INSIGHTS

We are sharing a conversation with our newest co-CIO, Karen Karniol-Tambour, so you can hear directly from her on how she’s seeing the economy and markets.

In this discussion, Karen talks through how she’s thinking about the world from a big-picture secular perspective and how she’s assessing cyclical conditions across the world. She also explains where she’s seeing the biggest mispricings and shares her advice for investors on how to manage the challenges of the current environment.

Transcript
Note: This transcript has been edited for readability.

“What you’re seeing now is this tug-of-war where, on one hand, markets are very excited that it seems that growth has not slowed yet — that even though there’s been significant tightening, even though you’ve had a true beginning of poppings of the bubble in some of the most bubbly parts of the economy where a lot of the money that was printed over COVID went, that hasn’t cascaded into significant weakness throughout the economy yet. And at the same time, there is a flip side to that, because every time the economy looks stronger than people expected, is more resilient than people expected, we see what we see today, which is inflation is not anchored at the level that it used to be. The bottom line is this is not a 2% inflation world. If we want to get back down to 2%, that’s not going to happen magically. It’s going to take either much more economic weakness than we’ve already seen or significantly more tightening in order to bring it down.” — Karen Karniol-Tambour, co-CIO

JIM HASKEL

I’m Jim Haskel, editor of the Bridgewater Daily Observations. We want to turn to our newest co-CIO, Karen Karniol-Tambour, so you can hear directly from her on how she’s thinking about the economy and markets today, both from a big-picture secular perspective but also from a more zoomed-in perspective, in terms of how cyclical conditions are evolving and where the biggest mispricings in markets are, as well as her advice for investors on how to manage the challenges of the current environment. So, let’s jump right into my recent conversation with Karen Karniol-Tambour.

Chapter 1: Reflections on Becoming Co-CIO

JIM HASKEL

Karen, it is great to have you here. I would just like to say, it’s also great to be able to introduce you for the first time on a BDO podcast as one of our co-CIOs. I just want to congratulate you personally on this new role. It is very well-deserved, and I think all of your colleagues are thrilled to see this happen. Now, there’s so much going on in economies and markets, and we’re going to get to that in a moment. But before we do, I would like to start just by asking you personally what it means to you to be named CIO or co-CIO, and how you’re thinking about this new position and how it differs. You’ve been a senior investor for many years, but how does it differ from the role you’ve been playing in terms of how you’re seeing yourself and how you’re feeling about this whole transition?

KAREN KARNIOL-TAMBOUR

Thank you so much, Jim. As a lot of people listening know, I really grew up at Bridgewater. I really grew up here, because I’ve been at Bridgewater since right when I finished school, and I stayed here because I fell in love with the content of what we do, with the process of how we do it, and with the people. If you start with the content, everybody is fascinated with how the world works. But we really get to ask the toughest, most difficult questions and try to understand them from a fundamental perspective—what’s really driving the world, cause and effect. So it’s fascinating. We get to do the most interesting things every day in the world, but it’s not just for intellectual engagement. We get to do it in a way that actually matters.

So, meeting clients, realizing how the research we do and how we manage money actually has real-world impacts—we get to do it in a way that’s both fascinating in terms of getting to learn and understand, but also recognizes human fallibility, recognizes that just sitting around opining about how the world works, you’re going to miss a lot of things. Many of the listeners know I spent my college years working with Nobel laureate Danny Kahneman on human judgment and decision making. There are very few places that recognize human fallibility and realize that you want to take a deep understanding of how the world works and augment that with technology to actually be able to stress test that thinking and move beyond the kind of biases and emotions that human decision making is naturally going to have on any topic and make it much more reliable and systematic in that way.

So, I fell in love with the content, fell in love with that process of being able to understand the world and have that turn into actual impact. But maybe even more importantly, I fell in love with the process of how we do it here, which is that we work together. We’re one team; this isn’t a place where each person has their own book. And that means harsh feedback. That means that we’re all in it together, so we all actually tell each other what we’ve got to do to get better. I know there’s no way in the world that I would be named co-CIO today if everyone around me—most importantly, Ray, Bob, and Greg, who set up and established this culture over the years, but all my other colleagues, including you, Jim, who is a great example of someone who gives harsh feedback—if anybody held back and said, “I don’t want to insult her, embarrass her, make her upset,” and didn’t just say it like it was and tell me when I was doing stupid stuff and keep giving me harder and harder challenges and tell me when I was messing them up, there’s no way I would have learned what I had over the years and had the experiences I did and been able to move forward. So that culture, I know, is what taught me everything.

