After speaking on a panel at the World Economic Forum in Davos, Ray Dalio joined the folks at CNBC this morning. In his interview, he explained where things stand in the global economy right now, and how investors should act accordingly.
Dalio is the head of Bridgewater Associates, the world's largest hedge fund with $150 billion assets under management.
He's known for his deep understanding of market cycles. Last year, Dalio released a video how the world's money machine works. It's a machine in which the use of either credit or money and the generation of debt creates different market cycles — recessions, depressions, boom years etc.
"I think we go so quickly thinking 'where does the economy go next' instead of thinking how it works," he told the Squawk crew.
So here's today's engineering lesson — some of which he talked about on his panel — it's about the United States, Southern Europe, China and you (the investor).
Dalio said that the US right now is in the middle of a post-recession short term debt cycle where assets will return about 4%. He calls this, "the boring years," and compared it to the economy in 2004 or 2006. We won't boom, we won't bust.
Southern Europe, on the other hand, is still struggling out of a nasty debt bubble — with debt rising faster than income — but unlike the United States, the region couldn't print money to inflate itself out of trouble. No one would fund Southern Europe's debt.
But still, that debt must be rolled over. To do that, Southern Europe's economy will remain depressed for quite a while — a very different position in the cycle from the U.S.
Then there's China, which Dalio said is going through a much-needed tightening of monetary policy. The country's break-neck growth speed is slowing. Sunday its Q4 GDP number came in at 7.7%. That's a slow down from the same quarter the year before when the number came in at 7.8%. Economists expect full year growth to come in at its lowest number since 1990 at 7.4%.
China's President, X Jinping, expected this slowing. In fact, instead of slowing, it's more of an attempt at normalization.
The problem is that getting things to normal will be bumpy, if it's achievable at all. As China tries to find balance in its economy the tightening can get too tight — as in, there isn't enough money floating around the economy to keep money flowing freely. Consumers can't do it with their purchasing power alone.
That's when the government steps in and injects money into the system again. It's a tough place to be in because the government doesn't want the economy to freeze, and Dalio believes it's a bubble.
We've already seen that happen this week. On Tuesday the Chinese government injected some cash into the banking system ahead of the Lunar New Year. It's a time of year when businesses pay a lot of Chinese migrant workers their yearly wages, people buy presents for each etc. The entire country needs cash.
While doing this, the government also announced that smaller loans would be written off bank balance sheets. That's not tightening, but it is the country trying to find a balance between keeping money flowing through its economy and not drowning in cheap money as it tries to mature.
And "balance" leads us to what Dalio talked about next — how to build a solid portfolio in our interconnected world. How do you invest in this environment?
China's tightening, the U.S. is growing slowly, Southern Europe's depressed — we're in a world where people want to buy financial assets. It's a hunt for returns. There's a lot of demand for cash.
At the same time, Dalio pointed out, longer term debt and liabilities are eating money.
"If I could say one thing to your investors, it's try to achieve balance," he said.
As an investor you need to diversify your portfolio and understand that in the type of world we're living in, your returns are going to look like this: 1% on cash, 3% on bonds, 4% on equities.
It's a low yield world, and you should plan accordingly.