Under the AI frenzy, Dalio began to hint about long-term risks
Author: Ray Dalio
Compiled by Deep Wave TechFlow
Original title: Dalio's latest warning: Don't be carried away by AI. The actual return on US stocks may reach -5% to -10% in the next 5-10 years
Guide: Qiaoshui founder Ray Dalio posted an investment note on X to settle accounts for the current market dominated by AI giants. His judgment is tough: high risk is a fact, low return is an opinion — the actual return on US stocks is likely to fall between -5% and -10% in the next 5 to 10 years. He's not advising you not to buy AI; he advises you not to bet all your chips on AI. This is the “Holy Grail of Investing,” which he summed up after more than 50 years of work, and now he's speaking publicly to everyone.
Investment principles: How should you play this deck of cards now
This note talks about how to invest in this game and play in the current situation.
You can think of it as bridge, poker, backgammon, or chess. It's your turn to take action. There is a computer next to help you judge the situation and give suggestions. To me, investing is what it feels like. Whether you have this computer at hand or not, I think you should ask yourself the question: how should I go about this step when the card is placed like this (in other words, what are the characteristics of the market and what forces are influencing it).
I've been playing this game for a long time. At this stage, my goal is to pass on my style of play, and to go one step further, to create a platform where all kinds of people can use it to explore and invest in this matter, whatever they want — learn and review how they would do it in the first place and do it well. I believe there is a right or wrong way to handle this deck of cards in hand. So when you're in a specific situation, you should ask yourself, “How can I bet in this situation?” Also, you need to be able to give reliable answers.
Next, I'd like to talk about what the market looks like now in my opinion, and what I think I should do (and I'm doing).
How to play this game now
What are some of the most critical conditions today, and how can I bet on them?
In my opinion — and probably everyone else too — we are now in a market where very few companies are concentrated in a sector with amazing new technology (mostly AI), dominating the overall trend of the market. These companies account for a high proportion of market capitalization and have a huge impact on the market and economy. It's the same every time this happens. There is a lot of excitement, uncertainty, and fluctuation in the new technology sector, and these feelings are transmitted to global stock markets. Therefore, the ups and downs and uncertainties of this sector are very important.
In addition to this, there are several other equally important variables, which are what I call the “five forces”: one is what is happening with debt and money, two is what is happening with political and social issues (these will greatly affect taxes and other politically-driven market factors), three is the impact of geopolitics on the market (such as those wars), four is what is happening in nature, and five is what is happening with new technology. I input these conditions into my investment system, and it calculates how to bet on these conditions, and at the same time, I myself am wondering what to bet on.
When considering how to bet, the most important question to ask and answer clearly is: do you want a) to bet more heavily on new technology than the market index (such as the S&P 500) already implied, to surpass this sector or the companies you think are the best; b) maintain weight about the same as the index; or c) be scattered from this concentration?
Almost everyone wants to buy the best assets, and they're doing it desperately, and this new technology seems to be changing almost everything. But history tells us that at this stage of the cycle, betting a high percentage of their chips on the few leading companies that produce this technology has failed the vast majority of people. There is logic behind this; in the past, it was always staged like this. The new AI technology is truly unique, but there have also been many new technologies in history that are unique and can be compared. You should check them out. If you choose to ignore them, then you have to give a good reason why this time isn't the case.
The risk is really high
All the stories of great new technology in the past have been played out in the same way and with the same logic. High risk and huge uncertainty are inherent attributes of these new technology companies. Looking back at their performance in a similar situation, you'll find that even the revolutionary companies that eventually won in the long run (such as Microsoft and Apple) were beaten at similar moments along the way. Also, at the moment when new technology companies are just starting out (not looking back after the fact), it's not easy at all to determine who will succeed or who will lose; IBM is an example. If you unpack all of these cases, you'll understand that the future of new technology companies is highly uncertain; this is their nature.
For example, they either cast too much or too little. The reason is that if they don't invest enough, they will definitely lose, yet they can't accurately predict the future, so they can't know if they've thrown too much. Pitching more and less comes at a cost.
Nor can they accurately predict all the changes that will affect them, including those exogenous — monetary tightening, wars, tax upheavals. Therefore, they all experience ups and downs, first making investors excited, then scaring the timid to death and washing them out. As a result, market fluctuations are amplified. Going one step deeper: These new technologies and new companies disrupted their predecessors back then. Eventually, most of them will also be disrupted by newer technology and newer companies, and in ways that are simply unimaginable now. We have to consider whether the same thing will happen to these companies today. The influence of quantum computation is considered one of the “known things”. What about those that haven't been imagined yet?
What about the risks posed by competitors? For example, China is producing and distributing AI technology, and Chinese policymakers have completely different views on the economy and AI. We are in a war of new technologies, and the leaders of all countries believe they must win. From a Chinese perspective, AI should be provided free of charge or at a low price because it has huge productivity dividends and can raise the overall standard of living. In their opinion, profit is not that important; what matters is the overall benefits brought by many people using these new technologies. I think they will compete in the international market just like in products such as automobiles, solar panels, and batteries.
The current situation is very similar to many moments in history that can teach us lessons. I can't help but think of the late Dutch Empire and the early days of the British Empire, where Britain surpassed the Netherlands in shipbuilding and other important industries. There is also the geopolitical conflict surrounding Taiwan. This should at least make us think of one possibility: whether China will use “not allowing chips to be shipped out of Taiwan” as a tool in a geopolitical game. There are other risks to AI stocks, such as the risk of rising wealth taxes and other taxes — this will force those who bet large amounts of their wealth on these stocks to sell; another example is rising anti-AI sentiment, which may limit the company's expansion.
