GIC and Bridgewater Identify the Major Issues Facing Investors in the Years Ahead

I'm Jim hasell editor of the Bridgewater daily observations and today I'm coming to you from Singapore uh where we are celebrating the 30th anniversary of a very special partnership between Bridgewater and GIC The Entity that is responsible for managing Singapore's International reserves as part of this Milestone Bridgewater and GIC have engaged in a series of of research projects to identify and assess the issues that we think are most important for investors to be grappling with in the years ahead in fact today we'll be sitting down the two organizations for the entire day reviewing the findings uh from that work but we also thought it would be a great opportunity to do a video cast and share some of those highlights with all of you and so joining me today from GIC is group CIO Jeffrey Jane subbage or otherwise known as Jeffrey J as well as the CIO for fixed income and multi-asset Leu Zumi and from Bridgewater coci Greg Jensen so I want to welcome all of you thanks you our conversation today will focus on four major areas three of which are in our joint research projects they include number one US exceptionalism uh it's been a driving force in markets so what produced that where are we today and given the pricing where are we likely to go in the future the second will focus on artificial intelligence or Ai and its impact on markets and economies uh the third will examine China and the deflation that's emanating from China and look at the implications of that for investors and the fourth is because we have Zumi here and even though we didn't focus on sustainability in the joint research projects we easily could have and so we want to ask her uh given her role as chair of GI sustainability committee about the sustainable investing movement and where we are and where we're likely to go so with that let's get right into it I want to start on the question of us exceptionalism this was an area that both organizations identified as a key issue uh for investors in the years ahead and something to Grapple with and Jeffrey I want to turn to you first because um the question is what produced this us exceptionalism where are we today and do you believe it will continue and I say that because so much of global portfolios are in the US so that if it doesn't continue that's a really big implication for markets and economies and so on uh thanks Jim I think um we should separate out economic performance versus markets performance so US economic performance has been really good exceptional but it's us asset performance that has been truly exceptional and particularly you know compared with everything else that in dollar terms it has been truly exceptional so I think we should break break these two up because I think the the economic factors are ones that probably are structural and don't change uh the US has um you know by resources and by size of of the the land mass and population actually has a huge um addressable Market just just domestically and so companies uh and and businesses that grow in the US actually can grow to a huge size achieve great economies of scale just in the domestic Market without having to do anything internationally the US has um by tradition um also been a land of uh immigrants which has brought in uh you know kind of a diverse population with its ability to create diverse new ideas and and innovate and that's definitely part of the US exceptionalism that has translated into the economic performance um through time as well and I think uh on top of that um the system of government policym with its good checks and balances with its responsiveness I think to to you know the the population to democratic uh calls for for policy changes um the policy response has also been very reactive to to what what are changing needs uh as the economy has grown and developed and and restructured through through the years I think all of those remain and it's it's definitely one of the you know some of the key reasons why the US has uh perform so well uh economically um there are however some other things that have really helped um us assets uh in in the last few years um some of those things are are shared with other countries as well so what what are those um first is that interest rates have been falling for a long time and that's been uh you know kind of a a big Tailwind um that that doesn't differentiate the US necessarily U taxes have been falling also um for for quite a while and that that has been um shared by some of the other countries but not necessarily by all but that's a good Tailwind also for the earnings growth uh that companies and assets uh get to see and then the the additional things are that um Us's Innovation um in the last 10 years particularly has been in areas where um there are economies of scale and scope or network externalities that uh us companies because they were the first develop some of these were able to take um market share not only uh within let's say the technology sector but also uh taking market share from retail from advertising that otherwise would have gone uh you know to both domestic and foreign competitors so I think the question uh for us as as investors is to ask you know are these things that can continue going forward but maybe I'll come to the the last uh two two thoughts that I have on that which is that some of that exceptionalism um is also cyclical so one of the things that that our joint research has shown is that uh valuations in the US have really grown well beyond those uh uh of other countries and well beyond um the fundamentals the earnings growth and and and so on and today us companies not only have earnings growth uh expectations that are well in excess of history but well in excess of what other countries uh earnings growth have as well but in addition to that there's still additional valuation Premier that is given to the US which you know is measured by the the the risk Premier if you will on top of everything that that um has been priced in in terms of growth these things historically have been quite cyclical and so so you know um it would not be surprising to see some of the exceptional performance on the asset price uh level actually erode over the next uh decade or so and you know we're we're always told that if if something you know achieves a market