The world’s biggest hedge fund manager is turning more defensive on concerns the political drama in Washington will impair the US government’s ability to function and weigh on already wobbly financial markets.
The move by Ray Dalio, the founder of Bridgewater, which manages about $150bn, comes in a month that has seen the benchmark S&P 500 dipping 1.7 per cent amid Donald Trump’s nuclear brinkmanship with North Korea and White House infighting over the president’s response to neo-Nazi demonstrations in Charlottesville, Virginia.
Although the S&P 500 closed slightly higher in New York trading on Monday, the fall since the start of August puts it on track for the worst monthly performance in almost a year as a series of “Trump trades” have fizzled out over the summer.
Mr Dalio, who was initially optimistic about the economic impact of Mr Trump’s policy agenda, wrote on Monday that divisions in Washington meant “conflicts have now intensified to the point that fighting to the death is probably more likely than reconciliation”, pointing to the president’s sharply diverging approval ratings among Democrats and Republicans.
The hedge fund manager said Bridgewater was “reducing our risk” because of the likelihood the conflicts will not be “handled well”, arguing that their resolution “will have a greater effect on the economy, markets and our overall wellbeing than classic monetary and fiscal policies”.
The US stock market rallied for much of 2017, partly on hopes Mr Trump would be able to enact sweeping tax cuts and ramp up spending on infrastructure, with the S&P 500 touching a fresh record high on August 8.
But since then, the North Korea stand-off and Charlottesville violence have been followed by the disbanding of the administration’s business councils and simmering concerns over stretched valuations, triggering a bout of nervousness among investors.
“If you look at various valuation metrics, it’s hard to argue that this isn’t an overstretched market,” said Mohamed El-Erian, chief economic adviser to Allianz.
Underscoring the view that the US stock market is overdue a correction, big investors such as Pershing Square’s Bill Ackman and Pimco’s Dan Ivascyn have recently said they have bought protection against any turbulence, and US equity funds have suffered nine straight weeks of outflows, with $4bn seeping out over the period according to EPFR.
Andrew Lapthorne of Société Générale noted that share buybacks — an important pillar for the stock market in the post-crisis era — have fallen by 20 per cent year on year, and argued that “over-leveraged US companies have finally reached a limit on being able to borrow simply to support their own shares”.
Some analysts and investors also fret that the Federal Reserve’s plans to begin scaling back its balance sheet — slowly ending the reinvestment of bonds it bought to prop up the economy after the financial crisis — could challenge financial markets. Although the reaction thus far has been sanguine, Matt King of Citigroup is worried that this will not last.
“Central bank purchases have had a much stronger impact on asset prices than they have on the real economy. This inevitably implies a vulnerability in asset prices when they back away,” he warned in a recent note.
The fading faith in Mr Trump enacting his promised economic policies has been particularly pronounced in the currency and bond markets, where there have been sharp reversals in several Trump trades that were popular immediately following his election victory.
US Treasury yields, which shot up after Mr Trump’s November victory in expectation of inflationary infrastructure spending, have sagged lower for much of 2017. The dollar has slid almost 9 per cent this year against a basket of other major currencies, and US small-cap companies, which would benefit from tax cuts and a stimulus-primed domestic economy, are down nearly 5 per cent in August. That puts them on track for their worst monthly performance since the global stock market slump in early 2016.
Still, with global monetary policy remaining easy and investors desperate for returns, Mr El-Erian said he would not be surprised if some began to take advantage of the recent wobble.
“Markets are now primed to buy the dips, and then the dips become shorter and shallower,” he said. “I would be strategically cautious, but understand if people tactically buy the dips.”