Dan Niles: Be Nimble - 30-50% AI Crash By 2027

0:00Who do you think are best placed for the next three to five years of the mega caps? It's obviously Google. I mean, as I said earlier, they have the full stack and they're the ones you should bet on. And unless something drastically changes, they will continue to be the winner going forward because they've got everything and they've got the massive cash flow to fund it. So in the short term, are semis at the most overbought they've been since 2000 or 1995 before they had horrific corrections? Absolutely. But if you're taking a longer term view and you're trying to pick individual names, Intel's just gone back to where it was in 2000 this past year.

0:41And it's still undervalued. To me, it doesn't make sense that the stock market's at an all-time record high and oil prices are up 60 % this year. And the bond market we saw last week, the 30-year yields and the 10-year yields hit the highest levels for the year. Like, one of those is wrong. Should people have higher cash ratings than the normal right now? 100%.

1:13Welcome to the Master Investor Podcast with me, Wilfred Frost, where we celebrate and learn from the success of the greatest investors, business leaders, and politicians in the world, giving you, our listeners, the edge. The Master Investor Podcast is sponsored by LSEG, Interactive Brokers, the World Gold Council, and BNY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice, or a personal recommendation. More on that in the show notes. I am delighted to welcome back to the podcast, Dan Niles, founder and portfolio manager at Niles Investment Management and one of the leading tech hedge fund managers of the last decade.

2:03Dan, you were the Master Investor Podcast's first guest just under a year ago. A very good afternoon from London. Good morning to you there on the East Coast in Florida. Thanks for coming back. My pleasure, Wilford. It's always great to see you. And what great timing, because we've just had a bumper week of earnings from the tech side of the bargain over the last couple of weeks. And markets obviously back at all time highs in light of that and some other factors, despite a lot of challenges ahead. I wanted to start though with this comparison you made a couple of weeks back right at a day off pretty much the the short-term market lows that we got in the middle of the Iran war you you wrote this on the 31st of March history may not repeat itself but it often does rhyme and you're comparing 2026 there, not to 1999, not to 2008, not to some of these final years of great bull runs, but to 97, 98.

3:08Just talk me through why you made that comparison, which, by the way, turned out to be right near the short-term lows. Yeah. I mean, if you look back and compare where we are today, you're about three years into this build out for the AI infrastructure. ChatGPT came out at the end of 2022. So you're, you know, entered year four. If you go back to that time period, 97, 98, and use Netscape Navigator's launch as kind of the starting point of this new thing called the internet, then 97, 98, you were in years three and four of the internet infrastructure build out. But back then in 97, as you may remember, you had the Thailand currency crisis.

4:00And so then the S &P dropped 11 % intra-year in 1997. And then in 1998, you had the Russian bond default and the failure of long-term capital management. and the S &P went down 19 % intra-year. But if you look at the full years, 97 after that 11 % intra-year drop finished the year up 31%. In 98, the S &P finished after that 19 % intra-year drop up 27. And why was that? It's because you had this backdrop of this huge underlying build out of this new thing called the internet. And so that's kind of where we are today in that, yes, you have this macro issue around oil in Iran, but in some ways it's a lot easier to deal with, right?

4:49Because that was a man-made event, the war. Whereas those currency crisis, Russian bond default, you could say was more structural several years in the making. And so that's why I thought this would be the bottom. We'd get through the war, obviously. And then the markets would continue to bounce off those levels and continue to run up because of this AI infrastructure build out. And one specific thing being agentic AI really kicking off in the beginning of the year. So all through last year, Dan, and as I said, and I refer people back to our conversation last June, You were saying, and you talked about the need to be nimble in markets, that you were going to get bearish, that the huge bull run in AI-related stocks that we were already enjoying was going to take a pause at some point.

5:45Did we essentially get that forced because of a geopolitical event in the Iran war? And now it's done and dusted so we can go on to another meaningful, at least year-long bull run in these tech stocks? Sort of yes and no. You did get a reset because of the Iran war. But the big thing that happened was this thing called agentic AI. And by that, what I mean is your viewers may be familiar with this thing called ClawedBot that came out at the end of November and it morphed. And by January 30th, it was called OpenClaw. And so what that enabled you to do was before you would ask your chat GPT or Gemini a question, it would give you an answer.

6:29So that's chat-based AI. With Agentic, you might go ahead and say, hey, this is Wilfred and go get me this data from the BBC website. Go get me this data from the Bloomberg website. Go to CNBC, get me this other stuff, and then go ahead and put this all in Excel spreadsheet, well, that requires 10 to 100 times more tokens to be generated. And you can see that in the token generation data, where in the two months prior to January 30th in the formalization of OpenClaw, token growth was about 20 % over the prior two months. In the two months following, the token growth was over 120%. And that token growth is continuing to grow because corporations are just really starting to adopt this because this is kind of what the promise of AI was, which is you replace people with this agent that can then run, you know, 24 hours, 48 hours and get whatever project you want done versus just a chat-based AI query.

