Ray Dalio Says Stocks Are Losing Their Buffer. Rising Bond Yields Are Becoming Harder To Ignore.

Ray Dalio said the stock market has been able to absorb rising bond yields because corporate earnings remain strong, but that protection is getting thinner as borrowing costs stay elevated.

The Bridgewater Associates founder told CNBC that stocks entered the current cycle offering investors a considerably better expected return than bonds, giving equities room to withstand higher interest rates.

That advantage has narrowed as stock prices have risen and bond yields have moved higher.

“We’re in the part of the cycle where interest rates can rise without sending the equity market down because there’s enough earnings growth and there’s enough expected return,” Dalio told the outlet at the Milken Institute Asia Summit in Singapore.

“But when that cushion comes down, then you’re coming later into that cycle. So that’s where we are.”

The benchmark 10-year yield had climbed above 5.3% earlier in the week, reaching levels not seen in more than two decades.

The Federal Reserve also showed the 10-year Treasury constant maturity rate hovering around 5.3% this week, with longer-dated yields remaining even higher.

Higher government bond yields can create more competition for stocks because investors can earn greater returns from fixed-income assets without taking on the same level of equity-market risk.

Dalio said that relative pricing gap has already narrowed. “Because of that change in pricing, that cushion has come down, and so now you’re starting to see credit spreads start to widen,” he said, adding that investors should look beyond headline profit growth and pay closer attention to the amount of cash companies are actually generating.

Asked about the outlook for corporate earnings, he said profits could continue improving even as free cash flow weakens.

“I think you have to pay attention to free cash flows. … Not just earnings,” Dalio told news the outlet.

“If you’re earning and then you’re investing and you’re not getting money out of that, you have a liquidity issue that’s evolving.”

Dalio said he expects earnings to continue improving while free cash flow deteriorates.

Free cash flow measures the cash a company has left after paying for operating expenses and capital investments. It can differ significantly from reported earnings, particularly for companies spending heavily on new infrastructure.

That distinction has become more important as some of the world’s largest technology companies commit large amounts of capital to data centers, chips and other infrastructure required for artificial intelligence.

Dalio did not predict an imminent earnings decline or stock-market correction. He said financial conditions have not yet tightened enough to sharply slow credit or spending.

He also expects pressure in the global bond market to continue. “We are in a bond bear market, that’s I think pretty clear, and I think that there’s more to go would be my guess,” he said.