'What you don't know is greater than anything you do know': How Ray Dalio would build a portfolio to withstand a popping AI bubble

By Barbara Kollmeyer

Look for inflation protection and unappreciated players in artificial intelligence, says the famed hedge-fund founder

Ray Dalio of Bridgewater Associates, pictured in 2024, is worried today about a bubble in AI. He says investors need mote diversification.

With major U.S. stock-market indexes returning to record territory this week, Ray Dalio has been busy warning about one of the biggest drivers: artificial intelligence - which, he says, has formed a bubble that's ready to pop.

'We must recognize that we are in a risky period.'Ray Dalio, Bridgewater Associates

"We must recognize that we are in a risky period," the billionaire founder of the hedge-fund firm Bridgewater Associates said in an interview on an episode of financial journalist Julia LaRoche's podcast that first aired Thursday.

Having cautioned last year about the prospect of froth in AI, Dalio has turned up the volume this year and begun to speak of the set-up as a bubble at risk of popping. Before the podcast appearance he had already warned earlier in the week about an AI bubble at the Forbes Global CEO Conference in Singapore, citing concerns about the debt investors were taking on to place bets on the technology even as interest rates are rising.

"The bubble before 1929 was a fabulous technology revolution, but the nature of those is that there's a great deal of uncertainty, and they need a lot of capital," Dalio, best known for predicting the 2008 global financial crisis, said in the interview with LaRoche.

As Dalio had explained in a Facebook post last month, investors in the past have been eager to bet on highly visible technologies, such as, a century ago, electrification. However, if stocks are priced too high or purchased with an abundance of debt, a crash can happen, as in 1929-33, when investors "fail to distinguish the miracle from the investment."

And while it's easy to create wealth through raising billions in capital or taking on debt, turning paper money into actual cash is harder to do. "You have to sell wealth in order to convert it to money [that's able to be spent]. That's what typically pops the bubble."

The AI run-up has occurred against a backdrop in which investors face such challenges as surging bond yields, which are pushing prices of that debt lower and making stocks appear more expensive, he said. Treasury yields BX:TMUBMUSD10Y are hovering at two-decade highs, yet the S&P 500 SPX and Nasdaq Composite COMP have each managed to log record highs this week.

'The vulnerability of assets to rising interest rates is something that I think one has to pay attention to.'Ray Dalio

"The vulnerability of assets to rising interest rates is something that I think one has to pay attention to - and that, when there's a lot of debt, there is down the line a devaluation of money," said Dalio.

He suggested investors maintain an allocation of between 5% and 15% to gold as part of a "balanced" portfolio, as that asset is hard money and a diversifier amid rising debt levels. Gold (GC00) is theoretically a hedge against inflation but this year has seen the precious metal pressured by rising bond yields and a stronger dollar. As it pays no interest, when yields rise so does the opportunity cost of holding the metal.

Dalio said he keeps about 1% in his portfolio in bitcoin (BTCUSD), just for the sake of diversification and not because he thinks it's a "great asset," given that it's not private but "can be watched," that a government could come between an investor and the asset, and that it remains to be seen whether artificial intelligence can "break it."

As for stocks on his radar, Dalio urged investors to watch out for companies poised for transformation by AI, for example through increased sales or reduced costs. Such companies are underpriced by markets, in his opinion, as he made clear how he felt about the popular names in the driver's seat for markets. "I think the superscalers and the other ones, big AI bets, they're overpriced, they're expensive."

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Apart from gold, Dalio prefers inflation-protected securities, or TIPS, and particularly leveraged TIPS that magnify exposure to inflation and interest rates, because he expects low returns on cash. "The real yield on inflation-indexed bonds is now about 3% - a pretty good yield - and I think that inflation pressures carry it forward."

The hedge-fund manager said balance and diversity in a portfolio are crucially important given a "very risky" period in the next two to four years, covering over such events as the midterms in November and the 2028 presidential election. "What you don't know," he said, "is greater than anything you do know about what the future will [bring]."

-Barbara Kollmeyer

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