concentration as the US market is in the msci world of 70% you know either competition or other cyclical factors will come in and and you know kind of turn that around and and I think we have to watch for that the other piece of exceptionalism really is around the dollar and the the strengthening of the dollar um in in some sense works with asset prices to self-reinforce flows coming into to the US and as as asset prices have done well more foreign flows come in uh domestic investors kind of return to to the Home Market and the dollar uh uh increases in value foreigners and and and domestics alike find that oh you know it allows uh dollar dollar measured performance to be even better or or you know if you invest in the US Yen Yen measured uh uh performance is even better and that that increases flows increases valuation increases performance um when that reverses unfortunately all of it reverses uh uh together as well so I think those are uh you know there are true fundamental exceptionalism that that we see U Market exceptionalism but there are some cyclical stuff um that I think could reverse great well Jeffrey shared so much and we largely see it similarly but just to add a little bit so when we when we did the the research with GIC you could start the clock in a lot of different is but I I think it's interesting to talk about the last 15 years because you entered in 2009 coming out of the financial crisis the markets weren't expecting the US to particularly outperform if you looked at expected earnings growth in Europe versus the US Etc they were about the same China if anything was priced to be exceptional um and and that period since 2009 has been this period of incredible exceptionalism both in growth although even more so as Jeffrey said in markets that's kind of the backdrop now you pull that forward and you've got exactly uh as Jeffrey said now you've got this fully priced in and actually the market is pricing in the next decade for us companies to be better than the last 15 last 15 years of exceptionalism was bigger than any other period in history over that time frame and to expect that to continue is at an extremely high hurdle so you started in 2009 with no hurdle us companies outperforming as they did was a huge shock to markets in a sense that played out in the pricing now you have to outperform to get the same thing in pricing you'd have to outperform by double because what was that that outperformance was already is already priced in that's hard to do and as you said when you think about what it means to have 70% of the equity Market in the world in US equities that means 70% of the money going into Equity markets has to go into Equity into US equities now that could come from BuyBacks that could come from the profits so there's real there reason to believe that's not impossible possible but it does mean that essentially to keep that up 70% of the money has to keep going in and for the if they go to 75 then 75% and you do know there's a cap 100 I believe um and so there's a there's a limit on that on that side to some degree so those are issues and the dollar similarly the dollar benefits these things are intertwined the dollar benefits from the equity Market because Global Equity flows mostly people go into the Benchmark 70% of their dollars go into the US that helps sustain a relatively big current account deficit you take that and the desire essentially in the world to borrow in dollars to hold dollars because essentially it's the debt of the of the you know it's what you need to save in to be able to pay your debts in the world so you have that at a very high level and you're seeing it the US suffers from you know we call it a Dutch disease but because technology is so concentrated in the US and so much strength and that recycles this money the rest of the industries in the US can't really compete on the global stage so the US is also very concentrated in terms of global corporations where they can where they where we really have an edge because the dollar is so high it's hard in other areas um to compete so those are are challenges going forward where what you really need to reconcile the pricing in the US is you need another you need a compounding of the productivity difference right and it's possible one of the benefits us companies have is there profit margins those profit margins so if you if you take the equity outperformance revenue um outperformed the rest of the world that was about a third of the outperformance margins outperformed that's another third two thirds are revenues and and profit margins and the final third was valuations right so basically if you stack up how how equities outperformed in the US it was a equal blend of more revenues because they out competed better margins um which has to do with the nature of the companies the productivity of those companies but also a shift in the power between corporations and labor and a shift in taxes and then the final um the final thing is is what Jeffrey described is cyclical the the valuation difference which just makes the hurdle it's p to the extent it's right it's pulled the returns forward like you've already got the returns the next decade if the US continues to exceed already in the price so that sets us up for a much more difficult decade particularly in asset markets for the us because the hurdle is so incredibly High Zumi let me bring you in here uh now because we've we've heard Jeffrey we've heard Greg talk about us exceptionalism and what they're really outlining is that the underlying fundamentals are there but the pricing is going to make it very difficult to replicate this you know for the next decade as we've seen in the last decade uh in terms of financial market returns but I there's an increasing question about a potential left tail outcome related to fiscal sustainability and if we walk back in time time we know that the US was highly highly indebted mostly in the private sector in the 2000 the early 2000s and of course we had the global financial crisis and since that time because of a mix of of policies we've gotten a huge transfer from the private sector to the public sector so such that today the private sector looks relatively healthy and if you look at the government debt particular the United States that's at all-time highs so I'm wondering how you think about that in terms of the