July 10, 2020
By Steve Blumenthal
“My experience in this business is if everyone is running in one direction
and you start to run in the other, and you seem crazy, if you’re right,
the rewards are enormous.”
– Catherine Wood,
Founder, CEO, CIO, and Portfolio Manager, ARK Investment Management LLC
Normally, around this time of the month, I share with you the latest valuation charts. They remain high. With that in mind, let’s pass on the charts. Instead, let’s look at more notes from the Mauldin Economics Virtual Strategic Investment Conference (SIC) 2020. Presenters included Felix Zulauf, Dr. Lacy Hunt, David Rosenberg, Mark Yusko, Ian Bremmer, George Friedman, Karen Harris, Leon Cooperman, Ben Hunt, Jim Bianco, and others. Over the course of the last few months, I’ve shared insights from many of the sessions. If you would like to receive an email with a summary of all the write-ups I’ve done, click here.
Today, I’m providing my bullet-point notes from Catherine Wood’s SIC 2020 discussion with Barry Ritholtz of Ritholtz Wealth Management. I promise, you are really going to like her.
Catherine doesn’t hug benchmarks. She’s not concerned about today’s high valuations, either. Rather, she invests in the things that will change our lives for the better. When I talk about “Core and Explore,” CMG’s simple overarching wealth management principle, Catherine’s ideas fall under the “explore” category. They are the types of bets that may meaningfully enhance your wealth. Her conversation with Barry was fascinating. Before we get into the details of their discussion, let me give you a little background.
Catherine Wood founded ARK Investment Management in 2014 to invest in companies and technologies that had the potential to change the world. She believes that innovation itself should be a piece of any investor’s portfolio, including transformative technologies she believes are headed for widespread adoption in the future. Think disruptive innovations in the areas of DNA sequencing, robotics, energy storage, artificial intelligence, and blockchain technology.
Catherine is the firm’s CEO, chief investment officer, and portfolio manager. She could have easily offered investment management in an expensive hedge fund structure, but being innovative herself, she instead decided to provide her active management via exchange-traded funds (ETFs).
Wood said, “We think the genomic revolution is the most inefficiently priced of all of the innovation platforms.” She added, “People don’t believe that diseases are going to be cured because of DNA sequencing, CRISPR gene editing, and other gene therapies. So the old world still dominates in terms of valuing the healthcare sector.” But, she said, “The genomic revolution won’t just help cure diseases—it will revamp agriculture and help create a healthcare ‘golden age,’ where research becomes dramatically more effective and costly trial failures become less common… We think that the returns on R&D that we’re going to see in the genomic space therapies and diagnostics and tools are going to be phenomenal.” Most investors are chasing yesterday’s returns. With her investments in innovative and disruptive technologies, Catherine is looking toward the future.
As an aside, I’m personally investing in a company that uses precision gene editing technologies to develop novel traits for the global agricultural seed industry. What does that mean? A trait could be something like a stronger pod in a canola plant. The pod holds the seeds that a farmer harvests. The farmer sells to a crusher who uses the seeds to make canola oil. In nature, some pods are strong; some are weak. Weak pods break in storms, meaning the farmer ends up harvesting less. But what if the farmer can plant seeds that ensure a field of strong canola pods? There are other traits scientists can edit for, like disease resistance and even herbicide resistance, which mean fewer chemicals are needed to spray on the plants. Stronger plants, with fewer chemicals, means a better earth.
Transformational-type investments are not without risk. Not all will win so size the bets appropriately. If you allocated 3% of your wealth to Amazon at $1.50 per share in 1997, when it was an internet book company and if Jeff Bezos failed, your portfolio took a 3% hit. Not the end of the world. If I’m right on my bio-agriculture bet, it is a game-changer for me and my family. Such is investing. “Core” defends wealth; “explore” may enhance it. And seeking explore-type investments may or may not be appropriate for you. Talk to your advisor.
