Ray Dalio says stocks and bonds need to drop further, he sees US recession in 2023

As the world waits for the Federal Reserve to deliver what should be its third “jumbo” hike in interest rates, Bridgewater Associates founder Ray Dalio shared a warning to anyone still clinging to the hope that asset prices at the downside may soon recover.

According to Dalio, the Fed must continue to substantially raise interest rates if it hopes to be able to tame inflation. Due to this, and other factors such as the ongoing war in Ukraine, Dalio predicts that stocks and bonds will continue to suffer as the US economy is likely to slide into recession in 2023 or 2024.

“Right now, we are very close to 0% per annum. I think it will get worse in 2023 and 2024, which has implications for the elections, “Dalio said during an interview with MarketWatch Editor-in-Chief Mark DeCambre at MarketWatch’s inaugural” Best New Ideas in Money “festival, which has kicked off Wednesday morning in Manhattan.

Fed Chairman Jerome Powell has promised that the central bank will do everything in its power to curb inflation, even if it causes markets and the economy to collapse in the process. But to achieve this, Dalio believes the Fed needs to raise key interest rates between 4% and 5%. Assuming the Fed hikes interest rates on Wednesday by at least 75 basis points, this would take the Fed funds rate above 3% for the first time since before the financial crisis.

“They need to get interest rates – short rates and long rates – up to around 4.5%, it could be even higher than that,” he said. Because the only way the Fed can successfully fight inflation is to distribute “economic pain”.

According to the CME’s FedWatch tool, futures traders predict that the Fed could raise the benchmark rate, which underlies trillions of dollars of assets, to 4.5% by July. But traders only see an external possibility that the rate will hit 5% before the Fed decides to start cutting rates again.

In the United States, inflation declined slightly after reaching its highest level in more than 40 years during the summer. But a report on consumer price pressures in August sent financial markets into a tailspin last week as elements of “core” inflation, such as housing costs, appeared more stubborn last month than economists had predicted. . But the ongoing energy crisis in Europe has led to even more severe increases in the cost of everything from heat to consumer goods.

Using some of the most basic principles of corporate finance, Dalio explained why higher interest rates are anathema to financial assets, as well as real assets such as the real estate market.

Simply put, when interest rates rise, investors must increase the discount rate they use to determine the present value of future cash flows, or interest payments, attached to a particular security or bond. Since higher interest rates and inflation are essentially a tax on these future revenue streams, investors typically compensate by assigning a lower rating.

“When you make an investment you pay a lump sum for future cash flows, so to tell what they were worth we take the present value and use a discount rate. And this is what makes all the boats go up and down together, ”said Dalio.

“When interest rates are lowered to zero, or around zero, what happens is that all asset prices are raised,” Dalio added. “And when you go to the other side, it has the opposite effect.”

While Dalio said he expected stocks to suffer more losses, he pointed to the bond market as a particular area of ​​concern.

The problem, according to Dalio, is that the Fed no longer monetizes the debt issued by the federal government. In September, the Fed plans to double the rate at which Treasury and mortgage bonds will leave the central bank’s balance sheet.

“Who’s going to buy those stocks?” Dalio asked, before noting that China’s central bank and pension funds around the world are now less motivated to buy, partly because the real yield on bonds after inflation has dropped significantly.

“We had a 40-year bull market in bonds … all bond holders did the
the price has gone up, and this has been self-reinforcing for 40 years, ”Dalio said. “Now you have negative real yields on bonds … and you have brought them down.”

When asked if “cash is still junk”, a characteristic joke Dalio repeated on several occasions, he said that holding cash is still “a junk investment” because interest rates are still not high enough to fully compensate. the impact of inflation. However, the true usefulness of cash depends on “how it compares to others”.

“We are in this mode of ‘devaluation of financial assets'”, added Dalio.

Asked if he’s still bullish on China, Dalio said yes, but made it clear that it’s a risky time to invest in the world’s second largest economy, which could create opportunities for long-term investors.

“Asset prices are low,” he said.

Dalio offered a humorous response when asked to share his thoughts on where the markets might be headed.

“There is a saying: ‘whoever lives near the crystal ball is bound to eat the ground glass'”.

Get insights into investing and managing your finances. Speakers include investors Josh Brown and Vivek Ramaswamy; in addition, topics such as ESG investments, electric vehicles, space and fintech. The Best New Ideas in Money Festival continues on Thursday. Register to participate in person or virtually.

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