Welcome to Market Overtime on Schwab Network. I'm Diane King Hall.
Today's guest has been one of the top tech stock pickers in recent memory, bringing his decades of experience to help him call the 2024 market rally and Cisco's rally last year. But entering 2026, he's warning that things may be different. Joining me now is Dan Niles, founder of Niles Investment Management, with his 2026 market outlook and his top five stock picks. Dan, it is great to have you back on Market Overtime. I love hearing your perspective, whether it's here on Schwab Network or elsewhere. As you know, I'm a longtime listener. So let's talk about the setup for this year. We've had a few years momentum for the S&P 500. Let's talk broad strokes. What's your big picture outlook for 2026?
Well, I think it's going to continue where 2025 left off in the sense that you're starting the year with easy money. And what I mean by that is the Fed in December switched from selling bonds to then they started buying 40 billion a month in short-term treasuries, so call it QE. In May, you're going to get a new Fed chair who's only going to be appointed by President Trump if he wants to cut rates by at least another 100 bips. So that'll keep the easy money going. And then you've got the tax benefits of the big beautiful bill hitting in Q1 where consumers are going to get 100 to 150 billion extra in tax refunds and then corporations will get favorable tax treatment on R&D and capex. And so I think you're going to see the year start off strong. It already has. The Russell 2000 is already up 8% for the year, which is pretty incredible.
But I think as you get towards the end of the year, things are going to get a lot more choppy. I think you've got midterm elections coming up. The Socialist Democrats gain more seats, which I think people will be worried about. They're not considered as business-friendly. And with multiples sitting up at 25 times trailing for the S&P 500, which is very high relative to where inflation levels are, and by other measures even like enterprise value to sales even higher than the peak in 2000, and the potential for the AI trade to get more discerning, which we've already seen at the end of last year, I think you could have a pretty big drawdown towards the end of the year.
Okay, Dan, let's get into what you mentioned about the Fed and your views on the Fed. So the Fed took the path that you expected last year in terms of the number of rate cuts. I'm hearing different viewpoints all over the place as it relates to how many the Fed will make this year, from one to two to potentially none. Where do you stand in terms of your expectations this year?
Well, I always like to say our job isn't to try to figure out what should happen, it's to figure out what you think will happen. And think back to 2021. CPI started the year at 1.4%. It finished the year at 7%. And the Fed said, 'Oh, don't worry, it's transitory.' And the S&P was up 27% for the year. So do I think the Fed should be cutting? Absolutely not. Inflation's been above their 2% target for four years. But President Trump will announce and put in a new Fed chair. The only way that person's going to get picked is if he wants to cut rates by at least another 1%.
And so you can do anything you want. You can say that inflation is transitory, much like they did in 2021. In this case, I think it's actually probably closer to being true. And so that just is going to keep the rate cuts coming. And the market, to your point, Diane, is trying to be rational and say, 'Well, really, we shouldn't have that many.' But it doesn't really matter that we shouldn't have that many. If we get them, that's just going to keep flooding easy money into the market, and that's just going to drive stocks much higher because inflation is bad for the 50% of the population that doesn't own stocks, but it inflates everything from real estate to stocks to crypto to you name it. And I think unfortunately that's what we're going to get. Which is why I think as you get towards the end of the year, it's going to get a lot choppier because you're going to be dealing with the aftereffects of that, much like you did in 2022 when you did have to deal with high inflation.
Let me ask you this, Dan. I want to dive into inflation a little bit more in a moment and how much that matters and your expectations for that. But I want to ask you a question about the Fed and the independence of the Fed and how much that matters now, especially given the expectation that whoever is Fed chair next will likely continue the path, honestly, it seems like no matter what, of rate cuts. But how much does the independence of the Fed matter to markets?
It should matter to markets, but I think the bigger thing is what the Fed actually does, because you can say the Fed was very independent in 2021 and they screwed up colossally, right? They thought inflation was transitory and we instead had the worst inflation in 40 years. Like that's a gargantuan miss. So I think you have to focus on what the policy is going to be. I think the day that it came out that the Justice Department might file criminal charges against Fed Chair Jerome Powell, the market I think actually finished up that day if I remember correctly. So should the market care? Yes. Does it care? No. Because it's focused on the fact that, oh well, if the Fed is going to keep giving us easy money, then hey, stocks are going to go even higher. And that's ultimately what investors focused on that day versus the Fed having more pressure not to be independent.
Okay. I want to talk a little bit more about your inflation expectations. So we recently got a CPI print that essentially came in in line with expectations. Shelter is still sticky in terms of where inflation is. So you know you don't have inflation really accelerating, but you don't have things exactly cooling. What are your inflation expectations this year?
I think they're going to stay above 2% because it's very hard to see with where services inflation is and how much average hourly earnings are up year-over-year. I think they're going to stay above two. I think the Fed, for their part, has shown that when faced with the decision between inflation or low growth, and let's be clear, AI is great for productivity, but it's not great for employment. And so I think you're going to see a lot of pressure on the labor market as you move through this year because of that reason, where you're sort of in this low firing environment, but you're also in a low hiring environment. And so I think inflation stays above two, but the Fed cuts anyway because that's what they want to do, and regardless of whether that makes sense.