In her interview with Barry Ritholtz at this year’s Virtual SIC, Catherine was fascinating to listen to. Barry was masterful in his line of questioning. When you click through below, you’ll find my bullet-point summary notes and (hat tip to Ed and the team at Mauldin Economics) a link to the audio of the interview. Why read or listen? You’ll love the way she thinks. In the interview, she shares her insights on the economy (she sees a big inflation cycle in a couple of years), the coronavirus, Tesla, NVIDIA, gold, bitcoin, AI, and a few other important investment themes. Here’s a taste:
- ARK believes it’s the first sharing economy company in the asset management space when it comes to research.
- The company has gotten so much more back than Catherine ever dreamed it would—from professors, from venture capitalists, from entrepreneurs, from the people who have rolled up their shirtsleeves and are doing the innovating, heads down.
- Why? This is a complementary or collaborative effort. Those who are innovating, heads down, rushing to transform the world, don’t have time to seize the opportunity. ARK spends all of its time seizing the opportunity.
You should certainly take a look at ARK Invest’s ETFs. And, a quick brief commercial, I’m excited to let you know we’ve just finished our research work and will be adding a portfolio of Catherine’s top ten highest conviction stock ideas to the CMG Mauldin Portfolios Platform. The strategy will be available at E*TRADE Advisor Services, Orion Portfolio Services, Charles Schwab, TD Ameritrade, Fidelity, Pershing, and RBC. Let me know if you’d like to learn more.
Grab a coffee and find your favorite chair. Today you’ll find my detailed bullet-point notes from the Woods-Ritholtz interview, the link to the interview (hat tip to Mauldin Economics for allowing me to share it with you), and the most recent Trade Signals post. Thanks for reading. I hope you enjoy this week’s post. It was fun for me to review and write.
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Included in this week’s On My Radar:
Catherine Wood founded Ark Investment Management in 2014 to bet on companies and technologies that had the potential to change the world. She believes that innovation itself should be a piece of any investor’s portfolio. Transformative technologies that she believes are headed for widespread adoption in the future. Think of disruptive innovations in the areas of DNA sequencing, robotics, energy storage, artificial intelligence, and blockchain technology.
Catherine is the firm’s CEO, chief investment officer, and portfolio manager. Being innovative herself, instead of setting up a hedge fund, she decided to offer her active management via exchange-traded funds (ETFs).
Wood said, “We think the genomic revolution is the most inefficiently priced of all of the innovation platforms,” adding, “People don’t believe that diseases are going to be cured because of DNA sequencing, CRISPR gene editing, and other gene therapies. So the old world still dominates in terms of valuing the healthcare sector.” She said, “The genomic revolution won’t just help cure diseases — it will revamp agriculture and help create a healthcare ‘golden age’ where research becomes dramatically more effective and costly trial failures become less common…. We think that the returns on R&D that we’re going to see in the genomic space therapies and diagnostics and tools are going to be phenomenal,” she said.
Barry Ritholtz interviewed Catherine at this year’s Mauldin Virtual SIC 2020. She was fascinating to listen to. Barry was masterful in his line of questioning. I promise, you are going to really like her.
Please note: The following is a transcription of the audio interview. Please forgive any typographical or grammatical errors.
BARRY: Let’s jump right into this. I have to start with your background. You went to USC, where you studied with a gentleman named Art Laffer, who, I think, might have had a little influence on the way you look at the world. Tell us about you and your work with Art.
CATHERINE: Yes, well, I was Art’s student at USC, and I couldn’t believe that I was going to be able to enjoy a major where, you know, first I’d get to learn about current events and then slowly but surely, Art would then suck us into the most complex mathematical equations you could imagine.
- He also introduced me to Capital Group on the West Coast when I was a junior in college, and I started at Capital when I was a junior. And I said, “Wow, I can’t believe this kind of an institution exists because again, studying the way the world was going to work, not just next year, but 20 years from now. So ’77, I was a junior and they were studying about Hong Kong, 1997.
BARRY: You eventually worked your way through a number of different hedge funds and various investment firms ending up at AllianceBernstein, where you managed about five billion dollars for close to 12 years. Is that about right?
