Dan Niles thinks the stock market is headed down. Maybe much less.
Niles, a Stanford-trained electrical engineer who once worked for the old microcomputer giant, has focused on tech stocks for more than 30 years, initially as a sell-side analyst at Robertson Stevens and Lehman Brothers. He moved to the buy side in 2004 and now manages Satori Fund, a technology-focused hedge fund. It’s black this year, though
23% loss, due to smart trading and some smart short sales.
Niles came off a bear year, and his fears were exacerbated. He thinks we’re heading into a recession, and sees
Standard & Poor’s 500
The index is down around 3000 – down 25% from here – or possibly lower. He details his bleak view — and shares a few stock picks — in the edited interview below.
Baron: Dan, when we talked in late December about the outlook for 2022, you told me your best pick was cash. “It’s going to be a tough year for anything in technology,” I said. This was spot on, but after the sell-off we’ve seen, why are you still bearish?
And the Niles: As the year came on, we focused on two things. The first is that we didn’t want to fight the Fed. The second is that we don’t want to fight the basics. With this year coming, our expectation was that the market would decline by at least 20%. In May, we revised those forecasts down 30% to 50%, from peak to trough by sometime in 2023.
We thought inflation would rise, and as a result, the Fed would be more aggressive than others had expected. Structurally, three things have been put in place to make inflation hotter. The labor market was shrinking, as the number of vacancies, relative to the number of unemployed, reached a record level. The second piece was commodity inflation. After the 2008-2009 recession, people did not invest in capacity for commodities such as coal, oil, and copper. Our view was that if demand was to be stronger than expected, then commodity prices would rise. The final piece was that we thought the housing market, with record low interest rates, would be very strong.
How do your inflation expectations explain your concerns about company fundamentals and stock valuations?
What does high inflation do? It reduces corporate earnings – and equity multiples.
From mid-June through mid-August, the Nasdaq Composite Index rose 20%. Then Federal Reserve Chairman Jerome Powell burst the bubble. Did people just cheat?
Earlier this year, I looked at all the bear markets since 1920. And every single time, you get sharp spikes. You lost 49% of your money, peak to trough, in the tech bubble of 2001, and 57% in the 2008-2009 recession. Either way, you had five gains in the S&P 500 of 18% to 21% on your way to the bottom. In the Great Depression, you had five upsurges of more than 25% between the crash in September 1929 and the bottom in June 1932, on your way to losing 86% of your money. So, summer wasn’t really anything special. People think, “Earnings estimates have gone down enough; things should be fine.” But they’re not.
Some media commentary after Powell’s speech focused on lower oil and other commodity prices, rising retailer inventories, and falling home prices. Critics emphasized that the Fed is too hawkish.
That’s why Powell said in his speech that the Fed will likely have to leave rates higher for longer than most people expected. In the 1970s, the Federal Reserve started cutting interest rates very early, not once, but twice, just as inflation showed the first signs of decline. That’s why Powell said, “We’ve made this mistake before, and we won’t do it again,” stressing that we’ll go through some pain. He’s seen this picture before.
What about the bulls confirming that inflation is already declining?
About 70% of the US economy is service-related. Labor is two-thirds of the average company’s costs. Only 10% are related to the supply chain, and 10% are energy costs. The only way to deal with inflation is to raise unemployment rates.
Since November, we’ve had a big drop in tech stocks. What makes her attractive again?
The S&P 500 is trading about 20 times the excess earnings. If you look at 70 years of history, when the CPI was above 3%, the price/earnings ratio, on average, was 15 times. That’s a pretty big drop from where we are today. And when the CPI is above 5%, the average price-to-earnings is 12 times. The last CPI report was 8.5%, and we’re trading 20 times. This seems unsustainable.
But some stocks are already down 70% or 80%.
I always like to ask investors: When a stock is down 90%, how much downside is left?
And of course the answer is 100%. Not 10%.
the correct. It can always go to zero. I recently read that about 5,000 Internet companies, public and private, went bankrupt in the 2001 and 2002 recessions. We haven’t seen that yet. But with interest rates rising, the economy slowing, and the balance sheets of some of these companies showing up where they are, you will see bankruptcies rebound in 2023.
