We are living through some of the most dramatic changes in Bridgewater’s 50-year history. Over the last 12 months, our focus has been on the new reality facing investors, with three interrelated dynamics at its core: (1) a new geopolitical and macroeconomic paradigm that poses (2) a threat to US-concentrated markets and portfolios amid (3) a once-in-a-generation technological disruption.
In our recent Q2 CIO letter to our clients, we described how these dynamics are playing out so far and the tactical and strategic opportunities we see today. Below, we’re sharing three highlights from that letter.
Bob, Greg, and Karen
Co-Chief Investment Officers, Bridgewater Associates
Navigating Through a Time of Extraordinary Change
In the new paradigm, interventionist governments are here to stay. Last quarter, we wrote about embracing a new geopolitical and macroeconomic paradigm, with modern mercantilism front and center. A few short months later, modern mercantilism is everywhere, and it’s becoming entrenched. This makes for a riskier, more zero-sum world, with governments at the wheel. Here are some of our key takeaways:
- The policy thrust has been chaotic, but it’s not random or transient. China has long been on the offensive with modern mercantilism, architecting a path up the value chain that also strengthened its position as a world power. Mercantilism has likewise been incubating for years in the developed world, but as a defensive reaction to the pain of hollowed-out manufacturing. As the imbalances created by globalization came to be seen as injustices, mercantilist ideas went mainstream—and they’re not likely to disappear with a changing of the guard.
- The Trump administration’s agenda has all the hallmarks of modern mercantilism. The US government is undertaking one of the largest-ever expansions of executive power to orchestrate the economy. Trade policy is explicitly aimed at reducing the trade deficit. Negotiations are leveraging trade partners’ dependence on US market access and military capabilities. National security is a driving force behind industrial policy. And institutions that would stand in the way, such as the WTO, have either been abandoned or, in the case of the Fed and NATO, pressured to fall in line.
- The general approach to implementing these policies has been to push as hard as possible, encounter intolerable outcomes, retreat, and then begin again with more information. This is naturally driving big swings in market expectations, with “Liberation Day” as the first extreme push. After a US equity sell-off, rising yields, and a falling dollar, the Trump administration retreated into a “pause” for negotiations. That de-escalation gave markets a sense of President Trump’s pain tolerance, lowered the odds of catastrophic economic outcomes, and made policy uncertainty less existential for businesses, helping to propel US equities out of their drawdown.
- Now, the US equity market is reaching new highs even though it’s only become clearer that de-escalations will not bring back the pre-“Liberation Day” status quo. Since April 2, the actual effective tariff rate has stayed above 13%, which is already the highest rate we’ve seen in decades. And as policies become less extreme, they also become more believable. Negotiations are starting to either yield deals that lock in high tariff rates or trigger re-escalations until they do.
- Mercantilism flowing from the US is now leading to even more mercantilism as other economies figure out how to fend for themselves. The political calculus is simple. As the Trump administration makes it harder for global exporters to compete in US markets and China pushes excess supply on the rest of the world, governments must either embrace mercantilist policies of their own or accept the slow, painful death of their industrial sectors. It’s hard to imagine many politicians who accept the latter remaining in power for long.
With little net movement in markets or capital allocation, accumulated imbalances are as large as ever.
Market and portfolio concentration in US assets has shifted very little even as the risks, many of which are emanating from the US, have grown much clearer. Foreigners need the US to drive demand in their economies, while the US is reliant on foreigners’ willingness to keep saving in US assets at current high valuations. The push toward modern mercantilism now poses a threat to the sustainability of that relationship, creating risks to US exceptionalism.
While mercantilist policies aim to (and may) lift the US economy by incentivizing domestic production, they also create a need for investment in defense and domestic demand in foreign economies, incentivizing global savers to draw on their savings. They could also temper the willingness to save in the US at current valuations by eating into US profits via tariffs, raising the risk of retaliation, and constraining the Fed. On top of that, the erosion of stable rulemaking along the way undercuts the “institutional stability premium” built into US assets and directly antagonizes foreign investors, whose inflows contributed significantly to the US equity rally of the last few years.
We are seeing signs that investors are starting to respond to these risks by reconsidering how fast they want to keep accumulating US exposure, particularly in currency markets. In the second quarter, we saw the US dollar sell off alongside global risk assets for the first time in many years, which served as a reminder that USD exposure is not inherently diversifying when risks are emanating from the US itself. Currency hedging and capital savings decisions can be made relatively quickly, and we’ve seen the dollar fall 10% against major crosses year-to-date, in part as investors increased their hedge ratios. Even so, that move is small relative to the secular USD rally.
Market pricing suggests strategic shifts to build resilience are a pretty good deal right now.
Stepping back, the inertia in markets means that we’ve gotten months’ worth of valuable information that we don't see fully reflected in prices. That, of course, creates tactical opportunities. For example, we see upward pressure on the currencies of global net savers looking to repatriate capital, and pressure for a decline in US equities (excluding AI-adjacent companies), where the broader market is priced at an unwarranted premium with sizable profit risks ahead. We think bonds outside the US look attractive in economies where central banks have maintained restrictive monetary policy despite soft growth and disinflation ahead, and the conditions for gold to extend its rally remain in place.
We also see current market pricing as a gift to investors who are looking to make strategic shifts toward a more resilient portfolio. It’s a rare time when diversification is better than free, but current pricing suggests that for portfolios concentrated around market cap weights, that’s effectively the case right now. Below are some of the attractive opportunities we see for strategic shifts:
- Geographic diversification and currency hedging have become both urgent and attractive now that pressures have shifted to favor markets and currencies outside the US.
- We also don’t see an inherent tension between reducing concentration in US equities and preserving AI exposure. In fact, we see a move away from being overallocated to the US market as more attractive if it’s done in a way that preserves AI exposure, since the rest of the US companies in aggregate are the ones priced for the most earnings acceleration relative to what they’ve achieved historically.
- And with real yields as high as they’ve been in 15 years (and many central banks likely to keep normalizing rates), environmental diversification out of typical, equity-centric portfolios into fixed income looks like good value, too.
- Geographic diversification and currency hedging have become both urgent and attractive now that pressures have shifted to favor markets and currencies outside the US.
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