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Billionaire investor Ray Dalio warned Thursday that stocks are facing mounting pressure from rising bond yields and the possibility of weaker corporate cash flows. Earnings are still growing, but he said that support is becoming less dependable as financial conditions tighten.

The Bridgewater Associates founder told CNBC that equities have endured the global bond selloff because earnings growth has kept expected stock returns attractive relative to bonds. Dalio cautioned that this advantage will narrow, leaving stocks more exposed as borrowing conditions become tighter.

“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 CNBC’s Sri Jegarajah at the Milken Institute Asia Summit in Singapore on Thursday.

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

The warning comes as U.S. Treasury yields hover near highs not seen in multiple decades. Investors are contending with large government deficits, persistent inflation and rising borrowing connected to investment in artificial intelligence.

Dalio said equities began the current cycle with expected returns that were significantly higher than those available from bonds. That gap helped maintain demand for stocks even as borrowing costs increased across the financial system.

The protection is now weakening as stock prices climb and bond yields rise. With the relative advantage diminishing, equities have less room to absorb additional increases in interest rates without coming under pressure.

“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.

Dalio also warned that investors could be overlooking a deterioration in the cash generated by companies. Headline earnings may continue improving, but those figures do not necessarily capture the liquidity pressures he sees developing.

Asked whether companies could maintain strong profit growth during the third quarter, Dalio urged investors to look beyond reported earnings. He identified free cash flow as a crucial measure for evaluating the financial position of companies.

“I think you have to pay attention to free cash flows. ... Not just earnings. Because 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,” he said.

“While earnings should continue to be improving, I would expect the free cash flows, I think, will be deteriorating.”

Dalio did not predict that earnings would decline, nor did he forecast an imminent stock market correction. He said financial conditions have not tightened enough yet to significantly restrain credit and spending.

The investor also expects the global bond selloff to continue as governments and companies compete for capital. Mounting debt issuance is placing pressure on investor demand and could keep borrowing costs elevated.

Governments are borrowing heavily to finance fiscal deficits, while companies are raising money to invest in emerging technologies. Dalio said that imbalance could continue placing upward pressure on interest rates as borrowers pursue available capital.

“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.

Higher borrowing costs will eventually force a reduction in credit and spending, according to Dalio. That pullback would weigh on economic activity and could ultimately spill into equity markets as tighter conditions move through the financial system.

For now, Dalio described the tightening process as being in its early stages. Earnings growth continues to provide support for stocks, but widening credit spreads and the prospect of deteriorating free cash flow suggest that the market’s protective cushion is wearing thinner.

DISCLAIMER: GoldInvestors.news is not a registered investment, legal or tax advisor or broker/dealer. All investment/financial opinions expressed by GoldInvestors.news are from the personal research and experience of the owner of the site and are intended as educational material. Although best efforts are made to ensure that all information is accurate and up to date, occasionally unintended errors and misprints may occur.