Are Investors Unprepared for the Next Downturn?


Dec. 26 2018, Updated 3:20 p.m. ET

Investors not prepared

As reported by CNBC, Ray Dalio feels that “the world by and large is leveraged long,” believing that the next bear market could be very painful as most are not prepared for it. At the Greenwich Economic Forum, Dalio said he doesn’t “think there’s much to protect investors” during a downturn.

While Dalio didn’t explicitly call for a sharp downturn, he insisted that investors should have a “strategic asset allocation mix. In other words, what will be the neutral portfolio in an overall period of time and then figure out where there is alpha. That will distinguish the winners and the losers.”

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Markets propelled by low rates

By saying markets are “leveraged long,” Dalio means that low-interest rates fueled the market rally through buybacks and acquisitions. The most recent bull market was propelled by historically low interest rates (TLT) from the Fed. Now, however, as the Fed has started tightening, markets are worried about the stock rally continuing.

When catalysts fade

When the Fed chair took an aggressive stance at the beginning of October, markets slumped on growth concerns. However, after his dovish speech on November 28, markets rejoiced. This cheer was short lived as the Fed hiked rates by 25 basis points on December 19, and sounded more hawkish than markets were expecting. The Fed’s hawkishness, ongoing US-China (FXI) trade tensions, and economic growth and earnings concerns have been major drivers behind markets’ recent sell-off.

In the four trading days following the Fed’s December 19 rate hike (AGG) and 2019 outlook announcement, the S&P 500 (SPY) has fallen 8.1%, the Dow Jones Industrial Average (DIA) has fallen 8.1%, and the NASDAQ Composite (QQQ) has fallen 9.4%. Next, let’s look at how Dalio suggests investors could weather financial cycles.


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