Dalio's Major Article: How to Position in the Current Market Environment?

This article aims to explore: How should you play your hand in the current investment game?

Imagine you're playing a game of bridge, poker, chess, or Go, and when it's your turn to move, a computer beside you assesses the situation and gives suggestions. In my view, investing is exactly like that—whether you use a computer as an aid or not, you should proceed this way: based on the current state of the "board," ask yourself what your next move should be. In other words, you need to act based on the existing characteristics of the market and the various forces influencing it.

I have been playing this investment game for many years. At this stage, my goal is not only to share how I play my hand but, more importantly, to build a platform where everyone can explore the path of investing according to their own wishes, learn from it, backtest past performance, and truly master this art. I believe that for a given hand, there are right and wrong ways to play. Therefore, when encountering a situation like XYZ, you should ask yourself, "How should I bet in this scenario?" and be able to provide a good answer.

Now, I want to share with you my views on the current market characteristics, what I think should be done, and what I am actually doing.

How to Respond to the Current Environment

What are the most important environmental factors now? How should one bet under these factors?

In my view (and perhaps in the view of many), we are in an industry cycle driven by a major new technology—primarily artificial intelligence—with only a few companies dominating market trends. These companies account for an extremely high proportion of the total market capitalization and have a huge impact on the market and the economy. All such periods share a common theme: there is significant excitement, uncertainty, and volatility surrounding the new technology industry, which transmits to global stock markets through this industry. Therefore, the volatility and uncertainty surrounding this industry are crucial.

Furthermore, there are uncertainties brought by other major drivers. I call them the "Five Big Forces":

• The state of debt and money;

• Political and social issues (which may significantly impact market factors like taxation);

• How geopolitical factors (such as wars) affect the market;

• Natural forces;

• The development of new technologies.

I would input these conditions into my investment system to consider how to bet in such an environment, while also thinking independently about where to place specific bets.

When considering how to respond to this environment, the most important question is: What choice do you really want to make?

• (a) Make a concentrated bet on new technology, over-weight this emerging industry or its top few companies, compared to a broad-based index like the S&P 500;

• (b) Keep exposure roughly at the index weight;

• (c) Diversify away from such concentration.

Almost everyone wants to find the best investment and is willing to work hard for it. Right now, a new technology seems to be changing everything. However, history shows that at this stage of such a cycle, most people fail because they put most of their chips on the stocks of a few leading technology companies. There is a logic behind this, and it has consistently evolved this way in the past. Although this AI technology is indeed unique, there have been many similarly "unique" new technologies in history that can serve as analogies and references. People should study these cases; if they choose to ignore them, they must be able to explain well why this time is different.

The Risk is Undoubtedly High

All past major new technology cases have shown similar evolutionary trajectories due to the same logical reasons. High risk and great uncertainty are inherent characteristics of these new technology companies. Looking back at the performance of such companies in similar historical environments, even the most revolutionary new technology companies that prospered in the long run, like Microsoft and Apple, suffered significant setbacks at similar stages of development. Moreover, in the early stages of these new technology companies, it's not easy to tell which ones will succeed and which will fail (think of IBM). If you look at all these cases, you'll find that major new technology companies inherently have highly uncertain futures.

For example, they either over-invest or under-invest. The reason is: if they under-invest and fail to win the competition, they are doomed to fail; but they also cannot accurately predict the future to judge if they are over-investing. Both over-investment and under-investment carry high costs.

Furthermore, they cannot accurately foresee all changes, including external shocks such as monetary tightening, wars, major tax adjustments, etc. Therefore, they all experience sharp up-and-down cycles: first exciting investors, then making them fearful and washing out weak-handed investors, ultimately leading to exaggerated market swings. Moreover, just as these new technologies and companies disrupted their predecessors, most of them will eventually be disrupted by newer technologies and companies in ways we cannot imagine in advance. Therefore, we should also consider whether the current new technology and tech companies face the same risk. The impact of quantum computing is one known risk. What about risks that haven't been imagined yet?

And what about the risk from competitors? For instance, China is producing and promoting AI technology, and Chinese policymakers have fundamentally different views on the economy and AI. We are in a new technology war, and leaders of all nations believe they must win it. Their understanding of AI and its impact on the economy and human well-being will drive them to provide this technology for free or at a low price because of its huge productivity-enhancing effect that raises overall living standards. In their view, the overall benefit of having more people use these new technologies is more important than profits. I believe they will compete internationally as they have with cars, solar panels, batteries, and many other products.

The current environment is reminiscent of many historical cases offering valuable lessons. I can't help but think of when the British Empire defeated the Dutch in key industries like shipbuilding at the end of the Dutch Empire and the beginning of the British Empire. AI stocks also face other risks, such as wealth taxes and other tax increases that could force large-scale selling by shareholders holding significant wealth; and growing anti-AI sentiment that could limit the space for companies to advance the technology.

I could list more concerning things, but I could also list an equally long list of huge opportunities that AI will create—and that's where I'm willing to place my bets. I am not saying these risks will necessarily materialize, nor am I saying one shouldn't bet on AI companies. I am only saying that there is undoubtedly a high degree of concentration risk in the market, and people should be aware of how to navigate such an environment. Based on my study of all similar cases and their logical reasons, I am certain the risk is high, and the best way to navigate this environment is: embrace diversification.