That brings me to the people, which is: it takes a very special kind of person to work here. Once you’ve done it together for so many years, as I have with so many of my colleagues—I’ve worked my whole 15 years here, and I know I’ll work for many decades more—those are very special relationships that are bound by a commitment to clients to do right by them, and to each other to do right by each other and give real feedback to each other.

So when you add that all up, what feels really different about the role is feeling now that I’ve been given the responsibility to, along with Bob and Greg, also be a steward of all that. Not only a steward of the outcomes to our clients, but also of that process, the people, the feedback, and what it takes to have an ecosystem like this, where we can learn about the world and keep improving together with our partners.

JIM HASKEL

Well, I can just say that we’re all very excited for you, and all of us look forward to working with you for years to come as well.

Chapter 2: The Paradigm Shift in Economies and Markets

JIM HASKEL

Let’s move on now to the economy and markets. Our listeners have heard Greg Jensen not too long ago, in the aftermath of stronger economic numbers, give his take on what that all means for the economy and markets. We heard Bob Prince on Monday and again in the wire today. Now we want to turn to you, Karen. I think it’d be great if you could just start by synthesizing at the high level how you’re seeing the economy and markets right now, where we are in the story, what are the most important dynamics you’re watching, and where do you think we’re headed?

KAREN KARNIOL-TAMBOUR

Well, you know, Jim, it couldn’t be a more interesting time to be watching the world and investing money, because I really believe that the next few decades ahead of us are going to be very fundamentally different than the decades behind us. What you see over and over again in markets when you have these paradigm shifts—and it really connects to people’s biases and what it’s like to make decisions—is that those paradigm shifts don’t get priced in right away. People start realizing them, they start talking about them, but it’s very, very hard for them to actually be incorporated into market pricing quickly, because it’s hard to process that the world is going to be different than it was. And people do keep investing based on the market experience that they’ve personally had.

So you’ve had many decades now, and certainly during the lifetimes of most investors that are alive today, where inflation was not really a factor. There were strong disinflationary forces. Monetary policy was the most important thing, and it flowed through increasingly very, very quickly. You had very, very, very rapid economic cycles because every time something went wrong, there was kind of a savior there, which was the Federal Reserve or other central banks around the world that, because inflation wasn’t a factor and there was a deflationary backdrop, could step in and just resolve the problem very quickly.

Now the world we’re living in is very, very different. Most of those deflationary impulses have faded or have gotten to the point where we certainly can’t repeat those deflationary powers that are behind us, and there are a lot of inflationary forces rising. While you have a lot of discussion about geopolitical tensions, about the need to decarbonize and address climate change, and about the type of social tensions that have risen, there hasn’t been quite an internalization that all of those things require inflationary spending. So, if for 40 years, every time you spent money as a business, you could pretty reliably say, “I’m spending money, and I know that I’ll reduce my cost structure. For example, I’m moving my labor offshore to India, and it’ll be cheaper there.” Now, most money being spent is not money that’s going to reduce your costs; it is actually a double-do. Let’s have a “more resilient supply chain,” which means build twice what I need, certainly not reduce my cost. Let’s decarbonize, which has long-term huge benefits for the world, but certainly, in the short term means spending money and shifting what you’re doing to now be involving lower carbon emissions. And the social tensions we’ve had, such that we’ve gotten to the point where there’s no unionization—it can only reverse. You can go from a lot of unions to zero; you can’t go to negative. You can only go up, and you can only address that with rising costs to address what your labor force is experiencing.

So all those things are an inflationary backdrop where globalization can only reverse to some degree, and we’re already seeing pieces of that. A lot needs to be spent to address the geopolitical tensions, the climate change story, and you’re in this environment where, coming out of COVID, a new method has been learned, which is that you don’t have to use monetary policy. You can actually bring in fiscal authorities and make that transfer of money toward whatever you’re trying to accomplish a lot more efficient, whether that’s literally pairing printing money with sending checks to people’s homes and just getting them in their hands, which is what we saw in the US, to augmenting their wages, like we saw in Europe, to what we’re seeing with something like the Inflation Reduction Act, which says, “Let’s take fiscal policy and just go directly and spend billions of dollars on the outcomes that we need,” in this case, reducing our exposure to climate change. That’s going to be a very hard lever to forget about and is naturally more inflationary, because you’re spending in order to resolve the issues that you have, whether they’re a downturn, social problems, environmental problems we need to deal with.