I can also give you a bunch of things to worry about, and I can also give you an equally long list of great AI opportunities I'd like to bet on. I'm not saying how these risks will end up, or that you shouldn't buy an AI company. I'm just saying that there is a huge risk of concentration in the market, which is undisputed, and you should know how to fight this situation. Starting from my research on all similar cases, and out of logic, I'm confident: the risk is very high, and the best way to deal with this situation is to:
Good dispersion
As you probably know, my motto is diversification, and my “holy grail of investing” is to try to hold 15 unrelated, risk-balanced positions. Put another way:
“A well-distributed combination of good bets will outperform a concentrated bet (it has a higher reward-to-risk ratio and can engineer better returns under the same risk). The more risk is concentrated in one segment of the market, the more diversified you should be, especially when the market is driven by a revolutionary new technology that naturally brings great uncertainty.”
It's not an opinion; it's mathematical certainty. For example, let's say a bet has a return to risk ratio of 0.3 (say, return of 6% to standard deviation of 18%, which is generally considered the level of a stock), then compare holding 5, 10, and 15 unrelated bets: I can get the same 6% return, but the risk measured using the standard deviation is reduced to 8%, 6%, and 5%, respectively. In other words, 15 good unrelated investments would increase my return to risk ratio by 4.3 times (from 0.3 to 1.29). If you want, you can also add leverage to get much higher returns at the same risk. This is a fact.
The reason I am confident is that I rely on backtesting, the actual returns I have given over my 50-year investment career, and the logic of probability: if I spread my bets well and then adjust them to the level of volatility I want, the long-term returns will be far better than the kind of centralized betting that most investors prefer. More specifically, with good diversification, you can get a better risk-benefit ratio than any concentrated bet; then adjust it to the level of risk you want, and you can get a higher return under that risk than any other approach.
Because I made this set of methods public, it has now become my “no longer so secret” method of success. But I rarely meet people who think about investment strategies in this way — in other words, very few people would think of a combination to construct this matter, and think of a well-structured and fully distributed bet mix. Compared to placing a single bet on a concentrated position on a few stocks in a major transformative industry, the performance would be worse. Most people only think about these stocks, whether the industry will rise, and how to bet on them. There is a huge performance gap between those who want to build a combination and those who don't. I'll look for an opportunity to talk more fully about how to make this set.
Based on the above, in my opinion, thinking about how to play the deck in front of me should make people ask themselves: How big should my concentrated positions be, and then spread out.
The returns seem very low
The high risk is an indisputable fact. Next, I'm going to give you an opinion; it may be wrong: the expected return is very low. This judgment comes from my valuation analysis and my bubble indicator readings — the actual return on stocks over the next 5 to 10 years seems to be around -5% to -10%, but there is quite a bit of uncertainty around these numbers. In my opinion, these stocks are long-standing assets and are very risky because it is difficult to reliably see the distant future, and they seem expensive and not in firm hands.
A question from my research team
At a recent meeting, someone on the team asked me: Why do you think the current market configuration is wrong? How do you know that the lack of diversification in today's market is not a good reason — for example, some investors think that the expected return on AI stocks will be very high. For example, when an industry accounts for such a high share of market capitalization, it is natural for this kind of concentration to appear in the index, or when people are extremely passionate about an industry, many investors will buy these stocks without smartly and reliably calculating how much future profits will be and how these profits should be priced?
My answer
Prices are rising for a variety of reasons, not all of which are good reasons. Some investors will keep an eye on the price and push the price upward because they find it attractive compared to the fundamental price; some hold these stocks because they believe it is a great new technology and see the rise in stock prices as confirmation that “this is a good stock”; others have index exposure and passively put a lot of weight on these stocks. In my opinion, you can wrestle with these questions and try to figure out what you want to do; you can also admit that you don't need to get tangled up at all because you just don't have enough information to bet confidently. You could just say, “I don't know enough to bet on this.” Then it really didn't go down.
It is the idea that “I must form an opinion, and my opinion is worth some money,” but the reality is more likely that you simply cannot form an opinion that is reliable enough to be worth betting on. (Note: To be clear, I'm not suggesting that you don't bet — and you can't avoid betting, because you always have to put money into some kind of investment or cash, and most people think that cash risk is the lowest; it's actually the worst long-term investment. What I suggest is that even if you don't have any tactical judgment about which market is good and which is bad, you should know how to spread your bets well. The approach is to have a balanced, strategic asset allocation portfolio when you don't have any confident tactical judgment. (But that's something we'll talk about later.)
So I believe knowing what you don't know and deciding when not to bet is just as important as knowing what you know so you can place a bet.
To put it more simply, I believe in this principle: since it's usually difficult to have enough information to focus on betting with justification, the best course of action is to only form a scattered combination of the bets you are most confident in and unrelated, and then engineer this combination to the desired level of risk. This is my “holy grail of investing.”
At the moment, in the face of the deck of cards in front of me, I don't think anyone can clearly understand what will happen next in this technology-driven market, so clear that one can place a big, focused bet. In my opinion, avoiding concentration and staying scattered is the best way to deal with this kind of “ignorance.” I know this is contrary to the theory you read in your textbook — the textbook basically says that the market works, so you “just trust the market.”
To sum it up: We now have an unusually concentrated market around a revolutionary new technology, which should just remind us not to confuse excitement about new technology with the appeal of new technology stocks, and then leave caution behind and hold a bunch of high-risk, high-correlation concentrated bets — especially if we could have reaped the same attractive returns at a much lower risk through clever diversification.
Note: I won't share my positions or tactical judgments with you because I don't want to be your investment advisor. But I'll soon share some of the key perspectives behind these judgments, including my bubble indicator readings and the logic behind them.
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