But that's also why, to be clear, much like in 2022, you had the stock market go down 19% after that increase of 27% in 2021. That's why I think the back portion of this year is going to be choppy because you're going to have to deal with some of what you're doing in the first half, which is probably overheating the markets. You're going to have to deal with that as you get towards the end of the year, and combined with, you know, the political landscape.
I want to go back to a term that you mentioned. It was a, you know, a hot-button term for a while, but it feels like we're allowed to use it again: transitory. And I want to tie it to tariffs, right? The view, I know, remember, it was such a, it was like we cannot use that word anymore, but now we're back to using that word. The market seemed comfortable assuming essentially that tariff-driven inflation is transitory. But what if the market is wrong? What would make you say, no, this is not transitory, this is structural?
It's really the way I always say it: it's never the data, it's how the market reacts to the data. Because I remember in 2021, I was on, you know, had numerous interviews where I'm like, there is zero chance this is transitory because services inflation is so high, and services is over 70% of the US economy, and you have twice as many job openings as people unemployed. So there's zero chance this is transitory. But the market just kept climbing because that's what people wanted to believe.
So I think what you're going to have to do is wait for the market to kind of acknowledge that this is becoming a problem. And right now, what it's really focused on is, you know, the Fed spiking the punch bowl. And that refers back to this old phrase of the Fed's job is to remove the punch bowl once the party gets started. But they're actually spiking the punch bowl right now by starting QE light and then in May getting a new Fed chair. And so you'll find out when the market's overheated when it starts to really get concerned. And watching the 10-year Treasuries is a good place to start, and the 2-year Treasuries. You'll kind of see the footprints of people going, well, maybe inflation is not as transitory as we thought. And maybe this is a problem when you combine it with deficits that are continuing to be negative and the fact that valuations are high.
And maybe you've started to see some of that because we haven't talked about AI, which I'm sure we will. But the AI trade to some degree now is being fueled by this easy money because even the biggest companies in the world are hitting the debt markets to borrow, and we start talking about credit default swaps again, right? As it relates to Oracle, for example. And so all of these things are becoming much more intertwined right now, which is why the Magnificent 7 as a group are down about 1% to start the year, even though the Russell is up 8% to start the year. And obviously the whole AI trade has been the biggest driver of the market for the last three years, but you could argue now it's also dependent on debt-fueled financing.
Okay, Dan, I'm glad you brought up AI because, you know, towards the end of last year, I feel like we were having that conversation about bubble. Throughout the year, we were starting to have that conversation about is it a bubble, is it not a bubble? And then there was, you know, some questions about the monetization of AI. Now that we're entering basically year four, you mentioned three years in, we're entering year four of the AI cycle. What is the market looking for? Is this about, you know, monetization here? Is this the year that that is where we start to have to see more material numbers around that?
Absolutely. And I think it's not just monetization on the top line, which I mean it's not just revenues, right? It's going to be profitability and cash flow. And a good example of that I think is Oracle, where if you look at Oracle when they reported in September, the stock was up 36% the next day because they had a huge order from OpenAI for about 300 billion within that bookings number of I think it was like 455 billion, and the stock was up 36% the next day. It was the biggest one-day move in history for any company with a market cap of over a half a trillion dollars. Since then, the stock's come down over 40%.
Because then people went, 'Wait a minute, how's OpenAI going to pay for this?' because they're doing only 20 billion in run-rate revenues exiting 2025, but they're anticipated to burn 150 billion in cash flow before they ever turn positive. And they've got capital commitments of 1.4 trillion. And so all of those things really starting at the end of October started to influence how a lot of these stocks traded. And so I think as you get towards the end of the year, to your point, Diane, we're going to find out that not every company that thinks they're going to do great in AI is going to win.
And I've said, you look at the aftermath of the internet bubble and you think about that, you go, 'Well, how many winners were there in search?' Well, one, Google. Well, what about in e-commerce? Well, there's really one, Amazon. Well, what about in social? Well, there's only one really, it's Meta. Streaming, Netflix. Audio, Spotify. But if you look at AI, the assumption is, well, all these guys are going to win. That's probably not going to be the case. I think Google's going to turn out to be the winner in consumer AI. And then in corporate AI, obviously Microsoft's got a hammer lock on corporations. Anthropic's doing very well in terms of the private companies. And you've got Oracle that got a hammer lock on databases for Fortune 500 companies.
But, you know, if you say, well, generally there's been only one winner, that makes it kind of tough to think that everybody is going to win. And so I think you're going to see a real shakeout happen towards the end of the year based on not just monetization, as you rightly brought up, but the profits you can generate from underneath that to fund this.
So I hear your point. I hear you. There are going to be winners and losers, obviously, but I don't think it has to be a zero-sum game. I think there will still be, you know, some who are at the top of the leaderboard. When you think about those who could potentially be the laggards, who's most at risk when the narrative flips around AI?
