In the Know - with Cathie Wood
In episode XXIII of "In the Know," ARK CEO/CIO, Cathie Wood, weighs in on the bond market, inventory overhangs, the latest employment report, ARK strategies, and more. As always, she also discusses fiscal policy, monetary policy, the economy, market signals, economic indicators, and innovation.
as at 3 December 2021
During November, broad-based global equity indexes – as measured by the MSCI World – depreciated as macro worries stalled investor confidence. The market is fearful that supply chain bottlenecks and labor shortages will prolong and exacerbate inflation, pushing interest rates higher sooner than expected. Following his reappointment as Chair of the Federal Reserve, Jerome Powell changed his tone on inflation, suggesting that it might not be transitory, which shocked the equity market. The US Treasury yield and the yield curve, however, seem to be at odds with the Fed’s view. The yield curve flattened as the 10-year yield fell below 1.45% and is now roughly 30 bps below the 1.74% peak posted at the end of March. Additionally, the long end of the yield curve remains inverted, and the US dollar continued to strengthen both anti-inflationary signals. On Capitol Hill, President Biden signed the Infrastructure Investment and Jobs Act, the largest infrastructure bill in history. Meanwhile, Congress continues to debate an additional bill focused on social and economic measures. In our view, midterm election campaigns and narrow majorities in both Houses of Congress will prevent the passage of unpopular and onerous tax measures.
Relative to the MSCI World Index, the Technology, Consumer Discretionary, and Materials sectors outperformed on balance, while the Energy, Financial Services, and Communication Services sectors lagged. The tug-of-war between growth and value stocks during the last ten months has been driven largely by uncertainty and tactical trading. We believe some investors are beginning to focus on inventory built not at the company level but in consumer households during the coronavirus crisis. Once concerns about an inventory correction become more widespread, fears should shift from inflation to deflation and slower growth. In recent earnings reports, retail giants Nordstrom and Gap reported rising inventories and falling sales relative to their respective pre-pandemic 2019 third-quarter levels. Furthermore, real GDP in the second quarter was up 2%, entirely from a buildup in inventories. Real final sales were flat.
Among the largest beneficiaries of the rotation toward cyclicals during the past ten 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.
In our view, inflation fears have been overblown. Understandably, given the massive monetary and fiscal stimulus in the global economy, most economists and strategists are weighing the odds of inflation, while we remain focused on the risks of deflation. In the short-term, supply chain disruptions have pushed headline consumer price inflation into the 6% range on a year-over-year basis, a rate that we believe 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 about possible double- and triple- the ordering of goods, which could result in a significant inventory overhang. As the world continues to reopen, 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. Additionally, the Chinese economy appears to be slowing as the government cracks down on real estate and other sectors, which may put intense downward pressure on commodity prices. Already, lumber and iron ore prices have collapsed from their respective peaks this year. Until recently, oil has been an outlier, its price surpassing a high point hit in 2018 as environmental, social, and governance (ESG) mandates influence corporations to shift capital spending from fossil fuels to renewables. That said, the rise in oil prices seems to be accelerating the shift from gas-powered cars to electric vehicles (EVs). While well-established auto manufacturers are blaming chip shortages for year-over-year revenue declines, our research suggests that EV manufacturers, which require 3-5 times more chips per car, are taking share from gas-powered vehicles.
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 could be the prime beneficiaries. The onset of the pandemic and each virus variant has generated broad fear, uncertainty, and doubt (FUD) in the equity markets, causing indiscriminate, algorithmic selling as a form of short-term risk management. Typically, FUD accelerates the adoption of new technologies as concerned businesses and consumers change their behaviors, and new market leadership emerges. In our view, the coronavirus crisis transformed the world significantly and permanently, suggesting that many innovation-driven stocks could be productive holdings during the next five to ten years.
ARK’s investment team has been monitoring closely both political activity in China and the continued political tension between the United States and China. The Chinese government’s heavy hand against any entity challenging its power, especially those with sensitive personal and other data, is impacting our outlook on pure play Chinese technology companies and the revenue base of non-Chinese companies with business in China. While we believe that China still is placing a high priority on innovation, in the short-term its government is more focused on equalizing the distribution of wealth and opportunities, so called “common prosperity”, as it moves to address negative demographic forces with policy measures like its new “three child policy”. ARK’s investment team will continue to monitor this rapidly evolving situation, evaluating its conviction in various companies and stocks impacted by China’s moves over the medium- to long-term.
During November, the Innovation fund returned around -13.7% USD.
The top contributors include Unity (U), Tesla (TSLA) and Shopify (SHOP). Shares of Unity (U) appreciated after beating third-quarter revenue and earnings expectations and raising full-year revenue. Additionally, Unity acquired Weta Digital, a digital visual effect company that can potentially aid in developing Unity’s real-time 3D content. SHOP contributed to performance. ARK believes the company will continue to benefit from the digitization of retail, experiencing tailwinds from both omnichannel and social commerce. Shopify is building the retail operating system for merchants, enabling seamless management of back-end, front-end, and integrated services. Shopify merchants reported record Black Friday sales this year, up 21% year-over-year.
The top detractors include Teladoc Health (TDOC), Roku (ROKU), Invitae (NVTA), Zillow Group (Z) and Zoom Video Communications (ZM). TDOC shares were negatively impacted by the broad “stay-at-home” stock selloff. ARK believes the market is missing Teladoc’s unique opportunity. In ARK’s estimation, Teladoc’s differentiators extend beyond their role as a dominant telemedicine provider. Teladoc’s accumulated talent in the data science/AI/ML field has enabled their data quality and volume-- and therefore their AI/ML generated insights-- to be best in class. This is what ARK expects will cause Teladoc to connect hospitals, doctors, patients, and insurance companies, and eventually become the data backbone of the healthcare industry. Even in a tough year-over-year comparison, Roku grew platform revenue and ARPU in the third quarter. Investors focused on a decline in operating system revenue and broader macro forces, pushing shares down and detracting from performance. ARK remains confident that Roku will benefit greatly from the shift to streaming platforms. During Zillow’s third-quarter earnings release, the company announced a significant miss relative to earnings expectations as well as plans to shut down Zillow Offers, citing difficulties in forecasting accurate home prices in volatile markets. In response, it will reduce its workforce by almost 25%. Shares of Zillow reacted negatively, falling sharply. In ARK’s view, this news is the result of execution issues associated with Zillow’s AI pricing algorithms despite access to ample data. Additionally, ARK believes that Zillow’s decision calls into question the scalability of iBuying business models rooted in high balance sheet risk.