CATHERINE: I was Chief Investment Officer of their Global Thematic Strategies when Lew Sanders was CEO
- They wanted research that was going to start from the top-down, trying to figure out how the world was going to work, not how it did work.
- And so I came in and deemphasized technology and we moved to other themes. They couldn’t be as technology-oriented as we are now because that was all sorting itself out back then.
- Twenty years later, the gleam in the eye of the Internet bubble became a reality. And the irony as an investor is that during the tech and telecom bubble, I watched investors chase the dream, chase it, and valuations became metrics measured in terms of eyeballs.
- And today, the dream is becoming reality.
- I think it was Mark Andreessen, who said all those ideas back then were just a little early. Petz.com is now—the modern version of it is Chewey.com and it’s very successful. So valuations do matter.
BARRY: So you spend 12 years at AllianceBernstein and in 2014 you make the decision to launch your own firm.
CATHERINE: Yeah, I think most people thought I was doing a very unwise thing, but my experience in this business is if everyone is running in one direction and you start to run in the other, and you seem crazy, if you’re right, the rewards are enormous.
- And I—working with Art Laffer and other economists and portfolio managers, mentors—we were figuring out, wait a minute, there are all kinds of signs here that interest rates and inflation are peaking.
- But it took until Henry Kaufman in August of 1982 capitulated and said, “You know what, maybe inflation is not embedded in the system at a double-digit rate.”
- It took a good two years, and for others, maybe even four to five years, to really believe that inflation and interest rates had turned. Those of us who had taken that position early did very well with it.
BARRY: You know, I’ve noticed a number of people have been coming out lately and talking about inflation as a potential threat like it’s the 1970s again. Do you have any opinion on the odds of an inflationary spike anytime over the next couple of quarters or even years?
CATHERINE: Well, I have to be very humble about this one, because while I got that first one right, I was worried after ’08, ’09. I watched the kindling on the central banks’ balance sheets and said, “Oh, my gosh, this could turn into one massive wave here of inflation.” It did not.
- And what we learned from that period was, yes, that the kindling was out there, but nobody lit it. There was so much caution and the velocity of money started falling and it’s still falling.
- One, I think the productivity burst we’re about to experience is going to surpass anything we’ve seen, maybe even in my investment lifetime. And that’s because I think the rubber band has stretched here. Businesses were for 12 to 18 months before the Coronavirus, they were pulling back.
- They weren’t keeping up with the consumer in terms of building inventories.
- They were cutting capital spending.
- They were worried about the China-US trade conflict.
- And they were worried about the inverted yield curves last year.
- And guess what? There is a recession, not for the reason they thought. There is a recession.
- Meanwhile, we see the consumer saving rate. Before the crisis, we were up to eight percent, a high rate by historical standards for the US. In March, we got to 13 percent. In April, 20 percent.
- And so what that’s telling me, I realize how much despair there is out there in certain quarters of the economy.
- We will end up with a stronger recovery. It will be very high in terms of productivity. And the other tailwinds for productivity here are what has happened to innovation.
- Almost every platform that Ed mentioned at the beginning, is gaining traction now at an accelerated rate, faster than it would have gained traction had we not had the Coronavirus crisis. So those, in those platforms are all deflationary. They’re all—the reason they’re taking off is costs are falling as the learning curve evolves, and we’re getting waves of demand unleashed. And we think that’s going to be true across the board.
- So those are going to be very deflationary impulses. That counter will be the kindling on the central bank’s balance sheet. So there’s going to be a tug of war there, but I don’t think we’re going to see a big inflation cycle for a number of years.
- I do worry about it in the out years. And the reason I worry about it is that now, unlike after ’08, ’09, people are saying, “Yeah, inflation, yeah.” We didn’t see it the last time. It’s unlikely. A slow- growth economy.