7:41So before we move on to the implication of Argentic and also the takeaways from MAG7 earnings, about the Iran war quickly, I mean, can you be bullish if the Iran war continues, even on these big tech structural themes in the background, if the Iran war or the strait remains closed for weeks and months from now, or do you need to see the strait reopen? You need to have it reopened. There's no question. I mean, you might, by some miracle, get out of this, but 10 out of the last 12 recessions have been preceded by a spike in oil prices, a sustained spike in oil prices. So if oil stays up at these levels in the mid-90s, and remember, we were sort of in the 60s before this started, you're probably going to be flirting with the recession by the time you get towards the end of this year.

8:38I mean, McDonald's, which reported recently, you know, surprisingly came out and said, hey, we're seeing some stress in our low end consumers. Their comp store sales missed. You know, obviously they're all over the world. And so when you see things like that start to pop up, you have to worry. And oil prices, they just seep into everything. But it takes time. So a spike and then a drop doesn't really matter. If it stays up at these levels for one to two quarters, you're going to have a huge issue because that'll seep into inflation. It'll go ahead and sap consumers' earnings power. And what we heard from McDonald's, you're going to hear from a lot of other companies going forward.

9:23And this is going to turn to a huge problem. And at that point, you're going to get a massive correction in the stock market. But the thing we know for sure, right, is we have an election in the United States coming up midterms in November. the incumbent party when you have a spike in oil prices leading into that just gets absolutely crushed and so president trump's going to want to get oil down and that means coming to some kind of resolution and from what you've seen right that's where he's going he's calling these things love taps these you know exchange of uh you know military actions by iran and the u.s which tells you he really wants this thing to end.

10:06Well, let's hope we get there. I do continue to wonder whether this is a harder genie to put back in the bottle than everyone might expect, but I guess we shall see.

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11:15Let's talk about Agentec AI because the other thing you wrote in your end of March post was the way in which this changes the bargain of which type of tech stocks are going to benefit the most. And in particular, focusing on the need of CPUs, rather than necessarily all the stocks that have performed previously. Expand on that for me a little. Sure. Well, as I said earlier, with the Gentic, you're doing multiple actions, multiple calls to APIs, opening up applications like an Excel or a Bloomberg or, you know, a CNBC website or SEC website, etc., and doing all of these things. And so you need an orchestration engine.

12:01You need something that goes ahead and organizes all of that. That's what CPUs do very well. And if you go back to training, you're just doing the same thing over and over and over again when you were training these AIs. that's what a GPU does incredibly well. And that's why you saw like an NVIDIA absolutely explode higher because CPUs weren't really valuable in training. You move to chat-based AI, again, that's pretty decent for a GPU. But now when you move to a Gentic, that's great for a CPU. So you went originally from about, let's say, eight GPUs for one CPU. when you move to a Gentic, that ratio gets closer to one to one.

12:46And so that just again shifts what kind of hardware you need to run this. And Intel has been given up for dead for decades, right? The stock has just gone back to its peak in 2000 this year. But between this move to a Gentic Plus the fact in Intel's case that they're probably going to end up with some pretty big foundry customers by the end of the year to help with supply being secure, being produced in domestic fabs run by U.S. companies in the United States. And in this case, Intel, that's really good for them. Obviously, it benefits names like AMD as well, which I also mentioned back then. Let's just dwell on both of those because you, as you said, correctly recommended them in March.

13:37I mean, Intel, as you've already wrenched, they've rallied so aggressively. Have you taken profits? Have you seen enough gains in just a matter of weeks? Well, I mean, here's the thing. There's obviously the short term and then there's the long term. If you think about it, we still haven't had NVIDIA or Apple or any of the people that have talked about getting a relationship or Tesla. with Intel starting to produce yet. If you look at it from a valuation basis and you say, okay, the one thing you know about semiconductor stocks is the earnings estimates are always wrong, right? They're either way too high or they're way too low.

14:21If you look at valuation and you say, well, I'm going to just look at it from an enterprise to sales basis. And you look at where an AMD is trading or TSMC, you can say, wow, you know, Intel is still undervalued relative to those companies on an enterprise value to sales basis. And so the stock should be able to continue to rise. And from a terminal value standpoint, like what is this stock worth two to three years from now, the composition of the business should look a lot different, right? They'll probably have some combination of NVIDIA, Apple, Tesla, others producing chips on their foundry business.