What you’re seeing in markets is that it’s taking a long time to process that we’ve shifted into that world. Markets are basically saying, “Wait a minute, we had a bunch of tightening; that’s behind us now.” They’re expecting a return to a world where the natural pull of inflation is to a comfortable 2% so that if they don’t see a reason for inflation to be rising, the assumption is low and stable inflation, and to those quick cycles where, if there isn’t a strong reason immediately to think there’ll be a large downturn, there won’t be one, because there will always be a way to solve the downturn.

So even though there’s some realization that the paradigm is shifting, markets are still not mostly pricing that. They’re still pricing primarily that growth will barely slow, inflation will go down to how it was, and there won’t be a need to really fundamentally change pricing in order to get the type of economic conditions that policy makers are going to want. That makes it a fascinating time to follow both how the world shifts toward this new paradigm, and how long it takes for markets to start catching up and pricing that, which won’t be immediate. You’re going to get reversals and it’s going to take quite a while for markets to fully process the new world that we’re in.

Chapter 3: Cyclical Conditions Around the World

JIM HASKEL

Karen, let’s go a level down and just talk a little bit about how you’re seeing the US picture and also the other economies in the developed world—Europe, Japan, so on—and how they might differ. On the US, we just got the inflation print today, and while it wasn’t wildly out of consensus, it was a little bit stronger than consensus. If you look into the guts of that you see that the inflation pressure is very much still there. Our synthesis has been that it’s going to be really hard for the Fed to engineer acceptable growth and anchored inflation at the same time, and this inflation print may reinforce how difficult that is. Help us assess the US picture, and then maybe go around to the other major economic centers as well, and we’ll ask about China in a second.

KAREN KARNIOL-TAMBOUR

Well, I think you hit the nail on the head with your question, which is that—and we’ve said this in many different ways—it’s going to be very, very challenging to both have strong growth and have the low inflation we’ve been used to because you have all of these inflationary forces in the system. So what you’re seeing now is this tug-of-war where on one hand, markets are very excited that it seems that growth has not slowed yet—that even though there’s been significant tightening, growth hasn’t slowed yet, seems to be doing relatively well, even though you’ve had a true beginning of poppings of the bubble in some of the most bubbly parts of the economy where a lot of the money that was printed over COVID went, that hasn’t cascaded into significant weakness throughout the economy yet. You’ve had some calming of energy prices. And at the same time, there is a flip side to that, because every time the economy looks stronger than people expected, is more resilient than people expected, we see what we see today, which is inflation is not anchored at the level that it used to be. The bottom line is this is not a 2% inflation world. If we want to get back down to 2%, that’s not going to happen magically. It’s going to take either much more economic weakness than we’ve already seen or significantly more tightening in order to bring it down.

But the important thing is that either one of those options is going to be pretty bad for most portfolios. If there’s still past tightening in the system that is going to slow the economy, that’s going to be pretty bad for equities. And if more tightening is necessary because the economy will prove resilient, but we still need to go and bring inflation down, that tightening to bring inflation down will be a significant negative pressure for all assets.

Then when you look at other economies—I’ll hit quickly on Europe and Japan. The main thing I would say about Europe is that while Europe is clearly seeing a very significant rally as you’ve had an easing in natural gas prices—and that’s great, it is fantastic for them, they didn’t end up having to have nearly the type of stagflation where you have to very literally choose whether to keep your house warm or be able to run a factory in that situation—Europe has still undergone a much more significant competitive shift, a transformation into what that economy’s like, than what we’re seeing in the United States. In other words, yes, natural gas prices aren’t what they were at the peak, but it’s going to be much more expensive to produce in Europe than it was before a few years ago.

So for Europe, just like we saw with Brexit, it’s very hard for policy makers to handle a change externally that makes the economy fundamentally actually less competitive, actually a worse place to go produce things and do business and employ people—very hard to offset that. You’re seeing the difficulties in getting policy makers to get together and put together any kind of joint laws across that whole bloc that offset that in some way and make it more competitive.