- This Coronavirus has killed some sectors as well. It’s going to take a long time to come back. Whenever people start to let their guard down on something like inflation, I get more concerned about the possibility. And of course, gold and potentially bitcoin are starting to reflect the same.
BARRY: Quite interesting. Let’s talk a little bit about your business model, which I find quite fascinating. You took a very open tack and said, we’re going to make everything open source. We are going to share everything we think about the world of investing and lay it out for everybody to see. That’s a somewhat radical approach, isn’t it?
CATHERINE: We call it radical transparency, and that’s very much what we are. Not only do we push our research out and share it, mostly in social media, we push it out, not when it’s finished, but as it’s evolving, because our analysts and I want to become a part of the communities we’re researching. [SB: Emphasis added. Love that!]
- We believe we’re the first sharing economy company in the asset management space when it comes to research.
- We have gotten so much more back than I ever dreamed we would, from professors, from venture capitalists, from entrepreneurs, for the people who have rolled up their shirtsleeves and are doing the innovating, heads down.
- Why? This is a complementary or collaborative effort. Those who are innovating, heads down, rushing to transform the world, don’t have time to seize the opportunity. We spend all of our time seizing the opportunity.
- We’re looking at how learning curves are evolving and costs are declining. We’re looking at when those costs are going to decline enough to capture another market—so the price elasticity of demand every step along the way.
- And we’re also doing it in a way that—I think if others want to emulate us, they’ll have to restructure their research departments because every one of our analysts, effectively, is a tech analyst, no matter what they’re covering, health care, industrial. They’re very comfortable with technology. Technology is seeping into every industry, every sector, blurring the lines between and among sectors. And beyond that, the five platforms that Ed introduced our panel with, they are converging. So there’s no way you can be a sector analyst and understand the kind of innovation and how quickly it’s going to evolve if you don’t understand the technologies that are driving them.
BARRY: No, I was going to ask, let’s talk about those sector analysts. You have said in the past, you think the traditional sectors that we define things as finance and energy and consumer, all the S&P sectors—or even if you want to get more granular—are effectively meaningless, especially given how technology has changed so many companies in so many sectors. Do we even, should we even conceptualize companies as belonging in different sectors? And what sector is an Amazon in and what sector is a Tesla in?
CATHERINE: Yes. When I was at AllianceBernstein, there, I used to describe what we were doing as we were moving more into the technologically enabled innovation. I used to say, “Well, these are stocks that fall through the cracks.”
- And actually, I started in my career that way. That’s how I got my break at Jennison Associates under Sig Segalas. I wanted to move from economics, but I wanted to keep the economics. I love economics, but I wanted to become a research analyst, an equity research analyst.
BARRY: So now let’s talk a little bit about your process. How do you go from thinking about a particular space, a particular area, a technology, one of these five platforms that you might publish about? How does that become a specific holding in one of your portfolios?
CATHERINE: Yes. So first, we’re studying the technologies themselves. Are they ready for primetime? So an easy way to explain what I mean by that is, in the early 2000s, part of the tech and telecom bubble had been sequencing the first whole human genome and personalized medicine. That was the dream.
- And the reality back then was it had cost $2.7 billion, and it took 13 years of computing power to sequence the first whole human genome. We were not ready for primetime, nowhere near it. Now we’re down to less than a thousand dollars per genome. We’re heading for one hundred dollars. We’ll probably go to ten dollars. And this is becoming a massive artificial intelligence project. We are going to be going to our geneticists every year or every other year to figure out what genes in our bodies have mutated. The earliest manifestation of disease is a mutation. We will be able to catch cancer in stage one, even—even pancreatic cancer. That’s Grail’s and it’s just come out.
- So the starting point, as you can see, is okay, have the costs come down low enough in this technology? And we use something called Wright’s Law. The actual equation is for every cumulative doubling in units produced, costs decline at a consistent rate. So Wright’s Law is a relative of Moore’s Law, but it is a function of units, whereas Moore’s Law is a function of time. And, actually, Wright’s Law has done better in forecasting what was going to happen to the semiconductor industry in recent years than Moore’s Law itself has.
