Hedge fund manager Dan Niles believes U.S stocks are in a bear market and could still see further volatility ahead — despite some brief rallies. Here's how he's trading the bear market. U.S. stocks have endured a torrid sell-off this year amid a troubling macro backdrop and an increasingly negative corporate outlook. Trading in U.S. stocks has remained volatile this week, even as the S & P 500 rallied last Friday to snap a seven-week losing streak. U.S stocks rose Thursday as the three major indexes each snapped two-day losing streaks. But Niles believes the rebound last week is "nothing but a bear market rally." "I think you have to take a big picture perspective, which is that the sharpest rallies are during bear markets," Niles told CNBC on Thursday. He noted that the S & P 500 had experienced five rallies of between 18% to 21% during the global financial crisis and the tech bubble, before eventually declining about 50% both times. "So, this is nothing more than that. And I think unfortunately, we expect the S & P 500 to be down between 30% to 50% at some point next year relative to the peak that we saw earlier this year," he added. A bear market rally typically refers to a sharp rebound amid a market that has dropped 20% or more from recent highs. How Niles is trading the volatility Niles said he's "investing across a basket," and taking on short bets to hedge his long positions. "For all the long [positions] that we have, we try to match them with shorts. We have got a lot of shorts in the U.S. That's also why we invest in a basket of names because I guarantee you there's a Snapchat in there that's going to blow up," he said. "That's why you want to have a broad diversification versus owning individual securities, he added. Niles sees an opportunity for investors to pile into what he believes is an oversold space of Chinese Internet. "The one area that we are looking at is the China internet names because in that sector, you've seen stocks come down about 73% or so versus the Nasdaq , which is down about 26% from its all-time record high," he said. He acknowledged that the social media, education, and gaming sub-sectors could still see continued regulatory scrutiny but believes that areas such as electric vehicles and other segments of the internet such e-commerce are likely to do "a lot better." "What we are trying to do in our portfolio is to keep as many shorts as we have longs as well as a fair amount of cash that we can then deploy at opportune moments to take advantage of bear market rallies and then get out," he said. Better off in cash Niles is also trading the bear market in another way — by keeping dry powder and staying on the sidelines. He believes there is inflation across all asset classes, driven by pandemic-induced stimulus introduced by the U.S. government. He noted that the U.S economy is valued at just $21 trillion but saw $10 trillion in stimulus pumped in by the U.S government over the last two years. "You put in [the equivalent] of 50% of GDP, and that has inflated all assets. It's bonds, it's crypto, it's cars, used cars, homes, boats, all of the different assets, including stocks, so with that money now having to be removed, everything is going to go down," he said. With the Fed now unwinding its balance sheet and adopting what is expected to be an aggressive pace of interest rate hikes, coupled with "very high" multiplies in the stock market, Niles believes investors are "taking a big risk." "Unless you're willing to trade the market, get short and be very aggressive and you can do this on a daily basis — just given the volatility — you're better off sitting in cash, suffering through the 6% to 7% inflation you're going to take because you're better off getting hit for 6% to 7% versus getting hit for 30% to 50% in the equity market," Niles said. Given the continued volatility in the market, it is also increasingly challenging for investors to call the bottom and buy the dip. "If you step in too early when stocks are down 60% to 70% such as Snapchat, they can still go down another 30% to 40% a day when they miss [earnings estimates.] So, just because a stock is down a lot doesn't mean that it's cheap," he added.
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Hedge fund manager Dan Niles believes U.S stocks are in a bear market and could still see further volatility ahead — despite some brief rallies. Here's how he's trading the bear market.