15:08And that will make the company a lot more valuable than what it was in the past. So in the short term, are semis at the most overbought they've been since 2000 or 1995 before they had horrific corrections? Absolutely. But if you're taking a longer term view and you're trying to pick individual names, Intel's just gone back to where it was in 2000 this past year. And it's still undervalued relative to what it can probably ultimately earn. And so would it surprise me to see the stock go down 15 to 20 % along with the entire semiconductor index over a short period of time, it wouldn't surprise me at all.

15:51But do I believe that by the end of the year, they'll be higher than where they are today? Yes. And Dan, what do you say when, just to broaden it out again, when you see the SOX, the SEMI's ETF up 70 % year to date, in light of also having, by the way, had the Iran war challenge, and people say it's 1999, not 97, 98. Do you have to rethink your thesis there when you see those really attention-grabbing performance statistics in the short term? No, because the other side of it, Wilfred, is that Agentic requires 10 to 100 times more tokens than chat-based AI. And so that's the difference. You're not talking about a small change.

16:40You're talking about an absolutely enormous change. I think when you look at where CapEx growth is right now, you can see that the numbers have moved up pretty dramatically. So you started the year thinking hyperscaler CapEx up maybe around 30 % for the year. Then Q1 guidance was given when companies reported Q4 results in January, February. And then that number moved from 30 % CapEx growth for 2026 up to about 60%. Then, you know, a couple of weeks ago, the big hyperscalers all reported again. And that number moved from 60 % CapEx growth to 70%. And so then this ties back to the fact that you're not talking about a small change in token generation required with Agentic.

17:34you're talking about 10 to 100 times more tokens needed when you do an agentic query relative to a chat-based query. Before we move on to earnings, and there was obviously some phenomenal numbers in the last couple of weeks from the big tech players, you mentioned the shift from the need for GPUs to CPUs. Is that bad news for NVIDIA? Well, on the margin, it'll change how the stock performs. That one, obviously, Broadcom's another one relative to some of the other players, right? Because Agentic requires more memory. It requires with some of the architectural shifts underneath, it requires more optical.

18:14And so you only have a limited budget. You don't have infinite money out there. And so what you're going to spend that money on is going to shift. And if the ratio was eight GPUs to one CPU, and that ratio is going to move closer to one-to-one, then obviously the stocks that are tied to that, those will be the ones you want to take a look at. And so that's why for me, the microprocessor vendors are a lot more interesting right now than the GPU vendors or other parts of the food chain. Hi guys, it's Wilf. I hope you're enjoying this episode. Just a quick reminder to please hit follow or subscribe on your podcast or video app so that you never miss an episode.

19:00And if you've got time, please do give us a five-star rating and leave us a comment. It really helps other people find the podcast too. Now, back to the episode. Let's dwell on earnings of the big tech players that we've seen over the last couple of weeks. Is Google Alphabet the standout of the mega caps? I mean, absolutely. I mean, you're seeing it in the numbers, right? Where if you look at Google Cloud for the fourth quarter, the growth rate year over year was 48%. When they reported the March quarter, that growth rate went from 48 to 63. So that's a 15 % acceleration. You look at AWS, that growth rate went from 24 % to 28%.

19:47So 4%, given that they're the biggest of the hyperscalers, that's not bad. You look at Microsoft, however, and you go, that growth rate went from 38 to 39. And so, you know, they're clearly the one that's struggling. But it's still accelerating slightly. And that's why you can look at kind of these are the numbers versus what these companies are all saying and see who's actually executing well and picking up a lot of share. And what do you think Google are doing well at the moment? Well, the thing is, Google has the full stack, right? If you look at them, they've got a leading large language model in Gemini, right?

20:30Microsoft relies on OpenAI, so they don't have one of their own. Amazon, who's heard of Rufus? So they've got that. They've obviously got their own chips. They've been producing their own internal chips for over a decade, which is the longest of any of the three. You've also got enormous cash flows funded by their ads business. And then you have N devices that they can distribute this technology through with their Pixel phones, which are really the model for the entire Android ecosystem, which is over 75 % of all smartphones sold wide are Android phones. So they've really got that full stack from top to bottom, which no other company has.

21:11Let's touch on Apple next. Is Tim Cook announcing his departure at a moment in time when he wants to think about his long-term share price performance? I mean, I'm not sure exactly what his motivation is, but I would say this. If you look at what Tim Cook did well, he was really good about the supply chain continuing on the legacy of Steve Jobs. When he took over, don't forget, the iPad had just been launched. And so the year he took over, Apple's revenues were growing 60%. And the next year, I think it grew like 40%. And then the growth obviously has slowed down since then. And so what innovative products have really come out?

