AQNU - Billionaire Ray Dalio Is Navigating U.S. 'Inflection Point' With These Stocks

2023-11-21 06:15:00 ET

Summary

• Billionaire Ray Dalio recently issued a stern warning about the U.S. economy.
• We analyze his comments as well as how his legendary hedge fund is positioning its portfolio in response.
• We also share our thoughts on Dalio's outlook for the U.S. economy and how we are positioning our portfolio differently than he is.

In a recent interview, billionaire investor Ray Dalio discussed the United States' impending debt crisis, highlighting that the country's balance sheet is nearing an "inflection point" before discussing its ramifications for bond yields moving forward. In this article, we take a closer look at his reasoning as well as his firm's (Bridgewater Associates) latest 13F filings to examine his approach to navigating the current economic climate, and then share how our approach differs from his.

Ray Dalio: U.S. Debt Nearing 'Inflection Point'

In his interview, Ray Dalio pointed out that - despite current low unemployment rates and decent household incomes - the U.S. economy faces some long-term challenges centered around its enormous debt burden. While he expects that over the short-term, interest rates will be fairly stable and potentially even decline some due to an economic slowdown, over the long-term the runaway growth in the U.S. debt burden will lead to conditions where the government has to borrow money merely to service its debt burden. This situation will undoubtedly put enormous strain on the U.S. economy and will likely exacerbate already rising political and social instability in the country as well as already declining foreign demand for U.S. bonds.

Moreover, given that he expects inflation to remain sticky in the 3-3.5% range moving forward, he sees a fairly high floor for bond yields of at least 100 basis points above the expected long-term inflation rate. This puts us in a scenario where long-term treasury yields will likely settle in their current range for the short term at least.

Ray Dalio's Top Picks

Given his somewhat pessimistic outlook for the U.S. economy and concerns about sticky inflation and interest rates remaining higher for longer, Bridgewater's top holdings in its latest 13F filings make a lot of sense:

A common theme emerges here among each of his individual stock holdings: all six of them are consumer defensive stocks that possess strong balance sheets (as evidenced by their stellar credit ratings) that make them fairly immune to higher for longer interest rates, considerable pricing power that protects them from persistently moderately high inflation, and recession-resistant business models that should suffer very little from a slowdown in the United States economy:

1. Procter & Gamble: Procter & Gamble's pricing power stems from its portfolio of essential consumer goods, ranging from hygiene products to household items. These products, often considered necessities, maintain steady demand regardless of economic conditions. Moreover, PG's strong brand loyalty allows it to pass on higher costs to consumers without significant backlash, thereby shielding it from inflationary pressures.

2. Coca-Cola: Coca-Cola’s iconic branding and global recognition give it significant pricing power and therefore relative immunity to persistently moderate inflationary pressures. Its beverages, considered affordable luxuries, tend to experience sustained demand even during economic downturns. Furthermore, KO's diverse product portfolio, including healthier options alongside its soft drinks, allows it to appeal to a broad consumer base, enhancing its ability to maintain its pricing power and profitability.

3. Costco: Costco’s membership-based business model is a key factor in its pricing power. The bulk-buying discounts and perceived value offered by Costco drive customer loyalty and frequent store visits. During economic slowdowns, consumers tend to become more price-sensitive, which plays into Costco's strengths as a bulk discount retailer.

4. PepsiCo: Similar to Coca-Cola, PepsiCo benefits from strong brand recognition and a diversified product portfolio that includes snacks and beverages. This diversification allows PepsiCo to balance the impacts of economic cycles across different product categories, thereby maintaining strong pricing power and profitability, even in a stagflationary environment such as what Mr. Dalio expects.

5. Walmart: Walmart's competitive advantage lies in its extensive supply chain efficiency and its positioning as a low-cost retailer. In economic downturns, consumers gravitate towards affordable retail options, benefiting Walmart. Its scale allows it to negotiate favorable terms with suppliers, sustaining its pricing power even when inflation is somewhat elevated.

