May saw broad-based global equity indexes continue to appreciate as confidence increased in the V-shaped recovery. The US yield curve appears to have stabilized, the 10-year Treasury bond settling in around 1.60%. On Capitol Hill, the Biden Administration continued negotiations for a new infrastructure bill. In our view, the odds of a significant tax increase to fund the bill have decreased.
Relative to the MSCI World Index, Energy, Financials, and Materials have outperformed on balance, while Consumer Discretionary, Technology, and Utilities lagged. In our view, this rotation from growth and into cyclicals and other value-based strategies has broadened and strengthened the bull market significantly, preventing another tech and telecom bubble and setting the stage for another leg up in innovation-based strategies. Had the equity market continued to narrow toward innovation, the odds of a bust similar to the one after the tech and telecom bubble would have increased. Instead, valuations have reset, particularly in “stay-at-home” stocks, many of which have been cut by more than half since last summer. In our view, the coronavirus crisis transformed the world significantly and permanently, suggesting that stay-at-home and other innovation-driven stocks will regain momentum.
Among the largest beneficiaries of the rotation toward cyclicals during the past six months have been the two sectors that we believe will be disrupted the most by innovation during the next five years: Energy and Financial Services. In our view, autonomous electric vehicles and digital wallets, including cryptocurrencies and decentralized financial services (DeFi) associated more broadly with blockchain technologies, will disrupt and disintermediate both Energy and Financial Services significantly during the next five years.
Fear of rising inflation is another driver behind the market rotation. Understandably, given the massive monetary and fiscal stimulus in the global economy, most economists and strategists are weighing the odds of inflation. Still, we remain focused on the risks of deflation. In our view, the collapse in many prices during the coronavirus crisis last spring created a so-called “base effect” that, along with supply chain disruptions, will push consumer price inflation into the 3-5% range on a year-over-year basis, a rate that three deflationary forces – good, bad, and cyclical – are likely to unwind during the next year.
Innovation is the source of good deflation, as learning curves cut costs and increase productivity. Conversely, we believe many companies have catered to short-term oriented, risk-averse shareholders who have demanded profits/dividends “now.” As a result, many have leveraged their balance sheets to buy back stock, bolster earnings, and increase dividends. In so doing, many have curtailed investments in innovation and could be facing disintermediation and disruption. With aging products and services, they could be forced to cut prices to clear inventories and service their bloated debts, resulting in bad deflation. During the pandemic, consumption shifted from services to goods as people were quarantined. As businesses have scrambled to catch up with demand, we are concerned that there has been double- and triple- ordering of goods, which could result in a significant inventory overhang. As the world reopens, incremental consumption should shift back to services which could end supply chain issues abruptly. In response to the excess supply, commodity prices could unwind as sharply as they have increased, resulting in cyclical deflation.
If we are correct in our assessment that the risk to the outlook is deflation, not inflation, then nominal GDP growth is likely to be much lower than expected, suggesting that scarce double-digit growth opportunities will be rewarded accordingly. Growth stocks in general and, specifically, innovation-driven stocks should be the prime beneficiaries.
This month, the ARK Disruptive Innovation portfolio benefited from sizeable moves in Shopify (SHOP), UiPath (PATH), Zoom (ZM), Palantir (PLTR), and Roku (ROKU). Shopify shares came under heavy selling pressure in early May amid a broader tech selloff. ARK believes the market rewarded Shopify’s competitive moat in the second half of the month, which resulted in the stock being a positive contributor. Shopify’s social commerce capability continues to excite the ARK team. PATH was a positive contributor to performance as shares rallied on the news. ARK believes that UiPath is well-positioned to capitalize on secular trends in process automation across industries.
The largest detractors from performance were Coinbase (COIN), Iovance (IOVA), Invitae (NVTA), Teladoc (TDOC), and Tesla (TSLA). In a thread of tweets, Elon Musk expressed concerns around bitcoin’s energy usage. This resulted in the price of bitcoin, and cryptocurrency in general, falling sharply. COIN is closely correlated to the broad cryptocurrency market and, as a result of Mr. Musk’s tweet, also sold off. ARK believes concerns around bitcoin’s energy consumption are misguided. Contrary to consensus thinking, ARK believes the impact of bitcoin mining could become a net positive to the environment. Mr. Musk will likely play a role in cryptocurrency renewable energy-driven mining. Tesla shares came under heavy selling pressure amid a broader tech and cryptocurrency selloff and pressure from China, which caused the stock to be a detractor. Vehicles sales in China disappointed, and the Chinese government increased scrutiny of Tesla’s autonomous driving data gathering. Elon Musk announced Tesla would no along accept Bitcoin as a means of payment, citing energy usage concerns. This caused a broad-based cryptocurrency selloff which negatively impacted shares. However, ARK believes Tesla continues to improve from a long-term standpoint. Vehicles export from China to Europe are improving. The Berlin Gigafactory landed early approvals to install machines. Finally, removing radar from the autonomous driving system signals that Tesla has an immense amount of reliable visual data.