Ray Dalio warns the stock market's cushion against rising bond yields is shrinking

• Stock prices have been supported by earnings growth offsetting rising bond yields, but this relative advantage versus bonds is shrinking as stocks climb and yields increase, with credit spreads beginning to widen
• Dalio expects free cash flows to deteriorate despite continued earnings improvement, warning investors may face liquidity issues as companies invest heavily without generating sufficient cash returns
• The bond bear market is expected to persist as governments borrow to finance deficits and companies raise funds for AI and technology investments, creating capital competition that will keep pressure on interest rates

Summary: Ray Dalio Warns of Shrinking Stock Market Protection Against Rising Yields

Ray Dalio, founder of Bridgewater Associates, cautioned Thursday that equities face increasing vulnerability as the cushion protecting stocks from rising bond yields diminishes. Speaking at the Milken Institute Asia Summit in Singapore, Dalio explained that earnings growth has helped stocks withstand the global bond sell-off by keeping expected equity returns attractive relative to bonds, but this advantage is narrowing.

Key Concerns:

Dalio highlighted a critical distinction between earnings and cash flows, warning that while corporate earnings should continue improving, free cash flows will likely deteriorate. He emphasized that investors focusing solely on headline earnings may overlook liquidity issues emerging from capital-intensive investments that don't generate immediate cash returns.

The billionaire investor noted that stocks entered the current cycle with significantly higher expected returns than bonds, but rising stock prices combined with increasing bond yields have eroded this relative advantage. Credit spreads are beginning to widen as this cushion shrinks.

Market Outlook:

Dalio expects the bond bear market to continue, driven by competing capital demands from governments financing fiscal deficits and companies investing in emerging technologies like artificial intelligence. U.S. Treasury yields remain near multi-decade highs amid large government deficits, persistent inflation, and AI-related borrowing.

While Dalio stopped short of predicting an imminent stock market correction or earnings decline, he warned that higher borrowing costs will eventually force reduced credit and spending, potentially impacting economic activity and equity markets. He noted that financial conditions haven't yet tightened sufficiently to significantly curb credit and spending, but the tightening process is underway.