Bridgewater’s Prince: Time to Think Different in an MP3 World
Bridgewater co-CIO Bob Prince explains the dangers of MP3 and suggests investors need to think outside the box, strategizing around cash flow returns – linking equity cash flow to stable spending sources in the economy.
Today’s MP3 world, where monetary and fiscal policies go hand in hand, has brought about important secular changes. Speaking at FIS Digital 2021 Bob Prince, Co-CIO of Bridgewater told delegates that MP3 has changed the way investors should think about bonds, stocks and portfolio building. This is against a backdrop of zero interest rates, a political and cultural shift from right to left, growing divergence between China and the United States, and growing ESG integration.
Prince explained that the way monetary policy is implemented has changed compared to the last decades.
“Under MP1, interest rates were the engine, used to change borrowing and lending levels to change spending patterns – you would see interest rate changes of 300 to 500 bps to move an economy. “he told delegates.
“Under MP2 which started a decade ago, QE has become the primary tool through which governments have printed money to drive up asset prices. Now, under the MP3, monetary and fiscal policies are used hand in hand.
Under MP3, the Fed borrows and directs money into the economy wherever it wants, supplementing income and increasing spending.
“Now governments are trying to remove interest rates so as not to offset the stimulus on the fiscal side,” he explained. “This means that the goal has become to remove and keep interest rates stable so as not to conflict with the person on the accelerator.”
This change in ties has big implications, he warned.
For example, this has led to the transfer of wealth from asset holders to debtors, as lower interest rates allow long-term debt relief. Yet one person’s debt is another person’s asset.
“We are the asset owners and we are on the wrong side,” he told delegates, citing the destruction of wealth in cash and bonds in recent years. “Cash holders have lost their purchasing power and have seen the value of their money decrease and the same process is happening in bonds as well. Cash and bonds are no longer a vehicle for savings.
Prince explained that the fiscal stimulus increases nominal incomes and allows governments to target their spending. Governments can send checks wherever they want, he said. Indeed, fiscal policy gives real freedom. Yet while MP3 has the ability to increase productivity in the long run and can resolve wealth inequalities, success also depends on the quality of decision makers.
Here, he pointed out that central banks now only play a supporting role for governments. He said governments are now heavily involved in the markets, adding that we would not have negative bond yields if it were market driven. Negative bond yields are a policy directive from governments, he said, adding that the distribution of liquidity by tax authorities simultaneously distorts asset prices.
It’s time to think outside the box
Next, Prince explained that increasing nominal income increases cash flow throughout the system with implications for real economy assets like stocks and real estate. Cue his argument for investors to think differently and get returns from the return on cash flow. He suggested that investors link cash flow from stocks to stable spending sources in the economy, explaining that it is possible to create a tracking portfolio of stable spending sources in the economy. Stable cash flow is always subject to price volatility, but it is possible to hedge it. He added that value managers generally offer stable cash flows that are less vulnerable to economic cycles.
Later, in a conversation with Stephen Gilmore, chief investment officer for the New Zealand Super Fund and Tom Tull, chief investment officer for the Employees Retirement System of Texas, Prince explained that historically, interest rate policy had a impact on an entire country. Now, as governments direct cash flows to specific sectors of the economy, investors can target assets that will have higher or lower income.
And rather than looking at the market through a public or private lens, Prince suggested that investors think of investments in terms of cash flow.
“Just think about what the asset’s cash flow is and what are its characteristics,” he said, adding that public and private assets are on the same level. He said it comes down to another degree of freedom and that investors should think about simply diversifying their cash flow.
As to whether investors should also lose their distinction between emerging and developed markets, he called the approach difficult. Emerging markets do not have zero interest rates, besides zero interest rates, deficits and printing money, that does not exist in Asia. This makes investing in Asia another source of diversification and he urged investors to move between east and west. China has an independent monetary system that drives the whole region.
“There is a risk there, but it’s a different risk,” he concluded.