- Ray Dalio says stocks have absorbed higher bond yields because earnings growth has supported expected returns, but that cushion is narrowing as Treasury yields remain elevated.
Bridgewater Associates founder Ray Dalio warned that the US stock market is becoming more vulnerable to rising bond yields as the advantage equities have held over fixed income begins to shrink.
In an interview with CNBC at the Milken Institute Asia Summit in Singapore, Dalio said stocks have so far been able to withstand the global bond selloff because earnings growth has kept expected equity returns attractive relative to bonds. But he said that buffer is becoming smaller as bond yields rise and equity prices remain elevated.
The warning comes as the US stock market continues to face competing forces from strong corporate earnings, artificial-intelligence investment and sharply higher borrowing costs.
Rising Treasury Yields Narrow the Equity Advantage
The Treasury market has undergone a significant repricing in recent weeks. The US Treasury reported a 10-year yield of 5.28% on Oct. 7, while the 30-year yield reached 5.67%. The 10-year rate was up from 5.24% at the start of October.
The move has increased pressure on stocks because government bonds now offer substantially higher yields than they did during the low-rate period that dominated much of the previous decade.
Dalio's argument centers on the relative return investors receive for owning equities instead of bonds. When expected stock returns are comfortably above government bond yields, investors can tolerate some increase in interest rates. As bond yields rise and stock valuations remain high, that margin becomes smaller.
Recent market action illustrates the tension. The S&P 500 and Nasdaq have remained close to record levels even as Treasury yields have climbed, while bond market volatility has increased.
Dalio said that credit spreads are beginning to widen as the cushion narrows, although he did not describe the move as an immediate stock-market crisis. He also said financial conditions have not yet tightened enough to materially suppress credit and spending.
The latest Treasury figures show why the bond market has become such an important part of the stock market outlook. Higher long-term yields can raise corporate financing costs and increase the discount rate applied to future earnings, creating greater pressure on companies whose valuations depend heavily on growth further in the future.
Dalio Shifts Focus From Earnings to Free Cash Flow
Dalio also urged investors to look beyond headline earnings growth and pay closer attention to free cash flow. He said earnings could continue improving while free cash flow deteriorates if companies invest heavily without generating enough cash from those investments. That issue is particularly relevant to the current AI investment cycle, in which technology companies are committing substantial amounts of capital to data centers, chips, and other infrastructure.
The distinction between accounting earnings and cash generation has become more important as companies take on additional financing to fund expansion. Rising borrowing costs can make those investments more expensive while also increasing the return companies need to generate on new capital.
The broader bond selloff is adding to those pressures. Reuters reported that the 10-year Treasury yield reached 5.364% during Oct. 7 trading, its highest level since 2002, while the 30-year yield climbed to 5.732%. US stocks subsequently retreated, with the Dow Jones Industrial Average falling 0.66% and both the S&P 500 and Nasdaq Composite declining 0.22%.
A strong Treasury auction later helped ease some of the pressure. The $39 billion 10-year note sale drew a 2.77 bid-to-cover ratio, while primary dealers took only 2.5% of the offering, according to Reuters.
The Federal Reserve remains another major variable. The central bank raised its benchmark interest-rate range to 3.75%-4% in September, and investors are assessing whether persistent inflation and elevated energy prices could lead to additional tightening.
Dalio did not predict an imminent stock-market collapse. His warning is more focused on the changing relationship between stocks, bonds, corporate cash flows and credit.
For investors, the key issue is whether earnings growth can continue to offset the pressure created by higher Treasury yields. If yields stabilize, equities could continue absorbing the higher-rate environment. If yields rise further while free cash flow weakens and credit spreads widen, the cushion supporting stocks could become considerably thinner.