They’re dealing with all the same challenges as the US of having to balance growth and inflation in a world that is no longer deflationary, while at the same time having this big competitiveness hit that is real and that they haven’t quite processed yet. “What will we be able to produce in this bloc and how will that work?” And the one thing I think Europeans do realize is they need a tight partnership with the US. That together as sort of a super trading bloc, the US and Europe are much more powerful together than they are apart. They can do rules that will have the whole world have to adhere to them, which is why you’re getting so much emotion about the Inflation Reduction Act and a desire to work together better.

And then Japan is just an outlier relative to a lot of the rich world, because they don’t yet have anything like an inflation problem. They had so many years of easier monetary policy than everybody else, but they realized they can’t think about their monetary policy in isolation because a lot of what makes them easy is what they are relative to other countries. So when you have the type of policy Japan does today, which is “We’ll buy unlimited quantities of bonds at basically zero interest rates; we’ll keep printing money,” it’s very different to have that policy when the whole world has inflation and is tightening relative to when it’s just you.

So what that means is that every day, without doing anything, their policy gets easier and easier on a relative basis. They’re going to have to figure out at what point to start getting out of that, not because conditions are so strong in Japan and they have gangbuster growth and an inflation problem, but because it’s getting to the point where that differential is just getting so large that it’ll build up more problems and more unsustainable situations. They don’t want to create the problems from this policy; the excesses that will be built up are becoming greater as that differential grows.

At the same time, you really see that this isn’t some economy that is dealing with large inflation pressures now. The way they’re starting to extricate themselves from this and planning for getting out is about the easiest way you could do it. In other words, they’re printing unlimited amounts every day and giving them to all the speculators that are betting on a tightening of policy, and all that money they’re printing is going to stay in the system, even when they tighten. They’re probably not going to remove it anytime soon.

So when you’re talking about stepping back and being an investor and thinking about diversification—we’ll hit China next, which is probably the most diversifying—but Japan would be my next location that’s worth looking at that at least conditions are very different and policy makers face a very different set of circumstances about how to handle them than what the US and Europe are like.

Then maybe I’ll say a sentence and hit on the emerging world outside of China, which is that it is really interesting how differently those assets have performed than the heuristic a lot of investors had in mind. I think a lot of investors saw emerging market assets as just a riskier version of what’s in other countries and not that different than just holding a risky stock. And it hasn’t been that way. That’s because those countries have fundamentally changed and have learned a lot from their experiences, and they do have different exposures. A lot of them are more exposed to China today and are really more part of a China bloc than they are exposed to the US and Europe, and policy makers are a lot more aware of inflation, a lot more aware of the trade-offs.

The easiest way to look at it is that, when you had the huge boom you had, the bubbles that are bursting today, when all the money went into crypto and tech stocks and whatnot, it didn’t actually go into emerging markets, which is a classic place it usually does go in bubbles. And so this now looks like a very different asset than it did in the years where it behaved like just the riskiest version of a stock.

Chapter 4: The Importance of China

JIM HASKEL

Then on China, that’s the biggest and last piece of the puzzle, both from a secular and cyclical perspective, I think, because secularly, it’s deeply tied into many of the inflationary trends you’ve mentioned, and cyclically, because we went from this zero-COVID policy that restrained economic activity and had a big impact on the disinflationary pressure in the second half of the year—and then a 180-degree turn and now China is completely open. So how are you thinking about China, both long term and short term, as an investor?

KAREN KARNIOL-TAMBOUR

I think for investors, China is maybe the single most important factor for a lot of decisions they’re going to make, and also the largest source of uncertainty, because there are so many things we don’t know. Let me start with some of the things we do know, which is that the notion that we’re countering China, that China is sort of “the enemy” or the kind of “other” in the West is now very well-established, and that’s having very significant impacts. One is what I talked about before, which is businesses understand there’s an imperative to spend to be less reliant on China, even though that’s difficult and they’re intertwined. They’re having a lot of kind of cognitive dissonance around “How do I do this? Because I’m so deeply intertwined with China.” But there’s no question that we’re getting a multiyear, probably multidecade route here of spending in order to extricate ourselves from China, or have a double-do, or deal with that concern in some way, and that’s a slow-burn inflationary thing.

