Systematic Relative Strength

Dalio divides the world into two groups.

Here’s how he describes the first, developed debtor nations (the U.S, Greece, Spain, and Italy, for example):

• They spent years overspending, financed by their government’s borrowing
• They are in the process of deleveraging debt
• As a result, they are being forced to lower their debt relative to their income levels, constrain spending levels and make improvements in the job market
• Some are worse off than others. Greece, Spain and Italy, for example, can’t print money to pay off their debts. To make up for slow credit growth, they will have decade-long depressions and debt defaults.
• The U.S. is trading like a country in decline

The second are emerging creditor countries (Brazil, India and China, for example). Here’s what’s happening there:

• They are leveraging up
• They will account for 70% of global GDP in 15 to 20 years versus 47% now. Read: They will be tomorrow’s economic leaders.
• Some, such as India and China, have currencies and monetary policy linked to those in the U.S. They are experiencing inflation because their interest rates are too low. They will have to unlink from the U.S. or face intolerable conditions.
• They are trading more like blue chips

I think the distinction between creditor and debtor nations is interesting. Western economists have for a long time believed that economic growth is driven by consumer spending. I think economists are confusing cause and effect. On the contrary, I think economic growth is driven by savings and capital investment—consumer spending is just the effect of the economic growth, not the cause of it.

Creditor nations have savings. Of course, if the savings get stuffed into a mattress (Japan) no economic growth occurs. But if the savings is turned into productive capital investment, you can see really dynamic economic growth (China, Korea, Singapore). There’s not necessarily a direct linkage between more rapid economic growth and a better stock market, but it might not hurt.

Lots of other things have to go right—countries have to have well-functioning political and legal systems, for starters. But if Bridgewater is right about the very long term shape of things, it seems pretty critical to have global tactical asset allocation as part of a core portfolio. Lots of individual companies around the world will also profit from these trends. No doubt there will be plenty of zig-zags in the long-term trend, but savings and capital investment should win out in the end.

…………

There’s more to the story, as is usually the case. I’m always curious about this stuff and I discovered that since 2007, the Bank of International Settlements has been publishing a list of creditor and debtor nations. Our crack researcher, J.P. Lee, sifted through the data. For each creditor and debtor nation he searched for a corresponding ETF, which was available for most economies of any size. If the economy was tiny and no ETF existed, he ignored it. Then J.P. calculated and averaged the returns for the creditor and debtor nations separately. The results might surprise you.

click to enlarge

In short, the returns seem unrelated to creditor or debtor nation status. This is a very small sample because only a few years of data are available, but there is no large, systematic advantage to owning creditor nations.

It suggests to me that tactical asset allocation is really important. Apparently creditor nations do not always invest their surplus domestically. It seems entirely possible that a creditor nation could invest the bulk of its surplus overseas, or wherever the best return is perceived to exist. Once again it seems that money goes where it is treated best—and that could be a creditor or a debtor nation at any given point.