Tuesday, July 31, 2012

More Ray Dalio quotes

More Ray Dalio quotes from Jack Schwager’s book Hedge Fund Market Wizards. I think the last couple of long paragraph quotes below are especially important in regards to the current situation in the U.S.

“We don’t use stops. We trade approximately 150 different markets, where I am using the term market to also mean spread positions, as well as individual markets. However, at any given time, we probably have only about 20 or so significant positions, which account for about 80 percent of the risk and are uncorrelated to each other.”

“I don’t believe in reducing exposures when you have a losing position. I want to be clear about that. The only pertinent question is whether my being in a losing position is a statistically meaningful indicator of what the subsequent price movement will be. And it is not. For that reason, I don’t alter positions because they are losing.”

“The way we change our minds is a function of how that information passes through our decision rules. Our decision rules determine the position direction and size under the circumstances….It is 99 percent systematized. These systems evolve, however, as the experience we gain might prompt us to change or add rules. But we don’t make discretionary trading decisions on 99 percent of our individual positions.”

On the origin of the Bridgewater system:

“Beginning around 1980, I developed a discipline that whenever I put on a trade, I would write down the reasons on a pad. When I liquidated the trade, I would look at what actually happened and compare it with my reasoning and expectations when I put on the trade. Learning solely from actual experience, however, is inadequate because it takes too much time to get a representative sample to determine whether a decision rule works. I discovered that I could backtest the criteria that I wrote down to get a good perspective of how they would have performed and to refine them. The next step was to define decision rules based on the criteria. I required the decision rules to be logically based and was careful to avoid data mining. That’s how the Bridgewater system began and developed in the early years. That same process continued and was improved with the help of many others over the years.”

When asked if the rules get revised:

“They are sometimes revised. For example, we used to look at how changes in the oil price affected countries. Between the first oil shock and the second oil shock in the 1970s, crude oil was discovered in the North Sea, and the U.K. went from being a net importer to a net exporter. That event prompted us to change how we configured the decision rule that related to oil prices so that when the mix of export and import items changed, the rule changed.”

When asked how he was able to perform well in 2008:

“Our criteria for trading in a deleveraging had already been established because we had previously studied other leveragings and deleveragings. Our analysis included both inflationary deleveragings, such as Germany in the 1920s and Latin America in the 1980s, and deflationary deleveragings, such as the Great Depression of the 1930s and Japan in the 1990s. I had also directly experienced the deleveragings in Latin America and Japan. We felt that if these sort of big events had happened before, they could happen again. We also believed that fully comprehending these events was important to understanding how economies and markets worked….In short, by knowing how deleveragings occur, we could monitor the appropriate factors, and by understanding the cause-and-effect relationships in a deleveraging, it was not difficult to be well positioned in 2008.”

When asked about the current economic situation, Dalio mentioned the importance of distinguishing between countries that are debtors and those that are creditors, and countries that can print and those that cannot print money. Debtor countries that can’t print money will experience deflationary depressions. In regards to those debtor countries such as the U.S. that can print money:

“Those that can print money, such as the United States, can alleviate the deflation and depression pressures by printing money. However, the effectiveness of quantitative easing will be limited because the owners of the bonds that are purchased by the Fed will use the money to buy something similar; they are not going to use it to buy a house or a car. In addition, fiscal stimulus will be very limited because of the reality of the political situation. So it is unlikely that we will have effective monetary policy or effective fiscal policy. That means we will be dependent on income growth, and income growth will be slow—maybe about 2 percent per year—because income growth is usually dependent on debt growth to finance buying, and I don’t expect any significant private credit growth. A growth rate of 2 percent is not sufficient to meaningfully lower the unemployment rate. There is a risk that if the economy deteriorates, we won’t have any effective tools for reversing the situation. The current situation is analogous to being in a recession and not being able to lower interest rates.”

“The best policy would be to spread out the problems over a long period of time so that nominal interest rates stay below nominal growth rates….You do it through a combination of monetary and fiscal policies that produce enough government spending to make up for the reduction in private sector spending to keep the economy from contracting. Avoiding an unmanaged contraction is essential in order to maintain social and political order. At the same time, there needs to be well thought-out debt restructurings because we can no longer allow our debts to rise faster than our incomes, and we need to gradually lower them….it is very important that the fiscal spending is used for investments that generate returns that are greater than their costs. We can’t afford to waste money.”


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