The second is that we see that legislation is happening that is increasing the role of government in places like the US and Europe that we would never see if there wasn’t a China competitor. The willingness to get government involved—if you look at the US, the CHIPS Act would never have passed; the Inflation Reduction Act wouldn’t have passed, Build Back Better. The whole notion that government needs to be more directly involved, which for many years was a little bit of a bad thing to say because government should get out of the way and let the private sector resolve it—there’s now a sense of, well, if China is going to spend so much money and so directly intervene, we have to be able to counter that, so we have to be able to get in there and actually shape the outcomes that we want. That’s really changing government’s role in the economy, and each one of those legislations has its own implications, but none of it would happen without China in the backdrop as the thing in people’s minds.

Those are the more known pieces. Then there are all the unknown pieces, which are, as an investor, can I actually get diversification by holding Chinese assets? A lot of questions about what it’ll be like to hold assets in China that have to do with legislation and how things play out and whether or not we actually get a cold war or a hot war and what that would be like. And then in the very, very, very short term, China is just such a large, complex economy that is still one of the most difficult ones to understand with a lot of questions of, as we get out of this immediate pop coming out of COVID, where that economy is going to settle, given all of their medium- and long-term challenges and all the goals they’re trying to balance.

JIM HASKEL

That’s exactly what I want to follow up on, Karen, because you recently wrote about China’s cyclical conditions in collaboration with our China team. How is that picture evolving and what does it mean both for China domestically and also for the global economy and global assets?

KAREN KARNIOL-TAMBOUR

Well, from a cyclical perspective, China is obviously in the midst of a very rapid reopening. The pace at which people have been sick with COVID in China is mind-blowing. It’s hard to even really process having that many people get sick so quickly, but it’s letting them come out of it very, very fast because it’s like a wave that’s going to be behind them very, very quickly. So in the first order, watching and understanding as they kind of roar back to life. The second- and third-order implications on global markets—it really affects almost every asset that investors hold because China is just such a big global economy, probably most notably commodity markets, figuring out what parts of spending are coming back. The more travel goes up, Chinese people take planes, drive. It actually affects things as they build things; it affects industrial metals. And you’re also seeing with its closest economies, some of the East Asian economies, they’re more and more influenced by Chinese demand and driven by them. So that’s in the near term what we’re really tracking to see how that very fast cyclical reopening is rippling through the rest of the world to most of the assets that are more commonly held than Chinese assets.

But then once you go a little bit further out, we have real questions, which we’ve also talked about in recent Observations, about how fast Chinese growth can be. We’ve gotten accustomed to what things look like coming out of COVID in places like the US and Europe, where, as we discussed before, a lot of money was printed and literally transferred to people to hold in their hands to spend. So coming out, you had a very, very fast improvement in household balance sheets and this kind of pent-up, not just desire to spend, but money that arrived in people’s pockets to spend and make very strong demand. In China, it’s the opposite. They’re actually still with a very significant debt overhang, they still have a big property bust that they’re going through, and they haven’t really used that mechanism of getting any stimulus to people in some kind of direct way.

So once you get out of that very quick COVID pop, there are a lot of medium-term elements of malaise that are still in the system and need to be worked through. What you’ve really heard from policy makers is that if it was a pretty useful heuristic for the last 20 years to just say “growth is good,” so Chinese policy makers will use everything in their power to just get growth, they’ve changed their mind about that. They realized that the excesses that are being created, that the reason they have a debt overhang today is because of how they produced that growth. They realize the dangers of those excesses. They also realize they have a lot more goals than just growth. They want to be self-sufficient. They want to think about national security. They want to think about what kind of technologies they’re developing in order to compete. So they’re not just going to see it as “growth rate equals good.”

That means that once you go past that immediate pop, you may not see the sort of strong growth and China being a growth engine that we’ve been accustomed to, and that we’re going to have to really carefully watch how policy makers balance such a wide range of goals that they have that they’re trying to bring together into a set of policies that will be coherent. They’ll probably err on different sides at different times, and that’ll probably not add up to very smooth, strong growth, especially given the overhangs that are still there in China.