sustainability of that and whether as a an investor you know you worry about a left tail type of outcome that would sort of change this Dynamic of us exceptionalism definitely I mean fiscal sustainability is a key concern uh for the US and frankly for some other countries too in the world and you look at the level of deficit we have today um and the fact that if you look at the items and the spending a lot of it is going to be Bak in the kick in terms of not having enough flexibility for any governments that come in to change that so you are almost looking at a level of De deficit that was sustained for a period of time so the question is what other politicians going to do in order to address this longer term concern on fiscal sustainability um now obviously there are different issues here I think one is a Time Horizon issue today the r minus G in the US is still negative so it's not like an imminent problem but at some point they will get to a Tipping Point so that's one I think two is also on a relative basis if you look at the US state of the fiscal sustainability but if you compare that to other countries it may look like that actually it is not as bad as some of the countries in terms of the urgency of the issue and then third of course if you're looking at um uh uh an easing cycle that's coming up you do have the ability for the US to then issue bonds at a lower cost and maybe lengthen duration as well so these are some of the tools and levers that at you know which the politicians the government we'll need to think about in order to manage it for the longer term but certainly we believe that the term premium for long end of the US bonds will need to go up to reflect that uncertainties around this go sustainability and around the issuance and Supply uh concern for a long end as well so the second topic we want to focus in is the artificial intelligence Revolution Ai and here we've had rapid advancements in capability and a lot of excitement about the potential for this technology also some worries about constraints and things of that nature we've had major outperformance in AI themed stocks uh within the US Stock Market and then leading the US Stock Market relative to other stock markets uh in the world and so um is AI already impacting the real economy or um should we expect that it soon will be and how do we see the Arc of its of its development and Greg I want to start here with you you are spending a lot of time on this subject and directly involved in many ways with this how do you see the Arc of AI and the impact will'll have on markets and economies yeah it's it's a issue that I think is hugely important to get your hands around and I've been thinking about it for a very long time if you take AI in its current form machine learning like prior to that let's say even coming to Bridgewater one of the reasons I was excited to come to Bridgewater was I love the idea of building systems and taking human intuition and programming that that into code which was obviously how bridgew is a big part of compounding our understanding over 45 years around 2012 I started getting super interested in this topic of when will machine learning actually be useful in the creative process and I believe around 2022 the end 2022 I I thought the components had come together enough that machine learning could take the next leap in the world and that's when we set up I laabs at Bridgewater to take the stuff we had been working on in the small ways of machine learning but to have 25 people fully focused on this which gives us two windows into this right window as Chief investment officer looking down at saying what's the productivity impact how much investment there's going to be all of those things and then having our hands dirty trying to build out machine learning to essentially determine what's next in the economy and what's next in markets and you know from both of those windows I think the the bubbles ahead of us not behind us I know it seems like there's been a lot of priced in and there's a lot of euphoria around a lot of these things but the the to me the pieces are coming together in such a way that you can actually get higher quality decision- making and that that's starting to happen and that the people that are closest to it are investing massively and recognize it for the the risk that it is to them if they don't stay ahead if you take a Google or whatever if you don't stay ahead in AI you're you're done for in that's really right now only across a few companies that feel that way I think as you go forward like what the future will look like is many companies across many sectors will feel if they don't do that they will fall behind and that will radically change the um the investment thinking right and that people will pour money into how to replace their workers with AI agents and how to become super tremendously more productive down that path so I think that we're only the real early stages of this and it's a little bit there's a ton of stuff going on that's a little bit hidden because everybody's kind of looking at the language models and everybody knows their thoughts on chat te and it does this dumb thing or whatever and um missing actually the or not necessarily I mean some people are not missing this but the impact it's having on physical sciences the impact that's going to have on healthc Care on vaccines on um those those things if um are moving incredibly quickly and so you look at where we are just over the last three years in terms of the impact that growth rate is massive so I those are my kind of my big picture thoughts now you could easily have an 18-month stumble along the way and and the biggest problems I see are that a it's easier to do destruction than production and that there's a lot of the AI stuff that can be used for destructiveness and I wouldn't be surprised at all there's a massive regulatory R doj there's these investig ations and there these things it's going to be very hard I mean we talked about us exceptionalism and it's not clear how tolerant the rest of the world is going to be the US corporates taking another leg of share via AI so it's very likely there will be reactions in other countries the regulations will be different across countries about where you can and can't use it so that's how I I kind of see it at this at this point as we turn back to the US