Paradigm Shifts and the Rise of a New Asset Class

This past week, legendary investor Ray Dalio published a blog post detailing why paradigm shifts are important, which have impacted the past 100 years, and what current macroeconomic conditions imply for the future. Aside from being a great read, the article drives home a very important tenet of becoming a great investor: study the past, determine the main levers that influence outcomes, and use those to frame your forward-looking point of view given the information you have today.

Source: Time

According to Ray, the way to identify paradigm shifts is:

Identify the paradigm you’re in, examine if and how it is unsustainable, and visualize how the paradigm shift will transpire when that which is unsustainable stops.

– Ray Dalio

The history of paradigm shifts is fascinating (you should read it!) but for this post I will focus on unpacking Ray’s analysis of where we are and where we may be headed.

The Next Shift

Since the Great Recession the late 2000s, the following factors have been shaping today’s macroeconomic landscape and are not sustainable moving forward. These include:

  • Low interest rate environment sustained by central banks, flooding the markets with cash
  • Excess capital has encouraged stock buybacks and increased private market investing, driving up asset prices
  • Increased profit margins due to automation and globalization
  • Corporate tax cuts acted as a one-time boost to stocks

As such, central banks won’t be able to boost the economy when it inevitably begins to sputter because interest rates are already so low, and increasing amounts of debt will be coming due that won’t be able to be paid off.

Where to Invest

Dalio ends his post suggesting that it would be a good idea to allocate a portion of one’s portfolio to the world’s globally recognized store of value, gold, in order to hedge against the depreciating value of money. I absolutely agree with this suggestion, but I would add one more thing.

Investors should strongly consider adding bitcoin exposure. Why bitcoin? First, let’s take a look at what makes gold attractive:

  1. Inflationary hedge
  2. Scarce
  3. Durable
  4. Fungible
  5. Widely accepted

Now let’s take a look at bitcoin. In addition to #1-4, bitcoin is more divisible and portable than gold will ever be. Its main drawback is that it’s not widely accepted today (#5). This makes bitcoin a hybrid of a store of value and a speculative asset. By speculative, I mean that it is volatile because it’s still not known if it will ever become embraced by the mainstream for what it is, a new kind of store of value.

Note: as of 7/22/19; Gold market cap estimate from Motley Fool

Still in its early days, bitcoin has the potential to serve the role of store of value with an asymmetric risk/reward profile depending on if the masses eventually adopt bitcoin. Given that we are at very low adoption rate globally, even if this metric creeps up minimally there should be noticeable upward pressure on its price. The major risk for bitcoin in an economic downturn would be that it’s considered a risk asset and, as portfolios shift to a more conservative allocation, people will avoid bitcoin. However, bitcoin has shown the past decade to have low correlation with other asset classes, which strengthens the argument for investors to add exposure to their portfolios for diversification benefits.

Source: The Block

I personally believe bitcoin will continue to see greater adoption, especially as younger digital-native generations start to manage more money and make more significant investment decisions. While Ray has previously said bitcoin is a bubble, I suspect his opinion will change over time as more sophisticated institutional investors take positions and less speculative activity takes place.

As always, none of this is investment advice. Do your own research…and I bet you will have a greater appreciation of bitcoin afterward.

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