22:03There hasn't been a lot. If you think about the last one, it was this Vision Pro ski goggles, as I like to call them, and nobody bought those. And so I think now putting a hardware guy in charge that hopefully can give you some innovative products, I think that's going to be interesting. And this year you should get a AI-enabled Siri, right? And they're a couple of years late on this product. And finally get a foldable iPhone probably late this year, early next year. And that should drive a pretty big upgrade cycle, because when you've seen big upgrade cycles, typically they're driven by changes in the form factor.

22:45And you saw that with the change to the iPhone 6, where you went from a four inch screen size to a five and a half inch screen size. And the growth accelerated from 7 % growth on the top line to 28 % growth on the top line in their next fiscal year. So I think that's what I'm kind of looking at and excited about. Obviously, the valuation is really high. But what you've seen is that people sort of do seem to treat their iPhones like consumer staples products. I mean, it's shocking to me. And Apple was one of my top picks coming into this year. But it's still surprising, even with oil prices as high as they are, that you've had the fastest two quarters of year over year growth rate since 2021 when you had COVID and everybody had to figure out how to work from home and were buying iPhones and everything else to make that happen.

23:41Let's touch on Meta. I mean, a lot of people have dwelt on Meta for a couple of quarters now with worsening free cash flow metrics. Were they the worst set of the MAG7 numbers that we've just had? Do they actually worry you or is it overdone that concern? Yeah, I don't think it's overdone because, again, if you go back to, well, who has a stack? You know, Meta has, with their latest launch, a model that's not too bad, right, in terms of large language model. But what they don't have is Amazon, Google, Microsoft all have a public cloud. And so they can go ahead and sell excess capacity to other companies.

24:23Meta doesn't have that. and they're pretty late in terms of trying to develop their own ASIC chip so that they can get their costs down. Obviously, they've got big cash flows. They've got great monetization. The other thing, though, which has nothing to do with AI, which should bother you, is this March quarter, they saw the first decline sequentially in history of people using their family of apps. So if you think about what they do, they sell ads, right? So how do you make money? Well, there's two ways. You get more users and you make more money per user. You now, it looks like you might've reached a saturation point on the adding more users part of it.

25:10And so you're taking away potentially one leg of growth, which makes sense, right? You've got three and a half billion people using their app, which obviously it's not allowed in China. And so that's a big percentage of the entire world's population. And so it had to happen at some point. And so that should concern you from a growth standpoint, combined with the fact of no public cloud. In terms of who the ultimate winners are of the mega caps, we've mentioned most of them in the last 15, 20 minutes. Who do you think are best placed for the next three to five years of the mega caps? It's obviously Google.

25:51I mean, And as I said earlier, they have the full stack and they're the ones you should bet on. And unless something drastically changes, they will continue to be the winner going forward because they've got everything and they've got the massive cash flow to fund it.

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26:54That's all the positives, I guess. Let's talk about some of the negatives of the AI trade overall. In the latest set of earnings, the FT's done a great piece of this. They pointed to the fact that about a third, 34%, much higher than normal, much higher than in recent years, of profits came under the guise of the income for the MAG7 names, which includes, but isn't totally reliant on revaluation of their non-listed assets, like the open AIs of this world or stakes in the anthropics of this world. Does that worry you when we're all celebrating big increases in earnings, but it's not all increases in free cash flow and it could fall as quickly as it's risen in future quarters?

27:46Yeah, absolutely. I'm approaching it from a different angle. I look at it and say, well, when did Eugenic AI come out? Well, you could say January 30th if you want to take the formalization of OpenClaw. So when should that ramp start to decelerate massively? Well, probably early next year. What do I think happens to these stocks sometime early next year from wherever they get to, they probably go down 30 to 50%. And so you've definitely, all of these structural issues you're seeing, they're definitely going to be a problem. And taking a very recent episode, so let's ignore the internet build out in 2001, 2002.

28:35Think about what happened in 2022. The Magnificent Seven as a group on average that year in 2022 went down 46%. That was the average change in the stock price. And that was just coming off of the build out of COVID. So fast forward to where the stocks are today, all the optimism out there. And I hear things like, well, you know what? Semiconductors might not be cyclical anymore. And so I start to laugh because I go, well, if you remember coming out of COVID, that's what a lot of people were saying. Well, you know, there's a structural build out and, you know, memory is not going to be cyclical.

29:19And then I think Micron had four quarters of negative gross margins. So by the nature of semiconductors, where it takes a couple of years to bring up a fab and demand can change. And you brought up earlier, Wilfred, which is 100 % true. What if this war doesn't get sorted out? Or even if it does get sorted out, much like the ExxonMobil CEO said at the beginning of May, it's going to take a, you know, it may take longer than what people think for this oil prices to normalize. You could have a huge issue as you get into, you know, early next year because of that. And you've got two companies that are accounting for half of the backlog at the hyperscalers, which is OpenAI and Anthropic.