simply shows how it works and why diversification is more important than being skilled even at 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 thing is to find your best 10 uncorrelated investments and put your money in them, and you'll perform much better. And this just gives you an example. So, this is the standard deviation, what's called risk, at 10%. And just imagine that I added an asset, I'll use a simple example, it has a 10% return and a 10% standard deviation. So, let's say the return is 10% and the standard deviation is 10%. And let's say I added a second investment correlated with it at 60%. The third and fourth and fifth and sixth, and so on. This is how the risks in my investment portfolio will change. This means that if you have a diversified portfolio of stocks, the average stock is correlated at about 60% with other stocks. And you can add 100 stocks, or 1,000 stocks, and you won't reduce your risk meaningfully compared to adding just five to 10 stocks. And you can see that that will reduce your risk by 10% or 15%. If you have an uncorrelated return stream, and you can get better than uncorrelated because you might get a negative correlation, but let's say I added an uncorrelated return stream, this is how the line goes. So, you can see that at five investments, you've reduced your risk to more than half. Five uncorrelated return streams. If you get to 15, you'll reduce your risk by about 80%. This means you've improved your return-to-risk ratio by five times. So, you can greatly reduce your risk without reducing your return. And that's the key, isn't it? So, when I look at this, I think there are two types of assets, what is your strategic asset allocation mix, what is your beta, in other words, what is the portfolio you typically own? And in my opinion, it should be highly diversified, but along these lines, meaning half in growth and half in inflation, whether it's high or low. Then alpha, you should have many different types of alpha. In our case, we have, as you know, more than 100 different types of alpha, and about 130 different types of markets in terms of trading. So, that's everything. Thank you for your patience. Um, let's start a discussion around this topic.