6. Johnson & Johnson: JNJ's pricing power is anchored in its diversified healthcare portfolio, including pharmaceuticals, medical devices, and consumer health products. The essential nature of many of its products, especially in healthcare and pharmaceuticals, ensures consistent demand. Moreover, JNJ's strong brand reputation in healthcare lends it a degree of pricing inelasticity, as consumers and healthcare providers trust and rely on its products.

Rounding out Mr. Dalio's top holdings are three ETFs: two based on the S&P 500 and another - its largest overall holding - based on emerging markets. Its exposure to the S&P 500 is probably largely intended for maintaining significant overall portfolio diversification and giving it some exposure to the A.I.-boosted 'Magnificent Seven' (Apple ( AAPL ), Amazon ( AMZN ), Tesla ( TSLA ), Meta ( META ), Alphabet ( GOOG ), Microsoft ( MSFT ), and NVIDIA ( NVDA )). Meanwhile, its largest holding gives it a natural hedge against a severe downturn in the U.S. Dollar, which would likely occur in the event that the U.S. fiscal situation continues to deteriorate.

Our Approach

While we certainly agree with Mr. Dalio that the U.S. government's runaway spending and borrowing are a tremendous threat to the country's long-term prosperity, our view on near-term inflation and how we are positioning our portfolio is somewhat different.

Given that shelter costs - which make up an outsized amount of headline and core inflation data - have a substantial lag in them, artificial intelligence's deflationary impacts are likely not even close to being fully felt and will likely only accelerate in the coming years, the rapidly vanishing purchasing power of American consumers, the economic slowdown in China, and the fact that the full impact of the Fed's rapid and significant rate hikes is also highly unlikely to be reflected in the current inflation data, we think inflation is heading a lot lower in the coming quarters. As a result, especially when combined with the fiscal pressures currently being felt by the U.S. Government as its debt servicing costs soar as well as the stakes being raised by the upcoming Presidential election, we expect the Federal Reserve to cut interest rates meaningfully next year and long-term rates to head below 4% and possibly even below 3.5%.

As a result, we think that while Mr. Dalio's bets are not particularly bad in the current environment, we favor undervalued, defensive, interest rate-sensitive REITs ( VNQ ) like Realty Income ( O ), utilities ( XLU ) like Algonquin Power & Utilities ( AQN ), and infrastructure/renewable power yield cos like Brookfield Renewable Partners ( BEP )( BEPC ) and Brookfield Infrastructure Partners ( BIP )( BIPC ). For long-term hedging against the decline of the U.S. Dollar and potentially even a debt crisis in the U.S., we favor gold ( GLD ), silver ( SLV ), and miners ( GDX ) like Barrick Gold ( GOLD ) as we recently discussed here , because precious metals have lower geopolitical and macroeconomic risk, and we believe that the rapid demise of the U.S. Dollar and economy would likely either be preceded by or immediately followed by a spike in global geopolitical and economic turmoil that would likely hurt most - if not all - countries, and not the U.S. exclusively. Moreover, gold prices have typically soared in the wake of the Federal Reserve ending its hiking cycle and, given that we believe this is the case right now, we are also bullish on gold's near-term outlook.

Investor Takeaway

Ray Dalio's insights and investment portfolio posturing reflect his expectation of a stagflationary environment in the near term followed by a U.S. debt crisis in the long-term. In contrast, our approach acknowledges the risks highlighted by Dalio but diverges in our near-term inflation outlook. Given that we anticipate lower inflation and meaningful interest rate cuts, we lean towards undervalued, interest rate-sensitive sectors such as REITs, utilities, and infrastructure stocks. Additionally, in hedging against potential declines in the U.S. Dollar and broader economic and geopolitical challenges over the long term, we favor precious metals over emerging markets stocks, though we do also have some exposure to that sector in our portfolio.

What do you think about Mr. Dalio's and our outlooks and investment strategies? Let us know in the comments section below.

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