Let’s talk about specific stocks. Two of your choices are high-volume hash bets, which some people may find surprising.
We are optimistic
[ticker: WMT] And the
[AMZN]. Look at the last recession. Walmart shares rose 18% in 2008 in a year in which the S&P 500 fell 38%. The company gained market share. If you listen to Walmart’s earnings calls, management is talking about the fact that consumers are trading down. You have more premium consumers who are shopping at Walmart. The company appears to be controlling its own inventory issues.
“Our plan is to sell [Apple] And go away after the launch of the iPhone 14 on September 7.“
Amazon’s valuation wasn’t nearly as low as Walmart’s, and I’ve seen growth slow from 44% in the March 2021 quarter to 7% in the June 2022 quarter. But, like Walmart, they will gain market share during the recession. Keep in mind that I don’t own these stocks in a vacuum – I’ve paired them with a basket of both online and offline retail stores. But the bottom line is that Walmart and Amazon are going to take retail market share from everyone else.
On the other hand, you are worried about the advertising market. What worries you?
If you go back to 2008-2009, ad revenue was down more than 20% in two years. At that point, the Internet accounted for 12% of the total advertising market. Now, the digital figure accounts for two-thirds of all ad spend. With the advertising stagnation, which we are likely to see next year, companies relying on digital advertising cannot escape; They are just too big.
Also, TikTok is taking market share from other social media companies, such as
(pop, explode). And the
[NFLX] It launches an ad-supported category. Those are dollars that could have gone to others.
[AAPL]As far as she talks about privacy, she is seeing her advertising business take off. You can short those ad-supported companies against Amazon for a long time.
What do you think of Apple?
We are tall now. Over the past decade, the stock has outperformed 60% of the time in the weeks leading up to product launches. But our plan is to sell and sell after the iPhone 14 launch on September 7. This reflects which direction we think the economy is headed, what higher price points for new phones are likely to be, and the fact that you’re starting to see high-end consumer spending weaken. I find it hard to believe that Apple’s revenue growth will accelerate from the 2% it reported in the June quarter to the 5% range, which some analysts expect for next year.
Dan, you’ve remained an optimist in the gambling sector. why?
[PENN] And the
[DKNG]. In the last recession, revenue from the Las Vegas segment fell 20%. But Penn Entertainment, which owns the regional casinos and racetracks, is down just 5% in that period. I expect them to hold on much better. We own DraftKings for online sports betting. About 20 states have legalized online betting, and we think California will follow. Both companies are down about 75% from their highs. Revenues this year are supposed to increase by 60% and double by 40% over the next three years. It is one of the last markets to go digital.
You have been working at
That’s right, although my position is hedged against other chip sales. Intel, at one point, was considered irreplaceable. They did everything they could to shoot themselves, fall behind in manufacturing, miss product launch dates over and over again, and lose market share to the
Advanced Micro Devices
[AMD]. They will lose more market share next year to AMD. People are pushing them back to double-digit earnings per share growth next year; They will be lucky if the profits are constant. But with new CEO Pat Gelsinger, an engineer is back in charge. They have a senior financial manager at Dave Zinsner, who just came from
[MU]. The stock is trading at a profit of 13 times.
Intel’s key is to move forward with its contract chip-making business. But wouldn’t that take a lot of time and money?
yes. But they just signed a big foundry client in
[2454.Taiwan], which is a large Taiwanese chip company. If they can find another big customer, inventory might be a better performer.
The cardinal card is China’s strained relationship with Taiwan.
One of the dangers we saw coming this year was Russia’s invasion of Ukraine, which it did. Another example we mentioned is the reunification of China with Taiwan, which we still believe will happen in the next five years. The day you hear China move in Taiwan, you’ll see Intel go up 10% or 20%. This is a geopolitical hedge.
You can see at least another major company sticking to Intel’s fab lists before the end of the year. And at some point, you can see which Apple you rely on so much
[TSM]Establishing a relationship with Intel Corporation. Intel is perhaps the most hated big-cap semiconductor company, but in this multiplier, it’s an interesting idea.
write to Eric J. Savitz at email@example.com
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