Dalio Says Equity Cushion Is Shrinking
On Thursday, billionaire investor Ray Dalio issued a warning that the protection stocks currently enjoy against climbing bond yields is getting thinner, even though corporate profits keep growing. Speaking to CNBC, the Bridgewater Associates founder explained that shares have held up through the worldwide bond rout because rising earnings have preserved an attractive expected return on equities compared with bonds. As financial conditions grow tighter, he added, that edge will shrink and stocks could become more exposed.[S1][S2]
Dalio described the current phase as one in which interest rates can climb without dragging the equity market lower, thanks to sufficient earnings growth and expected returns. But he argued that once that cushion erodes, the cycle moves into a later stage. His comments came as U.S. Treasury yields hovered near multi-decade highs, with investors weighing large government deficits, persistent inflation and rising borrowing tied to artificial intelligence investment.[S1]
Dalio noted that when the current cycle began, stocks offered far better expected returns than bonds, which kept demand for equities alive despite climbing borrowing costs. Now, however, with share prices higher and bond yields up, that relative benefit is eroding, leaving equities with less capacity to withstand rising rates. He cited widening credit spreads as an early indicator of this change.[S1]
Free Cash Flow Risk and the Bond Bear Market
Dalio further warned that investors might be underrating the danger of shrinking corporate cash generation, even while headline profits keep rising. When asked if companies could sustain solid profit growth in the third quarter, he advised looking at free cash flow instead of earnings alone. His reasoning: if a business makes money and puts it back to work without recovering cash, a liquidity squeeze can emerge.[S1]
Dalio said earnings ought to continue rising, but he anticipates free cash flows will weaken. He avoided forecasting either an earnings downturn or a near-term stock market correction, pointing out that financial conditions have not yet become tight enough to meaningfully restrain credit and spending.[S1]
Turning to bonds, Dalio predicted the global sell-off will persist as governments and companies vie for capital. Massive government borrowing to cover fiscal deficits, alongside corporate fundraising for new technologies, produces an imbalance that may keep pushing interest rates higher. He called it a bond bear market with further to run, adding that costlier borrowing will ultimately compel cuts in credit and spending, dragging on economic activity and possibly hitting equities too. At this stage, he said, the tightening has barely started, with earnings growth still propping up stocks as credit conditions begin to soften.[S1][S2]
