American billionaire investor and hedge fund manager Ray Dalio has predicted stocks could drop by around 20% as the US Federal Reserve raises interest rates aggressively in a bid to curb inflation.
The founder of one of the world’s biggest hedge funds Bridgewater Associates Mr Dalio issued the warning recently in a social media post, saying an interest rate rise from range of 2.25-2.5% to 4.5% in the US will cause a 20% decline on equity prices.
“It looks like interest rates will have to rise a lot [toward the higher end of the 4.5% to 6% range],” he said.
Mr Dalio said as interest rates go up, other markets will go down, leading to a weaker economy.
“This will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it,” he said.
He also warned the rises could be “significantly higher”, as possible economic crises in Europe and Asia or droughts and floods across the globe may occur.
US inflation remains high
The warning from Mr Dalio came on the same day US data showed the country’s consumer prices rose unexpectedly in August – sending stock markets trending downwards with fears of another outsized interest rate hike.
The consumer price index increased 0.1% in August, after there was no change in the month before.
Meanwhile, the all-items index has surged 8.3% over the last 12 months; however, which was a slight decrease on the 8.5% for the 12-month period ending July.
The energy index was up 23.8% for the 12 months ending August.
Mr Dalio warned a recession could be on the way as economists expect the Federal Reserve to raise its benchmark short-term rate to 4.5% (or higher) as soon as early next year.
If it does lift interest rates aggressively in the coming months, it will be harder for the Federal Reserve to achieve its goal of a “soft landing,” – curbing inflation without causing a recession.
Economic contraction will be required
Mr Dalio said a significant economic contraction will be required, but noted it won’t happen in the near-future as cash levels and wealth levels are relatively high at present.
“We are now seeing that happen. For example, while we are seeing a significant weakening in the interest rate and debt-dependent sectors like housing, we are still seeing relatively strong consumption spending and employment.”
He said that the Federal Reserve’s expected interest rise to 4.5% will have severe consequences for the stock market as well as the economy.
Mr Dalio explained the interest rate rises will impact asset prices negatively in two ways: the present value discount rate and, secondly, the decline in incomes produced by assets because of the weaker economy.
“When people lose money, they become cautious, and lenders are more cautious in lending to them, so they spend less,” he said.
“My guesstimate that a significant economic contraction will be required, but it will take a while to happen because cash levels and wealth levels are now relatively high, so they can be used to support spending until they are drawn down.”