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Wall Street’s ultimate bear warns of a recession and more pain for stocks ahead. Here are the buying opportunities he’s highlighting

March 23, 2022, 10:00 AM UTC

This veteran writer is always amazed at how the overwhelming share of Wall Street guests on TV business shows adopt the role of perpetual cockeyed optimists. Even throughout 2021 as U.S. stocks grew more and more outrageously overpriced by any conventional metrics, the money managers and market strategists frequenting CNBC, the Fox Business Channel or Bloomberg Television found ample grist for why shares would keep ripping higher. Among the rationales: Interest rates and inflation would stay super-slender for years to come; bonds offer such puny yields that money must keep flowing into stocks; and a new era of sustainable, double-digit earnings growth is here to stay.

But one prominent commentator didn’t join in the happy talk. He was a rare regular on the tube who reflected my view that the super-high-priced tech stocks that dominated the S&P and Nasdaq could never expand profits fast enough to justify their gigantic valuations. He’s Greg Branch, a CNBC contributor who manages portfolios as a partner at financial advisory firm 1847 Financial, and via his own outfit, Veritas Financial. I was especially captivated by Branch’s bearish comments on CNBC’s Squawk Box on March 9, after the S&P and Nasdaq had already declined by over 20% and 10% respectively from their late 2021 peaks. A great buying opportunity this is not, declared Branch. “We’re still left with an environment typified by rising rates and significantly decelerating corporate earnings,” he intoned. “It’s really hard to get multiple expansion in that environment. In fact, I believe we’ll get multiple contraction from here.”

In these spots, Branch, 48, projects a formal, zen-like image in the frame over the stock ticker. His onscreen dress is as contrarian as his views. Instead of the open collars and polo shirts sported by most other guests, the clean-domed, goateed Branch––who’s Miami-based––appears in tailored suits accented by floral pocket squares.

Branch’s grasp of market fundamentals led him to predict the collapse in super-pricey tech names, as well as the surge of inflation. So I wondered what makes him think markets are headed lower, and, in a continuing downtrend, where—if anywhere—investors can find good buys. Over a 90-minute phone conversation on March 16, Branch discussed the troubling macro headwinds, four sectors that should prosper going forward, from cloud computing to cybersecurity, and the background that took him from a blue-collar upbringing to studying classics at Princeton to talking more sense about stocks than practically anybody on the the air.

From studying Petronius to parsing the markets

Branch grew up in Riverhead, N.Y., only 80 miles from Wall Street, but a world away from the capital of capital. Riverhead is a working-class town where Long Island divides between the North Fork wine country and the gilded Hamptons. He was raised by his mother, a secretary at a vocational school who took night classes at a local community college. “At 13 and 14, I had to cook dinner for my younger brother and put him to bed,” recalls Branch. But he won acceptance at Princeton University to become the first member of his family, other than his mother, ever to attend college. At Princeton he majored in Greek and Latin literature, of all things, and wrote his thesis on The Satyricon, a satirical, often racy work from the first century A.D. by Roman writer Gailus Petronius. “My thesis gleaned all the issues Petronius had with Roman society in that day,” he says. “I wrote half of it in English and half in Latin.” In his emails, he highlights especially important points by preceding the insight with the Latin phrase nota bene.

Branch viewed himself as something of a Renaissance learner. He greatly enjoyed his courses in economics. “I wanted to show my quantitative bona fides,” he notes. “Then, a funny thing happened on the way to the forum.” While at Princeton, he took a summer internship at Goldman Sachs, and after graduating in 1996 cycled through jobs at McKinsey and Morgan Stanley before landing at Harvard Business School. Armed with an MBA, he switched to asset management. While at UBS during the financial crisis, he advised pension and hedge funds on topics ranging from troubled TARP investments to beaten-down stocks. “It was a great job until they didn’t pay me,” he says. In 2008, UBS told its top producers that it lacked the capital to pay them any bonuses. Branch, who says he’d been promised a seven-figure payout, left shortly thereafter.

He took a job with a smaller firm serving money managers in the Southeast, chiefly Florida and Georgia, and moved to Miami. “In the early 2010s, there were only a few pools of capital in the region,” he says. “I’d visit clients in Miami, Orlando, Atlanta, and Birmingham all in the same day.” Now he manages a substantial portfolio with a team of half-a-dozen analysts. His reading has shifted from the Greek and Latin classics to Lee Child’s novels featuring soldier-of-fortune Jack Reacher, who’s become his fictional hero. “He’s a huge guy at 6-foot-7 who’s highly intelligent and also an adventurer and a moralist,” says Branch.

Branch finds that too much investment advice is just too sunny

In addressing an investing audience, Branch believes that it’s critical to warn folks and funds when prices get totally out of whack with factors such as multiples, earnings, and interest rates that in the long run dictate future returns. He saw far too few of those alerts in the stomping bull market, and he still hears too many broad narratives about “can’t miss” technologies of the future, leavened by too little analysis. “Nobody pillories you for telling people they should buy stocks,” he says. “If you’re bullish, at some point in time you’ll be right. But it takes courage to be bearish.” Most of the investment world, he says, is always predicting that stocks are heading “up and to the right.”