Embrace Diversification

You might be familiar with my mantra "diversification." My "Holy Grail of Investing" is to strive to hold 15 good-quality, uncorrelated, risk-balanced bets. In other words:

A portfolio of well-diversified, high-quality bets will outperform a single concentrated bet. It offers a higher risk-return ratio and can be engineered to deliver better returns at the same risk level. The more market risk is concentrated in one area, the more one should diversify; especially when the market is driven by a revolutionary new technology, as the technology itself brings great uncertainty.

This is not an opinion; it is a mathematical certainty. For example, suppose an investment has a risk-return ratio of 0.3 (6% return, 18% standard deviation, a common assumption for stocks); then, if I hold 5, 10, or 15 uncorrelated bets, I can keep the 6% return while reducing risk (measured by standard deviation) to 8%, 6%, and 5% respectively. Therefore, by holding 15 good-quality, uncorrelated bets, my risk-return ratio increases from 0.3 to 1.29, a 4.3x improvement. You can then apply leverage on top of that if you wish, achieving higher returns at the same risk level. This is fact.

I am very confident about this. It comes from my backtesting, the actual returns from my more than 50-year investment career, and the probability logic within it: well-diversified bets, adjusted to an individual's risk tolerance, will produce much better returns over the long term than the concentrated bets most investors tend to hold. Specifically, through good diversification, you can achieve a higher risk-return ratio than any concentrated bet; adjusting it to your desired risk level allows you to get higher returns at your target risk than any other way.

Because I've shared this method, it's no longer my not-so-secret way of investing. However, I rarely encounter investors who truly think about investment strategy in this way. That is, I rarely meet people who genuinely think from a portfolio construction perspective—considering how a well-structured, diversified portfolio of bets would perform differently from simply holding the stock of one great, transformative industry company. Most people are just thinking about whether these stocks and this industry will perform well and how to bet on them. The final performance results between those who think about portfolio construction and those who don't can be worlds apart. Therefore, I will elaborate more fully on my views on this at another opportunity.

For all these reasons, in the current environment, when thinking about how to play your hand, you should ask yourself: How much concentration should I maintain before diversifying?

Expected Returns Look Low

The high risk is unquestionable. Next, I'll present a view that may prove wrong: expected future returns look low. My judgment on expected future returns comes from valuation-related analytical work and readings from my bubble indicators: real returns on stocks over the next 5 to 10 years seem to be in the range of -5% to -10%, although these numbers have a lot of uncertainty. In my view, these stocks are long-duration assets with high risk because it's difficult to reliably see far into the future; they also seem overvalued and held by an unstable investor base.

A Question Raised by the Research Team:

In the last meeting, a member of my research team asked me: Why do you think the market's configuration today is incorrect? How do you know that today's lack of market diversification is not for good reason? For example, some investors believe the expected returns of AI stocks will be very high; or when an industry accounts for such a high proportion of total market capitalization, index concentration naturally occurs; or when an industry is being hyped, many investors buy these stocks without making wise and reliable calculations about future earnings and how those earnings should be reflected in stock prices.

My Response:

Prices rise for various reasons, not all of which are good. Some investors consider prices and push them up because they believe prices remain attractive relative to fundamentals; some investors hold these stocks for a long time because they recognize it's a great new technology and see price increases as confirmation that these are good stocks; others hold index exposure, passively giving them large weightings in these stocks.

In my view, you can agonize over these issues to decide what you want to do; or you can realize that you don't need to agonize over this question at all because you don't have enough information to confidently place a bet. You can simply say: "I don't know enough to confidently bet." And then don't bet.

What gets people into trouble is thinking they must form a view and believing their view has value; but more likely, they are unable to form a reliable, bettable view.

To be clear, I'm not suggesting avoiding bets. Besides, you can't avoid betting because you have to put your money in some portfolio or cash. Most people think cash is the safest investment, but in the long run, it's almost certainly the worst investment. My advice is that even if you have no tactical views on which markets are good or bad, you should know how to place good bets through diversification. Specifically, by holding a balanced strategic asset allocation portfolio and sticking to it when you have no tactical views to bet on. But that's for another discussion.

So, I think: Knowing what you don't know and deciding when not to bet is just as important as knowing what you do know and deciding when to bet.

In short, I believe in the following principle: because it's usually hard to have enough information to justify a concentrated bet rationally, the best practice is to only hold diversified bets you have strong confidence in and that are uncorrelated with each other—that is, an engineered portfolio designed to your desired risk level. This is my "Holy Grail of Investing."

At this moment, given the current environment, I don't think anyone can see clearly enough what will happen next in this technology-driven market to make large concentrated bets. For me, avoiding concentration and maintaining diversification is the best way to deal with this "unknown." I know this is different from what you read in textbooks. Textbooks basically assume markets are efficient, so you should "trust the market."

In summary, the current market is exceptionally concentrated, revolving around a revolutionary new technology. This fact should remind us: don't confuse excitement about a new technology with whether the stocks of that technology are attractive, and don't abandon caution by holding a high-risk, highly correlated concentrated bet. Especially when, through clever diversification, we can achieve similarly attractive returns at a much lower risk level.

Postscript:

I won't share my specific holdings or tactical views with you because I don't want to be your investment advisor. But soon, I will share with you some key perspectives behind these views, including my bubble indicators and the logic behind them.

(Note: The above translation was completed with the assistance of DeepSeek, and the content is for reference only.)

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