Dan Niles thinks the inventory market is headed decrease. Maybe lots decrease.
A Stanford University–educated electrical engineer who as soon as labored on the previous minicomputer big Digital Equipment, Niles has targeted on tech shares for greater than 30 years, initially as a sell-side analyst at Robertson Stephens and Lehman Brothers. He moved to the purchase facet in 2004, and now runs the Satori Fund, a tech-focused hedge fund. It is within the black for the yr, regardless of the
Nasdaq Composite’s
23% loss, attributable to nimble buying and selling and a few sensible quick gross sales.
Niles got here into the yr bearish, and his worries have solely deepened. He thinks we’re headed for a recession, and sees the
S&P 500
index bottoming round 3,000—down 25% from right here—or possibly decrease. He particulars his grim view—and shares just a few inventory picks—within the edited interview under.
Barron’s: Dan, once we talked in late December in regards to the outlook for 2022, you informed me that your prime decide was money. “It will be a tough year for anything in tech,” you stated. That was spot-on, however after the selloff we’ve seen, why are you continue to bearish?
Dan Niles: Coming into the yr, we had been targeted on two issues. The first was, we didn’t wish to struggle the Fed. And the second was, we didn’t wish to struggle the basics. Coming into this yr, our expectation was that the market can be down at the least 20%. In May, we revised that forecast to down 30% to 50%, peak to trough, by someday in 2023.
We thought inflation would decide up, and that, because of this, the Fed can be extra aggressive than others had been anticipating. Structurally, three issues had been in place to make inflation run hotter. The labor market had tightened, with the variety of job openings, relative to the variety of unemployed, at a document stage. The second piece was commodity inflation. After the 2008-09 recession, individuals didn’t spend money on capability for commodities corresponding to coal, oil, and copper. Our view was that if demand was going to be stronger than anticipated, commodity costs would rise. The last piece was that we thought the housing market, with record-low rates of interest, can be very sturdy.
How does your inflation outlook inform your worries about company fundamentals and inventory valuations?
What does larger inflation do? It drives down company earnings—and inventory multiples.
From mid-June via mid-August, the Nasdaq Composite surged 20%. And then Federal Reserve Chairman Jerome Powell popped the bubble. Were individuals simply deluded?
Earlier this yr, I checked out all of the bear markets since 1920. Every time, you get sharp rallies. You misplaced 49% of your cash, peak to trough, within the tech bubble in 2001, and 57% within the recession of 2008-09. In each circumstances, you had 5 rallies within the S&P 500 of 18% to 21% on the best way to the underside. In the Great Depression, you had 5 rallies of greater than 25% between the crash in September 1929 and the underside in June 1932, in your approach to shedding 86% of your cash. So, the summer season actually was nothing particular. People thought, “Earnings estimates have come down enough; things should be fine.” But they’re not.
Some of the media commentary after Powell’s speech targeted on the drop in oil and different commodity costs, retailers’ extra inventories, and softening housing costs. Critics asserted that the Fed is being too hawkish.
That’s why Powell stated in his speech that the Fed will doubtless have to go away charges larger for longer than most individuals have anticipated. In the Nineteen Seventies, the Fed not as soon as, however twice, began reducing charges too early, simply as inflation confirmed the primary indicators of coming down. That’s why Powell stated, we’ve made this error earlier than, and we’re not going to do it once more, and burdened that we’re going to undergo some ache. He has seen this image earlier than.
What in regards to the bulls’ assertion that inflation is already easing?
About 70% of the U.S. financial system is tied to providers. Labor is two-thirds of prices for the typical company. Only 10% is tied to the provision chain, and 10% is vitality prices. The solely approach to take care of inflation is to drive unemployment larger.
Since November, we’ve had an enormous downdraft in tech shares. What would make them enticing once more?
The S&P 500 trades for about 20 instances trailing earnings. If you look again at 70 years of historical past, when the patron worth index has been above 3%, the trailing worth/earnings ratio, on common, has been 15 instances. That’s a reasonably large drop from the place we’re in the present day. And when the CPI has been above 5%, the typical P/E has been 12 instances. The final CPI report was 8.5%, and we’re buying and selling at 20 instances. This appears unsustainable.
But some shares are already down 70% or 80%.
I at all times prefer to ask buyers: When a inventory is down 90%, how a lot draw back stays?
And, in fact, the reply is 100%. Not 10%.
Right. It can at all times go to zero. I learn not too long ago that about 5,000 web corporations, each private and non-private, went bankrupt within the 2001 and 2002 downturn. We haven’t seen that but. But with charges going up, the financial system slowing down, and steadiness sheets for a few of these corporations the place they’re, you’re going to see bankruptcies decide up in 2023.
