- Economic risks prompted Jamie Dimon to offer up a bearish outlook this week.
- Ray Dalio expects valuation to be pressured by persistently higher interest rates.
- Stanley Druckenmiller is net short this year because of an economic slowdown.
- Paul Tudor Jones thinks assets could rally if recession prompts a Fed pivot, but short-term yields will fall first.
J.P. Morgan’s CEO Jamie Dimon spoke frankly about the risks facing stocks this week, saying a looming recession could cause another wave lower, shaving 20% more off the S&P 500.
That’s a discouraging view, given how much we’ve already fallen, mainly because his position at the top of one of the world’s biggest banks provides insight into the economy few possess.
His concern got me wondering: What do other influential folks think about the stock market right now?
No, I’m not interested in TikTok or Reels’ stars. Instead, I’m talking about been-there-done-that market gurus who are so good at investing that Jack Schwager featured them in his fantastic Market Wizards books.
(Sidebar: If you’re unfamiliar with these books, buy them. They feature great “day in the life” interviews with many of the most influential investors of our time. If half of these books aren’t dog-eared or highlighted by the time you’re done reading them, I’d be shocked.)
Ray Dalio: Higher rates mean lower valuations
First up is Ray Dalio, the 73-year-old multibillionaire founder of Bridgewater Associates, the largest hedge fund on the planet with assets under management of about $140 billion. Dalio started Bridgewater in 1975, so he’s seen his fair share of good and bad times.
What’s he saying about stocks?
In mid-September, he wrote on Linkedin, “It looks like interest rates will have to rise a lot (toward the higher end of the 4.5% to 6% range)...This will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it.”
You can read Dalio’s full post here, but, essentially, the TL;DR is his math suggests that higher-than-expected (persistent) inflation will increase the risk-free rate of return, negatively impacting the ‘value’ of future cash in discounted cash flow models. This leads him to conclude that if rates are 4.5% or more, it would result in a 20% haircut to equity valuation, reducing the wealth effect and dragging on the economy. He writes:
“The rise in interest rates will have two types of negative effects on asset prices: 1) the present value discount rate and 2) the decline in incomes produced by assets because of the weaker economy. We have to look at both. What are your estimates for these? 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 (on average, though greater for longer duration assets and less for shorter duration ones) based on the present value discount effect and about a 10 percent negative impact from declining incomes.”
Dalio’s view that risk assets will become less attractive relative to alternatives if rates stay high is probably why he posted on Linkedin one week ago, “I’ve changed my mind about cash as an asset: I no longer think cash is trash. At existing interest rates and with the Fed shrinking the balance sheet, it is now about neutral—neither a very good or very bad deal. In other words, the short-term interest rate is now about right.”
Stanley Druckenmiller: A lost decade, but opportunities along the way
Next up? Stanley Druckenmiller, the 69-year-old founder of Duquesne Capital, a hedge fund he began in 1981 and closed in 2010 when it was managing $12 billion.
Druckenmiller’s best known for his role as lead portfolio manager of George Soros’ Quantum Fund between 1988 to 2000. There, he and Soros became famous for “breaking the Bank of England,” profiting over $1 billion from shorting sterling.
However, Druckenmiller should be best known for his amazing track record. Over a four-decade career, he never had a losing year.
What’s he think?
Last week, he expressed concern, saying: “Our central case is a hard landing by the end of ’23…I will be stunned if we don’t have recession in ’23. I don’t know the timing, but certainly by the end of ’23. I will not be surprised if it’s not larger than the so-called average garden variety…You don’t even need to talk about Black Swans to be worried here. To me, the risk-reward of owning assets doesn’t make a lot of sense.”
He’s worried because it’s uncertain how high rates will rise to undo the after-effects of massive fiscal and monetary stimulus during COVID. For that reason, he’s been betting against stocks this year, saying he’s been running 0% to 20% net short.
Unfortunately, Druckenmiller doesn’t think the U.S. stock market makes much, if any, headway over the next ten years. However, that doesn't mean there won’t be chances to make money. For instance, he’s been buying biotech stocks this year.
Paul Tudor Jones: Plan for recession and a big rally when the Fed pivots
Finally, let’s check in with billionaire speculator Paul Tudor Jones. He founded Tudor Investment Corporation in 1980 after working as a commodities broker for E.F. Hutton for four years. Jones is best known for predicting the crash in 1987.
He said last week about a recession, “I don’t know whether it started now or it started two months ago…We always find out, and we are always surprised at when recession officially starts, but I’m assuming we are going to go into one…If we go into recession, that has really negative consequences for a variety of assets.”
On stocks? He thinks stocks could fall 10% in a recession, and bond yields will forecast when stocks will rally. He said, "Most recessions last about 300 days from the commencement of it…The first thing that will happen is short rates will stop going up and start going down before the stock market actually bottoms.”
If so, watching short-term bond rates, such as the 2-year yield, is critical. A flight to quality usually includes buying bonds and sending yields lower (similar to in Q4 2018 and Q1 2019). When that happens, the path higher for stocks becomes easier. Particularly if the Fed pivots.
Back to Jones:
“When it stops hiking, there will be a point when it starts to either slow down or even, at some point, it will reverse those cuts. And when that happens, you'll have just a massive rally in a variety of beaten-down inflation trades, including crypto.”
The Smart Play
It’s important to remember that while these legends have decades of experience, they’re all actively managing their accounts. Each has made a name for themselves by being flexible, and they’re not immune to being wrong.
For example, Jones is famous for his rigid approach to controlling risk, writing, “the key is to play great defense, not great offense.” When he’s wrong, he cuts his losses quickly. Druckenmiller could be right, but he could also be wrong. For instance, he suggested the risk-reward for stocks was terrible in May 2020. Yet, stocks rallied significantly through 2021.
Dalio also recognizes mistakes come hand in glove with investing.
In Hedge Fund Market Wizards, Schwager writes that Dalio “Strongly believes that learning from mistakes is essential to improvement and ultimate success. Each mistake, if recognized and acted upon, provides an opportunity for improving a trading approach. Most traders would benefit by writing down each mistake, the implied lesson, and the intended change in the trading process. Such a trading log can be periodically reviewed for reinforcement. Trading mistakes cannot be avoided, but repeating the same mistakes can be, and doing so is often the difference between success and failure.”
Indeed, experience informs Dalio, Druckenmiller, and Jones’ views, but that doesn’t mean you should abandon your financial plan because of them. Their opinions may change, and they’re not going to call to tell us first. For this reason, their comments should be viewed as another data point, rather than gospel. After all, your financial situation is your own, and ultimately, only you – and your advisors – can craft solutions that make the most sense.