Ray Dalio did some math: Rates at 4.5% would sink stocks by 20%

Ray Dalio came out with a gloomy prediction for stocks and the economy after an inflation higher than expected shock financial markets around the world world this week.

“It looks like interest rates are going to have to go up a lot (towards the upper end of the 4.5% to 6% range),” the billionaire founder of Bridgewater Associates LP wrote in a LinkedIn article dated Tuesday. “This will reduce private sector credit growth, which will reduce private sector spending and therefore the economy.”

A simple rate hike to about 4.5% would lead to about a 20% drop in share prices based on the present value discount effect, he said. On top of that, he estimates a 10% negative impact from decreased revenue.

The rate market suggests that traders have fully priced in a 75 basis point hike by the Fed next week, with a slim chance of a full percentage point move. Traders expect the Fed funds rate to peak near 4.5% next year, from the current range of 2.25%-2.5%.

Dalio noted that investors may still be too complacent about long-term inflation. While the bond market suggests that traders expect an average annual inflation rate of 2.6% over the next decade, his “guess” is that the increase will be around 4.5% to 5%. With economic shocks, it can be even “significantly higher,” he added.

Dalio said the US yield curve will be “relatively flat” until there is an “unacceptable negative effect” on the economy.

A deepening inversion of key curve measures, seen by many as a potential harbinger of recession, has helped reinforce a more dovish view of economic activity among investors.

Investors, who speculate that the Fed will push the economy into a recession next year in the struggle to curb inflation, already see policymakers cutting rates in the latter stages of 2023.

The S&P 500 is headed for its biggest annual loss since 2008, while Treasuries have suffered one of their worst beatings in decades.