Chapter 5: The Biggest Mispricings in Markets

JIM HASKEL

OK, so let’s go now from—we’ve gone the high level, we’ve gone down one level to survey the major economies, and now I want to go to the markets and the connection to the markets. When you look at that picture that you just discussed and you also compare that to what the markets are discounting, where do you see the biggest mispricings right now?

KAREN KARNIOL-TAMBOUR

I think the biggest mispricing in markets today is really the combination of markets. It’s not one market that’s mispriced. It’s that the different things that are priced into various markets can’t coexist at the same time. So if you start with equity pricing, equity pricing is more or less that you’re not going to get a very significant slowdown in profits or the economy. Now, you’ve already seen profits starting to turn down, and that hasn’t been extrapolated to say that more is ahead of us. Now, that may be true. That is possible. I think it would be very hard to accomplish because profits are even more sensitive than the economy is, which is why profits have already come down when the economy is still relatively strong, because of the type of environment we had coming out of COVID.

But let’s say that equity pricing is true. In that environment, it then seems almost impossible to imagine that rates pricing could possibly be correct. Because if you have ongoing strong profits and you don’t start getting a reverberation through the economy of slowing labor markets, a slowing economy, why would the Fed possibly turn so quickly and ease for a period of a year or two, starting relatively soon into that environment with the inflation being as it is today? So if you look at the pricing of rates, it’s basically telling you inflation is coming back down to totally normal levels, don’t worry about it, and the Fed’s going to able to start easing for a while relatively soon.

Now, if you take rates pricing, that also could be plausible, but that would be plausible if the economy collapses. If the economy is very, very weak, then it seems pretty plausible that inflation will keep coming down and the Federal Reserve would want to ease into that relatively soon in order not to let the weakness become self-reinforcing. So either one of the markets could really be correct. But the summary of those markets together feels like an implausible scenario, because those actors just won’t behave in those ways in response to the other market’s conditions.

That’s one of the great things about being an investor that can look across all global markets at the same time, which is that you can find mispricings that connect to the overall kind of story that markets are telling you across all the different pricings that exist and be able to say, “If A happens, B can’t happen, and vice versa.”

Chapter 6: Assessing the Currency Markets

JIM HASKEL

One market that you didn’t mention was the currency market, and I do want to turn to that and get your perspective, because that’s an area of interest for a lot of clients for lots of different reasons. The US dollar has come down significantly from its peak in September, but it’s still close to 20-year highs. How are you currently thinking about the US dollar right now, both relative to other developed world currencies and EM currencies as well?

KAREN KARNIOL-TAMBOUR

Well, I think as you’re saying, in the medium term, the US dollar really has a lot of vulnerability at this point, because we’re coming out of a very long period where US assets were so favored by global investors. These were the dominant assets being bought because of what performance was like, and there was such a narrative that only US tech companies are really going to eat the world and where performance is going to be. People are just so over-invested into US assets and the US is overspending; the dollar is strong and other places are extremely cheap. I mean, I was just talking to friends who went to London and said, “I’ve never thought I’d ever think London is cheap. Would you ever believe you’d think London is a cheap city to be in?” And so you’ve really gotten to extremes in terms of anything that you can think of in terms of value, and structurally what you think, over time, the pricing of currencies needs to converge to such that it is similarly competitive to produce in different parts of the world.

That said, in the near term, there could be additional sources of dollar strength because there are a lot of flows that need to go back into the dollar for structural reasons. I’d say this period of currency market volatility has really been, for us, reinforcing of the need to deeply understand who are the different flows in the currency markets. Most people that are buying and selling currencies are doing it for reasons other than the currency; they’re in there for other reasons that drive them to. We talk about this a lot, with of examples of: if you go buy a Toyota, you’re not thinking about betting on how structurally competitive the yen is; you’re just buying a Toyota because you think that’s the most competitive car. Those are the flows that’ll end up eventually making the dollar fall, because structurally it ends up being overvalued. But in the near term, there are a whole lot of investors that have a reason to go back into the dollar as they’re managing risk and rebalancing their portfolios and seeing what’s happened in market action. They could give us another leg up, especially because the recent move down has been so fast and so correlated with market moves that any pause in those other market moves is going to lead to flows the other way.

Of course, when we say the dollar, currencies are always relative, so it’s always a question of relative to what? And so if you just look at the two most significant currency pairs, the yen and the euro, they’ve both had structural reasons for the weakness that have led to where they are.

