🌎Macro#08: Ray Dalio Disagrees with Majority of Wall Street Estimates

“I estimate that a rise in rates…will produce about a 20 percent negative impact on equity prices”.

Sep 20, 2022

Source: Web Summit, CC BY 2.0, via Wikimedia Commons

You have already heard, but recent inflation numbers were pretty bad.

The Consumer Price Index report released Tuesday showed that prices increased by 8.3 percent from a year earlier. This is compared to the 8.5 percent increase in July.

Even though gas prices have decreased, other expenses, like rent, healthcare, and restaurant meals, have increased more quickly. For example, check out the graph below, where inflation rapidly increases, excluding food and energy.

If this trend continues, it could severely affect the economy and American households. Already, rising prices are putting a strain on budgets and forcing people to cut back on spending. However, if inflation continues to increase at this rate, it could lead to widespread economic hardship.

So the key questions are, 1) what can we expect? and 2) when would it happen?

Ray Dalio explains in his new article the mechanism of how inflation, interest rates, markets, and the economy are linked. Then, he also shares his opinion on what will happen in the future.

It is specifically interesting because his long-term views are pretty different from Wall Street’s perspective.

And this matters for us, retail investors, because where there is dislocation with the market’s perspective, there is opportunity.

The Mechanism: How Inflation Affects the Economy

Ray Dalio mentions in his article that “the process starts with inflation.”

Inflation is when the prices of things go up. This happens when more money and credit are spent on things (demand). Also, if there are supply disruptions, the number of products and services goes lower, shooting prices higher.

Next, central banks decide how much money and credit should be available by transacting debt assets. Currently, the central bank is raising interest rates to fade the amount of money and credit available.

Then, prices go down in equities, investing assets, and properties. When interest rates rise faster than inflation, it makes it harder for people to afford things. Since investors know all this will slow down economic growth, they expect earnings growth to be lower, too — which is reflected in the prices of investment assets.

Finally, the economy is affected. When the interest rates are high and there is not much credit available, people spend less, and there is a crash in equities.

Source: Ray Dalio’s Framework, Made by Author

Differences in Ray Dalio’s and Wall Street’s View

Inflation

The first dislocation between Ray Dalio's and Wall Street’s views is the long-term inflation outlook.

Wall Street: Inflation is really high, but markets estimate it will come down to 2.0% in the long term.

Source: Inflation Forecast from FOMC, IMF

Many believe that the markets will come down to pre-pandemic levels, but Ray Dalio strongly views the opposite.

Ray Dalio: Ray Dalio suggests it will be about 4–5% long-term.

In the near term, I expect inflation will fall slightly as past shocks resolve for some items (e.g., energy) and then will trend back up towards 4.5 percent to 5 percent over the medium term. — Ray Dalio

Interest Rates View

Wall Street: Markets estimate interest rates to go down to 1.0% in the next ten years.
Ray Dalio: He estimates real interest rates of 4.5–6% short-term and long-term. That is a pretty big gap.

I think it looks like interest rates will have to rise a lot (toward the higher end of the 4.5 to 6 percent range) and a significant fall in private credit that will curtail spending. — Ray Dalio

Ray Dalio’s Predictions on What Will Happen

As Ray Dalio believes that interest rates will rise, he estimates there will be a 20% negative impact on equities.

I estimate that a rise in rates from where they are to about 4.5 percent will produce about a 20 percent negative impact on equity prices-Ray Dalio

Another 20% market decline will be devastating as the S&P500 has already declined 19% this year.

How long will it take?

He believes the decline will take some time, as cash/wealth levels are relatively high now. Also, there is low unemployment, which will support the flushing out of the equity markets.

In conclusion, Ray Dalio’s view can be described as a pretty bearish outlook.

The inflation rate will stay above what people expect
Hence, interest rates will rise
Thus, markets will go down
And the economy will be weak.
Combined with external and internal conflicts, we should be extra cautious.

So what does all this mean for investors?

It means that markets are currently underestimating the amount of inflation we will see in the future. This could lead to major market corrections as reality catches up with expectations in the coming years.

So what can we do to protect ourselves?

We must diversify our income sources, save money, and invest in assets that will hold their value. Read below to see what Warren Buffet has been purchasing.

Warren Buffet Accumulated Massive Positions in these 5 Stocks During the Downturn

Of course, no one can surely say how things will play out.

Great thinkers such as Elon Musk also believe rate hikes can actually lead to deflation.

What do you think? Will inflation ease up?

This is not financial advice. I am not a financial advisor, and you should do your own research and not just listen to anyone on the internet. Nothing contained in this publication should be construed as investment advice.

If you want to read more about what other legendary investors, such as Chamath, have been doing in the current downturn, read here.

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Suggestions for Furthur Reading/Research

Inflated World