- So that is central to our research and then this idea of cutting across sectors. If this is going to become an exponential growth platform, it can’t just hit one sector. It’s going to have to be opened up, sort of like the Internet. Many people had no idea how ubiquitous it was going to become.
- Well, and the same with battery technology. You know, batteries, we’ve gotten used to cell phones and laptops. But this idea that batteries could actually run cars, really no one thought that was going to happen, especially not the way Elon Musk was doing it. It wasn’t going to happen for 10 years, and again, underestimated, completely wrong. We’re ready for primetime now. The total cost of ownership of an electric vehicle is lower than that of a gas-powered vehicle. And EV sales are starting to pull away from gas- powered sales.
BARRY: So I want to come back to Tesla in a few moments, but I have to ask, so how does this translate into selecting a specific stock and saying, okay, I want this company in one of these portfolios that I’m holding?
CATHERINE: Okay, so we’ll take the next stage in. We take a white sheet of paper. That’s our start. And we tasked our autonomous vehicle analyst, Tasha Keeney, in 2014 with okay, what’s going to go into an autonomous vehicle? What is it? We have no preconceived notions. Go out there, talk to the people who are making this happen. That’s why we want to be a part of those communities.
- And one of our brainstorms every Friday, we do have a brainstorm, she came back and she said, well, you know, it appears that the brains of an autonomous vehicle are going to be GPUs—the brains or the central nervous system.
- Now, at that time, PC sales were dropping at a double-digit rate. NVIDIA was considered nothing but a PC gaming chip company. And here I have an analyst coming into our brainstorm saying it appears GPUs are going to be the brains. And then we have another analyst who’s focused on artificial intelligence, who spent nine years at NVIDIA saying, okay, well, that makes sense because autonomous vehicles, that’s an AI project, an artificial intelligence project, and NVIDIA is probably gonna be the biggest player there.
- And I’m looking at both of them. I’ve been around the track a few times—many times, and for that matter. And I’ve always owned NVIDIA because gaming was going through various iterations. But I’d never heard anyone talk about autonomous vehicles and artificial intelligence in the context of NVIDIA. NVIDIA, which was in our next generation Internet portfolio at maybe a two percent position for gaming, went into what we call now our autonomous technology and robotics portfolio.
- We took it right up, we started legging into it, one percent, two percent. It ended up being in the top 10, close to a 10% position because it is one of the biggest players. it’s going to be—other than Tesla—it probably will be the biggest AI chip manufacturer for vehicles.
- Now, we just had a different take on this, a different take in two ways. One, time horizon. Most people could have cared less at that time that NVIDIA was going to have anything to do with AI or autonomous. Just—it wasn’t relevant to the companies they were investing in in the next one to two years. It was so much more relevant to us. And so I think that time difference—investment time horizon difference—gives us a lot of opportunities to take advantage of misconceptions or short-term disappointments in stocks like NVIDIA.
- And of course, PCs at that time were dropping at a double-digit rate. We had a lot of time to build up that position and it went from $14 to $20 to $300 in two years. Now, that’s the kind of, well, that’s better than VC-like returns.
- Well, guess what? That is one illustration of how inefficiently-priced innovation is in the public equity markets in contrast to the private equity markets.
BARRY: So let’s talk about something else that I think we can argue as inefficiently priced. You mentioned Tesla. It’s one of your biggest holdings at about 10 percent in one of your funds. You’re not merely bullish on Tesla. You’re, this is going to change the world and change everything. And your price target keeps going up. It started out around 4,000, went to 6,000, and I think I read somewhere 7,000 was in the offing. Are you still as bullish on Tesla as you ever were?
CATHERINE: Yes, indeed. So we have, of course, adjusted our forecasts. Remember, we have a five-year forecast for the Coronavirus. It really does very little to move our model. So our price target, just because of the Coronavirus, and we tend not to adjust for this sort of thing, but many people were asking us, so we redid the models, went from seven thousand to sixty-eight hundred. So it really didn’t matter.
