All-Weather Critique

Dalio, through a long, arduous, and philosophical journey, has decided that it is better to not try
and predict the market. The All Weather Strategy is an asset allocation strategy that earns a
decent return in all market conditions. Dalio stipulates that there are 2 major drivers of prices economic growth and inflation.
To create an allocation that performs steadily under all market environments, we must hold
assets that balance each other's weaknesses. Since equities suffer in periods of economic
growth, we must have assets in our portfolio that counter this effect. This is a summary of
assets that perform well in their respective area's:

Dalio postulates that all the assets in these four buckets should generate return above cash
over a long period of time. By making each bucket equally as risky - by leveraging up the less
risky assets such as nominal bonds, we should be able to theoretically balance ups and downs
in the 4 categories, and isolate beta. This exposure to the market should then provide a steady
return regardless of prevailing market conditions.
I see two problems with this theory
1) The relationships between some of his chosen assets, and the factors are weak.
2) The economy cannot simply be broken down into 4 economic states, and these may not be
the fundamental factor.
Asset/Factor relationships:
Equity / Economic Growth:

The dynamic seems simple: if companies are producing more products, they should
demonstrate earnings growth, which means the value of these companies should go up. Let's
see what the numbers show -I did a regression on the equation below, with annual returns over
53 years:

The annual data, and revealed that these factors were very likely insignificant. This is
confirmed in a paper by BNY Mellon AM.
Commodities / Economic Growth
Commodities are the major input for consumption - all products are derived from basic
materials. It seems obvious that in times of economic growth, when there are more products
being produced, that there would be more demand for commodities and thus the price would
go up.
However, the other side of the equation is important - the dynamic between commodity
suppliers, and their customers. Most commodities are fragmented industries - many companies
crowd the space and thus compete on market price. The fact that storage costs are high
contributes to the need for commodity producers to continually make sales to operate
efficiently. This means that although customers will demand more products, the price is inelastic in upwards movement due to suppliers. Thus, I believe that economic growth will have a
minimal relationship with commodities.
Dalio also believes that exposure to commodities over the long run, gives guaranteed returns that the value of commodities increase over time. Value is derived from the current value + the
discounted value of future cash flows. For equities, it makes sense, as there is upwards mobility
in the discounted value of future cash flows. Commodities on the other hand, do not have any
cash flows. The value is derived from the physical self, which does not change. It can be argued
that the value, accounting for technological efficiency, over time should not change drastically,
unless a new use for the commodity is found.
Thus over the long run, I do not believe that long term growth in commodities above cash is a
"sure thing".

4 Bucket Model:
The economy cannot be simply broken down into 4 buckets - there are many other important
factors that contribute to a growing economy. Some of these include political landscape, the

level of interest rates, import/export relationships, pace of technological advancement,

regulations (controlled or free). Stock price movement is itself is a function of many variables,
not just "economic growth & inflation".
This can be showcased by the last three bull markets. In the past 5 years, many people would
characterize equities growth to low interest rates, and equities have been extremely sensitive
to FOMC meetings. In the years before the Great Recession, we can attribute the growth to a
lack of regulation. The tech bubble was ably named. Ask yourself the question: is economic
growth equally correlated to regulation activity, technological advancement, and changes in
interest rates? I haven't looked at the numbers yet, which I would like to do soon. I do not
predict a strong and equal relationship.
Dalio talks about breaking down revenue streams into their separate components in order to
analyze the relationships between asset classes. The problem is, the more granular you get, the
more components you have, and the harder it becomes to manage so many different
"buckets". A 2 factor model of economic growth and inflation to me, seems over simplified.
Conclusion:
John Maynard Keynes talked about "animal spirits" - the ability for a nation to somehow over
the long term sustain economic growth and innovation. This comes solely through an innate
quality in humans, which shows up unpredictably, to become highly productive. Animal Spirits and similar principles fortify my beliefs that a simple model 2 factor model of the world will not
predict asset movements.. In principle, if we can find asset classes that move directly inverse to
each other in all economic states, and still provide long term return, then we should be able to
find a steady growth portfolio with low volatility. For this to happen, we need to find these
asset classes, and find all the factors that correspond to every economic state. It's a tough task
It seems as if the relationships between factors and asset prices is constantly changing. Thus,
there is no such thing as an all-weather portfolio - at least one that keeps allocations static. If
we are able to constantly analyze the changing relationships between assets and their factors,
then it may be possible to obtain this all-weather portfolio - this is definitely not a passive
strategy. The all-weather strategy could then, with a lot of work be a very successful active
investment strategy.