Let’s speak about particular shares. Two of your picks are large-cap retail bets, which some individuals may discover shocking.
We’re bullish on
Walmart
[ticker: WMT] and
Amazon.com
[AMZN]. Look again on the final recession. Walmart shares rallied 18% in 2008 in a yr wherein the S&P 500 declined 38%. The firm gained market share. If you hearken to Walmart’s earnings calls, administration talks about the truth that shoppers are buying and selling down. You’ve bought extra high-end shoppers buying in Walmart. And the corporate appears to be getting its stock points underneath management.
“Our plan is to sell [Apple] and go short after the iPhone 14 launch on Sept. 7.”
— Dan Niles
Amazon’s valuation isn’t practically as little as Walmart’s, and also you’ve seen development gradual from 44% within the March 2021 quarter to 7% within the June 2022 quarter. But, like Walmart, they will achieve market share throughout a recession. Keep in thoughts that I don’t personal these shares in a vacuum—I’ve them paired towards a basket of shorts of on-line and offline retailers. But the underside line is that Walmart and Amazon are going to take retail market share from all people else.
On the opposite hand, you’re fearful in regards to the promoting market. What issues you?
If you return to the 2008-09 interval, advert revenues dropped greater than 20% in two years. At that time, the web was 12% of the general advert market. Now, digital is two-thirds of all advert spending. In an promoting recession, which we’re more likely to have subsequent yr, corporations reliant on digital promoting can’t escape; they’re simply too huge.
Also, TikTok is taking market share from different social-media corporations, like
Meta Platforms
(META) and
Snap
(SNAP). And
Netflix
[NFLX] is launching an ad-supported tier. Those are {dollars} that may have gone to others.
Apple
[AAPL], as a lot because it talks about privateness, is seeing its advert enterprise take off. You can quick these ad-supported corporations towards an Amazon lengthy.
What is your considering on Apple?
We’re lengthy proper now. Over the previous decade, the inventory outperformed 60% of the time within the weeks main as much as product launches. But our plan is to promote and go quick after the iPhone 14 launch on Sept. 7. That displays the place we predict the financial system goes, what is going to doubtless be excessive worth factors for the brand new telephones, and the truth that you’re beginning to see high-end shopper spending weaken. I’ve a tough time believing Apple’s income development will speed up from the two% they reported within the June quarter to the 5% vary, which some analysts expect for subsequent yr.
Dan, you’ve stayed bullish on the playing sector. Why?
We personal
Penn Entertainment
[PENN] and
DraftKings
[DKNG]. In the final recession, income from the Las Vegas strip fell 20%. But Penn Entertainment, which owns regional casinos and race tracks, was down solely 5% in that interval. I anticipate them to hold in lots higher. We personal DraftKings due to on-line sports activities betting. About 20 states have legalized on-line betting, and we predict California will comply with. Both corporations are down about 75% from their highs. Draft-Kings ought to develop income this yr by 60%, and compound at 40% over the subsequent three years. It is without doubt one of the final markets to go digital.
You’ve been dabbling in
Intel
[INTC].
That’s true, though I’ve my place hedged towards different chip shorts. Intel, at one level, was thought-about unassailable. They did every thing they might to shoot themselves within the head, falling behind on manufacturing, lacking product launch dates again and again, and shedding market share to
Advanced Micro Devices
[AMD]. They are going to lose extra market share subsequent yr to AMD. People have them returning to double-digit earnings-per-share development subsequent yr; they’ll be fortunate if earnings are flat. But with new CEO Pat Gelsinger, they’ve an engineer again in cost. They have an awesome CFO in Dave Zinsner, who simply got here aboard from
Micron Technology
[MU]. And the inventory trades at 13 instances earnings.
The key for Intel is getting their contract chip-making enterprise going. But received’t that take plenty of money and time?
Yes. But they only signed on a serious foundry buyer in
MediaTek
[2454.Taiwan], a big Taiwanese chip firm. If they will discover one other massive buyer, the inventory could possibly be a greater performer.
The wild card is China’s testy relationship with Taiwan.
One of the dangers we noticed coming into this yr was Russia invading Ukraine, which is what occurred. Another we cited was China’s reunification with Taiwan, which we nonetheless assume will occur within the subsequent 5 years. The day you hear that China is shifting on Taiwan, you’re going to see Intel rally 10% or 20%. This is a geopolitical hedge.
You might see at the least one different main firm decide to Intel’s fabs earlier than yr finish. And in some unspecified time in the future, you possibly can see Apple, which is so reliant on
Taiwan Semiconductor
[TSM], strike a relationship with Intel. Intel might be essentially the most hated large-cap semiconductor firm, however at this a number of, it’s an fascinating thought.
Thanks, Dan.
Write to Eric J. Savitz at eric.savitz@barrons.com