“We’re expected to recognize when something goes to extremes, sending stocks too far up and to the right, signaling that markets are way overpriced,” adds Branch.

As for the view that investors shouldn’t time the market or individual stocks, Branch claims it’s bunk. “My job isn’t to say ‘buy and hold.’ It’s literally to time the market and individual names. We get paid to recognize excesses. Entry points matter,” he declares. Indeed, Branch believes that buying cheap is the top factor in notching superior gains.

Branch sees a market “bifurcated” between “fashionable” losers and “structural” winners

Branch sees three headwinds to today’s markets, negatives so strong that they’re likely to pull even the relatively good buys still lower. The first is rising interest rates. “Higher rates are a headwind for the overall market because they depress multiples, and the effect is most pronounced for stocks where earnings are low now, but that the market projects will grow incredibly fast going forward,” he observes. “With those tech and growth stocks, it’s future earnings we’re actually valuing, and that stream’s worth a lot less when rates rise. The markets were giving those stocks multiples they didn’t deserve.”

The second is decelerating earnings growth. S&P profits in 2021 swelled by an incredible 41% over their record level in 2019. But even the usually overconfident analysts polled by S&P predict a gain of just 6% for this year. Branch thinks the number will be in the low single digits. “Investors think that companies are on sale because they’ll repeat past earnings growth. But for most companies, that won’t happen,” he says.

The third is a continuation of rampant inflation. Branch says the forecast he’s most proud of is his call on inflation. In the summer of 2021, the consumer price index jumped to around 5%, from under 2% in February. Branch forecast on multiple networks in July and August that inflation would exceed 6% for the year, and ramp up from there. “I was concerned that far more jobs were available than people looking for work, and that we’d see a continuation of high wage inflation that would become embedded,” recalls Branch. “The Fed and most on Wall Street were saying that inflation was transitory and that the supply chains would restore themselves. I contended that was poppycock. I said that the situation would get much worse unless the Fed acted quickly.”

In his TV appearances, Branch argued that the Fed should raise rates in September of last year, when earnings were still great and consumer spending surged in the reopening. “I wanted the Fed to act when everything was roses,” he says. “Now the Fed will have to raise 1.5 points in the midst of geopolitical turmoil.” That delay, he says, poses two problems. First, it ensures that inflation will run hot unless the Fed takes strong action. Second, the Fed’s need to clamp down raises the risk of a recession.

Today’s persistently high inflation, says Branch, adds to the pressure that rising rates are already exerting on P/Es. That’s because investors become increasingly uncertain on how sharply the Fed will curb credit, potentially triggering a recession. That uncertainty prompts investors to seek safety by demanding more cents in earnings for every dollar they spend on equities.

All told, investors are simply way underestimating the dangers of the triple threat of rising rates, relatively stagnant earnings, and high inflation. “The market is currently pricing in the best-case scenario for earnings and prices,” says Branch. “The risks to the downside far outweigh any upside potential. I see another leg down from here for both profits and stock prices, even without a recession. Now, it’s far more likely that we see a recession this year than an upside surprise, which is the current consensus––in fact, the consensus is that we see mid-teen S&P gains from here.” If the economy skids into a downturn, he says, earnings could retreat to the levels of 2019, when the S&P finished the year at 22% below today’s levels.

Branch believes that investors should distinguish between two categories of companies whose stocks thrived in the past 18 months. The first are the “fashionable” players that temporarily feasted from roaring sales fed by the stay-at-home economy. Believing the trend will continue, investors rewarded them with giant valuations. But those favorites are already fading along with the pandemic. Among the fallen names that won’t come back, Branch points to Etsy, Peloton, and Snap. As for the latter, Branch says, “some people are old enough to remember Myspace. That’s fashion for me. And fashion goes out of fashion when you get better alternatives.”

For Branch, shrinking P/Es will hit almost all stocks. “This will be a two-step process,” he says. “When the market fully digests the impact of the unfolding risk factors and paucity of earnings growth in 2022, we’re going to see a pullback that will affect all companies.” So even his favorites may decline in the short term, presenting excellent buying opportunities. “Those are the ‘structural’ winners, the category killers, the ones building the cloud or delivering packages,” he says. “Those are the companies that benefit from secular tailwinds. They’re the ones that aren’t facing margin pressures, that aren’t facing top line challenges, that are already demonstrating robust, durable earnings growth. They sustain demand whether there’s no stimulus or fiscal support or if people go back to offices.” These companies don’t need multiple expansion, and can even withstand P/E contraction, and still deliver strong relative performance because of their solid earnings.

Last year, Branch was high on banks. Now he sees the category as neutral

“In July 2020, I was saying that bank multiples were so low they were crazy,” he says. “The markets falsely perceived that lenders were under the same duress as in the Great Financial Crisis. But the tougher capital requirements meant their balance sheets were in far better shape, and that they could withstand the stress of the pandemic.” Banks were selling at roughly one times book value, versus their normal level of around 1.7 times. He saw lending and capital market activities taking off for such diversified banks as J.P. Morgan, and a surge in IPO and capital markets business for both a Morgan and a Goldman Sachs. And that’s what happened. Since July 2020, the KBW Bank Index has rocketed 73%.