In Europe, that shift in structural competitiveness is both a good reason through time for Europe to be cheap but also over time needs to be worked through, because that cheapness is what will end up driving flows into Europe and bringing them back to a more normal place.

In Japan, the most important question is how fast will they actually normalize their monetary policy to be a bit closer to what it is in the rest of the world? So Japan’s one of the only economies in the developed world that does not have really an inflation problem. They’re very far from a point where they have to tighten into problematic inflation. That said, every time the rest of the world tightens, they get easier and easier and easier on a relative basis, and that’s what the yen has really reflected through time. So at this point, there’s already some speculation priced into the yen that they’ll normalize at some pace, and how fast they choose to at least exit the extremity of that differential will really be the most important factor for the yen.

Chapter 7: Advice for Investing in the Current Environment

JIM HASKEL

Let’s now turn, Karen, to the other role of our CIOs, which is to help our clients understand their own risk and aid them where they can in terms of advice. It’s a very tricky environment—we talked about this—for everyone to manage portfolios, especially over the medium term, because it seems like the range of outcomes is even bigger and larger than usual. So if I was a client of Bridgewater’s, what are the biggest pieces of advice you would give me on how to think about building a portfolio that has a chance to do reasonably well in this environment and be prepared to survive what seems like pretty significant tail risks? Are there any traps that I should be looking for? How would you advise me?

KAREN KARNIOL-TAMBOUR

Well, I would say a couple of things. I think that this is a really good environment to reassess what liquidity risk means to you. So many portfolios have shifted into illiquid assets and oftentimes without thinking really hard about what kind of liquidity do I really need and how much I’m willing to pay for that liquidity risk—for the fact that these are illiquid assets. This is a good time to reassess, and it does depend on every investor and their circumstances how important that liquidity is to them. But it’s a good environment to remember that you should get paid for the fact that you’re in a much more illiquid asset.

It’s also a good time to reassess what I think has become a little bit of a mantra among a lot of investors that there just is no alpha in public markets, that the reason to be in private markets is that there’s no alpha in public markets, that they’re so well priced. All you need to do is look at the massive shifts that you’ve had in every public asset and realize that the opportunities there are very, very significant for someone who can understand the environment and that you’re going to get winners and losers, and this is not a type of market where no alpha is available. It’s just a matter of being able to harvest understanding what are the forces that are available there.

Third, I think that diversification has gotten a lot more challenging, which is part of why thinking about where you’re getting your alpha, what you’re being paid for liquidity premium, and where alpha is available is so important. Diversification has definitely gotten more challenging. China, probably the biggest source of diversification, has become more difficult for people because of geopolitical concerns, and honestly, political concerns on investors themselves of where they want to be invested and what their stakeholders want to do in terms of managing that. Then the other most basic form of diversification that existed was there was an assumption that bonds and stocks are diversifying because every time the economy falls, bonds are going to rally. That is just not nearly as true in an environment of volatile inflation, where inflation is significant and it hits both stocks and bonds at the same time.

So without as many opportunities for diversification, that means that any opportunity you do have for diversification needs to be harvested much more significantly. You have to be a lot more serious about thinking, “What do I have that protects me against inflation? What do I have that gives me any geographic diversification?” and lean into that, because you know that opportunities for it are just less than they were before.

Finally, as I was saying before, you don’t have to fully buy in that what I’m saying is correct—that there is a chance that market pricing is off and you could get either stickier-than-expected inflation or weaker-than-expected growth. I’m saying one of those things is very likely, but all you have to believe is that those scenarios have some likelihood of happening to then look at your portfolio and realize that most portfolios, if either one of those scenarios pans out, don’t have a lot of protection against either one of them. So thinking very hard about if there is some probability—you can put your number on it, maybe you think it’s a lot lower than the one that I believe—but put your number on that probability and say, “What is my protection if I actually end up with inflation being a lot stickier than expected or growth being a lot weaker than expected?” There are probably very few assets in most investor portfolios that can do that, which is why it’s a real time to lean into those and think about how do you increase those to match roughly the proportion that you think that that probability is likely to transpire.

JIM HASKEL

Great. Well, Karen, thank you so much for your time, and we look forward to talking to you regularly and certainly in the not-too-distant future.

KAREN KARNIOL-TAMBOUR

Thank you so much.

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