Niles got here into the 12 months 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 perhaps decrease. He particulars his grim view—and shares a number of inventory picks—within the edited interview under.

Barron’s: Dan, when we talked in late December in regards to the outlook for 2022, you informed me that your high decide was money. “It is going to be a troublesome 12 months for something in tech,” you mentioned. That was spot-on, however after the selloff we’ve seen, why are you continue to bearish?

Dan Niles: Coming into the 12 months, we had been centered on two issues. The primary was, we didn’t need to battle the Fed. And the second was, we didn’t need to battle the basics. Coming into this 12 months, our expectation was that the market could be down not less than 20%. In Might, we revised that forecast to down 30% to 50%, peak to trough, by someday in 2023.

We thought inflation would decide up, and that, in consequence, the Fed could 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 file stage. The second piece was commodity inflation. After the 2008-09 recession, folks didn’t put money into 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 ultimate piece was that we thought the housing market, with record-low rates of interest, could be very robust.

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%. After which Federal Reserve Chairman Jerome Powell popped the bubble. Have been folks simply deluded?

Earlier this 12 months, I checked out all of the bear markets since 1920. Each 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 instances, you had 5 rallies within the S&P 500 of 18% to 21% on the best way to the underside. Within the Nice Despair, you had 5 rallies of greater than 25% between the crash in September 1929 and the underside in June 1932, in your solution to shedding 86% of your cash. So, the summer time actually was nothing particular. Folks thought, “Earnings estimates have come down sufficient; issues needs to be high quality.” However they’re not.

A number of the media commentary after Powell’s speech centered 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 mentioned in his speech that the Fed will doubtless have to go away charges larger for longer than most individuals have anticipated. Within the Seventies, the Fed not as soon as, however twice, began chopping charges too early, simply as inflation confirmed the primary indicators of coming down. That’s why Powell mentioned, we’ve made this error earlier than, and we’re not going to do it once more, and harassed 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. economic system is tied to providers. Labor is two-thirds of prices for the typical company. Solely 10% is tied to the provision chain, and 10% is vitality prices. The one solution 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 happen to look again at 70 years of historical past, when the buyer value index has been above 3%, the trailing value/earnings ratio, on common, has been 15 instances. That’s a reasonably large drop from the place we’re at present. 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.

However some shares are already down 70% or 80%.

I at all times prefer to ask traders: When a inventory is down 90%, how a lot draw back stays?

And, after all, the reply is 100%. Not 10%.

Proper. It may at all times go to zero. I learn lately 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. However with charges going up, the economic system slowing down, and stability sheets for a few of these corporations the place they’re, you’ll see bankruptcies decide up in 2023.

Let’s discuss particular shares. Two of your picks are large-cap retail bets, which some folks 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 12 months during which the S&P 500 declined 38%. The corporate gained market share. If you happen to hearken to Walmart’s earnings calls, administration talks about the truth that shoppers are buying and selling down. You’ve received extra high-end shoppers purchasing in Walmart. And the corporate appears to be getting its stock points beneath management.

Amazon’s valuation isn’t practically as little as Walmart’s, and also you’ve seen development sluggish from 44% within the March 2021 quarter to 7% within the June 2022 quarter. However, like Walmart, they will acquire market share throughout a recession. Understand 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. However the backside line is that Walmart and Amazon are going to take retail market share from everyone else.

However, you’re nervous in regards to the promoting market. What considerations you?

If you happen to 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 prone to have subsequent 12 months, corporations reliant on digital promoting can’t escape; they’re simply too huge.

Additionally, 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. These are {dollars} that might have gone to others.

Apple

[AAPL], as a lot because it talks about privateness, is seeing its advert enterprise take off. You may quick these ad-supported corporations towards an Amazon lengthy.

What’s 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. However our plan is to promote and go quick after the iPhone 14 launch on Sept. 7. That displays the place we predict the economic system goes, what is going to doubtless be excessive value 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 12 months.

Dan, you’ve stayed bullish on the playing sector. Why?

We personal

Penn Leisure

[PENN] and

DraftKings

[DKNG]. Within the final recession, income from the Las Vegas strip fell 20%. However Penn Leisure, which owns regional casinos and race tracks, was down solely 5% in that interval. I count on them to hold in so much higher. We personal DraftKings due to on-line sports activities betting. About 20 states have legalized on-line betting, and we predict California will observe. Each corporations are down about 75% from their highs. Draft-Kings ought to develop income this 12 months by 60%, and compound at 40% over the following three years. It is likely 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 may to shoot themselves within the head, falling behind on manufacturing, lacking product launch dates time and again, and shedding market share to

Superior Micro Units

[AMD]. They’ll lose extra market share subsequent 12 months to AMD. Folks have them returning to double-digit earnings-per-share development subsequent 12 months; they’ll be fortunate if earnings are flat. However with new CEO Pat Gelsinger, they’ve an engineer again in cost. They’ve an ideal CFO in Dave Zinsner, who simply got here aboard from

Micron Know-how

[MU]. And the inventory trades at 13 instances earnings.

The important thing for Intel is getting their contract chip-making enterprise going. However gained’t that take a number of money and time?

Sure. However they simply signed on a serious foundry buyer in

MediaTek

[2454.Taiwan], a big Taiwanese chip firm. If they’ll discover one other giant buyer, the inventory may very well be a greater performer.

The wild card is China’s testy relationship with Taiwan.

One of many dangers we noticed coming into this 12 months was Russia invading Ukraine, which is what occurred. One other we cited was China’s reunification with Taiwan, which we nonetheless suppose will occur within the subsequent 5 years. The day you hear that China is shifting on Taiwan, you’ll see Intel rally 10% or 20%. This can be a geopolitical hedge.

You might see not less than one different main firm decide to Intel’s fabs earlier than 12 months finish. And in some unspecified time in the future, you 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 attention-grabbing concept.

Thanks, Dan.

Write to Eric J. Savitz at [email protected]