Ray Dalio stirred up discussions in October by stating that the likelihood of WW3 escalating from 35% to 50% over the next two years. Marking on the Israel/Gaza situation, he expressed concern that the conflict might extend into the entire region amidst China’s actions against Taiwan. On the whole, he highlighted that these combined factors lifted the possibility of a ‘hot’ global conflict by 50%.
Dalio kept the exact method he used to assess the 50% likelihood of WW3 in the upcoming years undisclosed. Nevertheless, his company indirectly unveiled its anticipation of who will prosper the most in the evolving global structure:
Bridgewater Associates’ most recent 13F revealed that its primary position was with IVV iShares Emerging Markets ETF (IEMG). Both IEMG and IVV constituted 5.5% of the total portfolio. The acquisition of IEMG shares essentially implied a wager on China, as five of the fund’s top 10 holdings encompass Chinese stocks. Moreover, the most weighted non-US stock in Bridgewater’s portfolio is China PDD Holdings (PDD), positioned 16th. PDD stands as one of only two foreign individual stocks to break into the top 20 in Bridgewater’s portfolio.
It is plausible that Dalio himself influenced the decision to invest in emerging markets. While he no longer oversees Bridgewater’s portfolio, he continues to serve at Bridgewater as a director and CIO mentor. “CIO” denotes chief investment officer, and Dalio is advising the current holder of that position. Therefore, it is likely that Dalio still holds sway over the fund choices made by Bridgewater.
In light of this, Bridgewater’s backing of emerging markets, especially China, is quite intriguing. Dalio has previously stated that the US and China are headed towards a clash. Indeed, their recent WW3 prognosis of 50% implies the imminent likelihood of such a conflict, as the US and China would likely find themselves on opposing sides in such a war. The significant bet on China seems to infer that Dalio and/or his team believe that China will emerge relatively unharmed from the anticipated conflict, or at least not worse off than the other major players. If this assumption holds true, Chinese stocks could prove to be a wise long-term investment – albeit with substantial short-term downside potential if an event akin to WW3 were to occur.
The rationale above may explain why Bridgewater turned to the IEMG fund instead of individual Chinese investments. Investing in China exposes individuals to significant risks: in a WW3 scenario, disruptions in the businesses’ supply chains and the delisting of their stocks from the NYSE could transpire. The latter of the two scenarios actually occurred during the Trump administration, even when the US was not at war with China. Hence, a major single-stock investment in China harbors risks. In contrast, IEMG offers extensive exposure to China in a hyper-diversified package comprising 2,700 stocks. Furthermore, the fee is merely 0.09%! For those keen on investing in China through a diversified approach, IEMG may present a substantial investment opportunity.
Historical Trends Suggest US Stocks are Poised for a Downturn
I have long held the belief that foreign equities are on the verge of outperforming US equities in the long term. My conviction in this scenario is based on observations regarding the lofty valuations and financial history of US stocks (especially US tech stocks). Unlike Dalio, I do not view WW3 as particularly probable. The fact that the Cold War did not lead to a Third World War implies that global tensions would need to be exceptionally severe for a “hot” Third World War to transpire.
Nonetheless, relative valuations indicate that the US’s extended period of outperforming global equities is likely to conclude soon. Presently, the S&P 500 trades at 24 times earnings, whereas the rest of the world trades at 11.8 times that! US stocks are currently twice as pricey as their global counterparts. In essence, these stocks are far from inexpensive.
In itself, this does not signify an inevitable decline in US stocks. They can continue to exhibit strong performance from this point onward. Nevertheless, it is probable that foreign stocks will surpass US stocks due to their lower valuations and comparable, if not superior, growth rates. Presently, JP Morgan (JPM) estimates that global equities will grow at 7.8%, while US equities will grow at 7%. This forecast originates from JPMorgan Asset Management, a global asset manager devoid of geographic bias. This aligns with comparable forecasts from individual investors such as Charlie Munger, Li Lu, and even Ray Dalio himself.
Thus, we witness foreign stocks being sold at half the multiple of US stocks, while many forecast equivalent or even superior earnings growth for foreign stocks. This suggests that foreign equities, not US equities, will reap the benefits of numerous expansions in the coming decade.
The sole fundamental factor that might argue for the outperformance of US stocks from this point is risk aversion. If global markets exhibit exceptionally high risk in comparison to US markets, US stocks warrant a premium. Nevertheless, this risk premium would need to justify US stocks being twice as costly as foreign stocks. Sustaining this seems improbable. Historically, scenarios like this have not endured indefinitely. During the late 1960s, American stock markets entered a momentous “lost decade”, while Japanese stocks experienced a monumental surge. It was not until 1989 that Japan’s winning streak eventually concluded.
Implications for Today
Irrespective of Ray Dalio’s reasons for favoring global stocks, one thing remains indisputable:
Both historical patterns and multipliers suggest that they will outperform at present. The disparity in valuation is substantial, and history demonstrates that there is no assurance of US markets outperforming.
What actions should investors take in light of this information?
One option is to effortlessly invest in emerging market funds, similar to Bridgewater’s approach. I have personally heightened my exposure to emerging markets this year for reasons akin to Dalio. I have taken positions in Vanguard All-World ex-US Fund (VEU) and selected individual Chinese stocks, albeit IEMG could be equally effective.
Another option is to concentrate specifically on a single foreign market. Presently, Buffett is heavily investing in Japan, while others (like myself) are directing more attention towards China. The choice of which part of global stock trading to focus on is left to individual discretion. However, if one perceives the likelihood of an imminent WW3, they might favor Japanese and Singaporean stocks over Chinese stocks. The logic detailed in this article applies to all foreign markets, not any specific one. Thus, markets exposed to “WW3 risk” can be avoided, if preferred. The bottom line here is that, now more than ever, some global stocks need to be included in one’s portfolio. What was once merely a good idea is now on the brink of becoming indispensable.