But now he thinks the fun’s probably over. “The P/Es are back in the normal range, meaning the banks aren’t nearly as cheap,” he says. Branch also cites several forces that could restrain earnings. “Banks borrow short and lend long, so even though rates are rising, the yield curve is flattening at the same time. Net interest margins may not be as good as in most rising rate periods,” he notes. Another negative: The capital markets business is unlikely to perform nearly as well as its blockbuster showing in 2021. He also thinks that credit losses, at tiny levels in the past year, will creep up. “Banks went out on the risk curve as the economy improved,” says Branch. “Household and corporate debt is rising. We’ll see more defaults that will hit profits, though nothing like the levels in the financial crisis.” On balance, Branch has shifted from highly enthusiastic to neutral on the banks.

Four sectors featuring “structural” champs that should keep thriving

The first group that Branch predicts will surmount the challenges of rising rates and high inflation is what he calls “the builders of the cloud.” “They’re not pulling demand forward; they’re constructing the computer infrastructure the world is moving to,” he says. The three main architects, he points out, are Alphabet, Microsoft, and Amazon. Once again, Branch doesn’t recommend specific stocks. But the trio epitomizes his “structural” designation. Alphabet grew its profits by 42% over the past four quarters, and Microsoft and Amazon posted 37% and 22% gains respectively. Alphabet (P/E: 24) and Microsoft (31) have relatively modest multiples, especially considering the size and staying power of their earnings, while Alphabet still looks somewhat pricier at a P/E of 48. Branch also likes the semiconductor giants that supply the builders with the right tools. The field’s giants include Nvidia (NVDA), Oracle (ORCL), Adobe (ADBE), and AMD (AMD). The fall in all their prices since their November peaks has raised their allure: Since then, Adobe’s down 36%, AMD 30%, Nvidia 25%, and Oracle 15%.

A second area in which Branch sees big potential is package delivery, the domain of FedEx (FDX) and UPS (UPS). “Demand in the industry will grow by 10% annually, and although the providers are making multibillion-dollar investments, capacity will grow much more slowly,” he says. “So the industry will have pricing power. It could increase margins by eliminating some of the less profitable economy services.” Both of the titans look like bargains. FedEx sells at 13 times earnings, and UPS at 15 times, and both are logging double-digit earnings increases.

A third sweet spot, says Branch, is payment services, a field ruled by Visa and Mastercard. “During the pandemic, we pulled forward 10 years of market share gains in e-commerce,” says Branch. “The crisis accelerated the move from physical to online shopping. You can pay in cash at Walmart, but the largest share of digital payments by far go by credit and debit cards. The industry captures most of that extra revenue.” He points out that the volume of debit card transactions is up 50% since 2019. Another potential bonus: The pandemic caused a big decline in cross-border transactions: Americans buying cosmetics in Paris, say, or German tourists dining in Manhattan. As cross-border spending inevitably returns to pre-crisis levels, the card companies should get an extra profit boost on top of today’s strong advances: Visa (V) garnered 27% earnings growth in the final three months of 2021, and earnings per share for Mastercard (MC) rose 43%.

The final selection: cybersecurity, an industry thrown into the spotlight by Russia’s invasion of Ukraine. “I deal with a number of municipalities that have told me that they’ve had breaches and that daily threats and attacks are rising significantly,” he says. “A number of states have allocated far bigger shares of their budgets to cybersecurity. Even before the current conflict broke out, channel checks at municipalities and corporations indicated that the number of daily threats/assaults was dramatically rising.” He observes that Vladimir Putin’s chief retaliatory weapon versus the U.S. is cybercrime. Among the industry’s prominent players are CrowdStrike (CRWD), Okta (OKTA), Zscaler[/hotlink] (Z), Palo Alto Networks, and Telos. All have strong revenue growth, and all except Palo Alto (which is flat) are significantly down from their highs of late last year, even after recent gains due to the geopolitical upheaval. Branch thinks the industry’s poised for a rise in M&A activity that could greatly benefit investors.

It’s one of the century’s big secular trends, says Branch. As the cloud takes on more of our personal and professional lives, as we transact more over the internet and as more of the data we use is increasingly stored and retrieved from the cloud, we’ll see a commensurate rise in our need for security.

It’s interesting that the fields Branch picked aren’t conventional deep value choices. The reason is that value needs P/E expansion, and that’s not going to happen, he argues. Many of the leaders in his categories still have relatively high multiples, even after the recent selloff. Branch says that negative macro factors will probably drive most stock prices still lower, regardless of quality and even in the categories he recommends. Hence, it’s probably a good idea to wait for lower prices before shopping.

The kid from Riverhead is also a kind of moralist, a highly analytical truth-teller on the financial markets. It’s a role that’s all too rare on Wall Street, a world where fashion and momentum too often dominate the mindset, and the airwaves.

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