pricing the only way the US pricing can make sense I think in the end is that you get a productivity Miracle about twice the size of what you had in the last decade and um and that's possible I do think the fuel is there the ability to make higher quality decisions in at scale is huge I think the power that is about to be Unleashed in the world which is has many productivity possible benefits and a lot of things to worry about as you go through it because I think there will be lots of Vin along the way so that's kind my my view of where it'll go Jeffrey there's a lot to digest there from what Greg said how are you seen um the AI Arc and uh in your position as group CIO at at GIC and um how is it affecting the decision- making here at at GIC sure yeah I think uh you know in in many ways I I agree with Greg that um the future uh impact um the future adoption and and use um will will be great because the the potential to to you kind of uh improve your processes out earn uh what what you're doing today uh and out compete um will be huge and and everybody will will eventually kind of need to need to adopt it um but I think you know Greg's example of of what Bridgewater is doing uh itself um is illustrative of of I think many of the issues that as an investor in in this this and you know we we you we have to think about right so um today um what you have let's say in in the large language models and there are you know three to seven relevant ones and and so on um uh are tools that are being built that require a massive amount of investment investment to learn to to to train the models and and so on and it's already pulling in a lot of capex um you know whether it's it's uh buying of Nvidia chips to allow the models to learn the data centers that that need are needed to house them the energy that that's uh required to to power it the next question is can these General models actually be used uh by themselves to improve productivity can they just be adopted and and and adjusted actually they can't so I think unlike um you know search models or or you know social social media where the consumer or the company can just Port it into the company and immediately you know how to use it right um to be able to use large language models for the business applications that you want as opposed to you know asking them to write you a trip itinerary of Croatia or whatever um requires an ability of the company to uh adapt those models for its use and if you know if they're used quantitatively um those models by themselves are not good at hand handling numbers and math and and and mathematical Concepts so you need some knowhow and ability to to to then convert that into the need the needs that you need for you you want to fulfill for your own company and so I think the next um stage of investment you know apart from these kind of uh purveyors of picks and shovels will be what other companies that can differentiate themselves by being able to use uh the large language models and apply them specifically for for their their their company's use even better use proprietary data to to to Really enhance the the the Competitive Edge that they get out of that so so I think what we will see is that there will be a stock differentiation between the companies that have that DNA have already been been using it and and will will differentiate themselves positively with all the others who who won't and who will struggle because talent to to hire in to do this is is very scarce will struggle maybe for years um to be able to to to do that so I think I think from a Investor's point of view you know we have to look for that differentiation so you know every every legal firm potentially could replace a lot of kind of uh uh Associates you know with with AI those that can can use it well you know will initially be be relatively few unless and this is the second Point unless we see a proliferation of companies that adapt the large language models for the industry users that could really take advantage of this Zumi let me turn to you on the question of China which is the third big topic that our two organizations uh put a you know have done research on and and that is basically China was the success story of the global economy for many many years uh and the growth rate was very high there was lot of urbanization all that was a positive story and then in the last few years what we've seen uh after a period of you know overinvestment and high Leverage is now stagnation and in fact even more pernicious deflation that's emerging from uh the Chinese economy so I want you if you would to start in and just tell us what the arc is of China where are we where are we likely to go uh is this going to be a worry for investors looking into the future um maybe let's take a step back and look at perspective from history China enjoyed very exceptional period of growth rate on average about 10. 4% between year 2000 and 2010 uh in part thanks to um this really fast and strong exports market share gain especially post WTO entry in 2001 but also because of very favorable um demographic um you know profile as well as fast Urban ization but then the decade after that and maybe just before um covid you see that growth has also moderated but it's still very impressive at 7. 3% on average between 2011 and 2019 and thanks to the three traditional growth engine so this would be exports um Investments and consumption but also like you said Rising leverage so this rapid rise in leverage really increases the vulnerability for Chinese economy so when it comes to um Co when Co hit in 2020 we see quite a remarkable adjustment to um Chinese growth rate to now 4.

7% between 2020 and 2023 now there are obviously a range of Confluence of factors at play here some cyclical some structural but both sets of drivers are really acting in the same direction at the same time on the Chinese economy so let's start with the circal factors one is um this postco recovery has been quite subdued so that has knock on impact on um confidence business confidence um but also on job availability as well as wage growth um so year to date till July we have seen that personal income tax has uh declined by 5. 5% and that is after a minus 1% year onye in 2023 and based on the latest statistics that we saw average wage growth in 38 major cities in China has decelerated from 2 2% in q1 this year to now.