BARRY: What is it now?
CATHERINE: Alright, that’s just our base case. That’s our base-case view is that they have a 30 percent shot at becoming an autonomous platform. It assumes that they won’t go up in market share at all. They’ll just hold their 17 percent global market share. And that is the one assumption that is changing radically here.
- We are seeing other traditional auto manufacturers as they are seeing their balance sheet under some stress, they are pulling away from some of their EV projects. I just saw that Cruise Automation, which is GM’s autonomous division, just laid off eight percent of its workforce after, in 2019, going on a huge hiring spree.
- So they’re, you know, they’re having to throttle back on some of these projects. So our assumption is that we’re probably wrong on the 17 percent market share staying stable.
- It’s probably going to go up because Tesla is getting more aggressive. It’s getting more aggressive in terms of its investments, and it now has what looks like a fortress balance sheet compared to the other auto manufacturers when at precisely this time last year, it was sinking because traditional auto analysts were saying, “This company is going to run out of cash.”
- And, you know, my response then was, “Wait a minute, aren’t markets open? You can’t run out—it’s not going to run out of the cash. We’re certainly going to be there. The other top 10 investors are going to be there for them.”
- And these are bargain-basement prices, so we were averaging down aggressively as it sank, you know, below 200 into the 180s, and of course, now it’s over 800. That’s just one year. And just think about it, fortress balance sheet versus, “they’re running out of cash” a year ago.
BARRY: So what would it take to get you to say our model about Tesla is wrong? What could possibly happen to make you change your mind?
CATHERINE: Well, we used to think—and we do have a scoring system when it comes to innovation. We have a six-point, six-metric scoring system, zero to ten each.
- And in the beginning, we were focused on thesis risk, which is one of our risk metrics. And the question was, are regulators going to allow this? And so we had… the thesis risk on it back then was pretty high.
- What we’ve seen since it’s gone through its own—seeing fatalities in its own cars and having the regulators take a close look at it—we have seen that the regulators have warmed up because the regulators know 80 to 90 percent of fatalities are caused by human error.
- And now Tesla has collected at least 12 billion miles. It’s probably 14 billion miles worth of driving data to feed their AI engine. And the more data they have, the safer this vehicle’s going to be. It’s going to be the safest vehicle on the road. In many ways. It already is. So that one has gone down.
- Another—I can just—using Tesla to illustrate is a very good one to give you a sense of the scoring system.
- So people, management and culture, okay. So Elon, according to some people, is a nutcase. We do not agree with that at all. But his tweets do get quite, shall we say, I don’t know, pretty wild sometimes.
BARRY: They’re colorful.
CATHERINE: Colorful, that’s the word I was looking for, thank you. And so we really don’t care about those tweets. The only one we did care about was funding secured.
- So the first metric that we score is people, management, and culture, right?
- And this was bad. It wasn’t true. It was going to get the FCC on his back. It was gonna be a distraction to the board, to management, to employees, and to shareholders.
- So we ducked that score. Within two months of that, we had taken profits. Within two months, Tesla released specs for its AI chip. We had not expected that to happen for a year. It came out and James Wang, who had been at NVIDIA, knows a thing or two about chip specs, said, “Whoa. If this is true, they’re four years ahead of NVIDIA.”
- They’re four years ahead of NVIDIA—not because NVIDIA is behind, but because NVIDIA has to operate at the cadence of traditional auto manufacturers, which is four- to five- year design cycles, whereas Tesla’s design cycles are six months to one year. So that’s the real difference here. That score—moats, barriers to entry went up. So you can see how we have a lot—I haven’t described the other three, but we have a lot of scores to consider every Monday at our stock meetings.
BARRY: So let’s stay with Elon for a moment. Some of his—now, I’m fascinated by him and think he’s an intriguing guy. Some of his comments and behaviors have been pretty wacky. Most recently, a few months ago, he said, “Oh, this Coronavirus will be gone by April.” But the one that I think really shook everybody was going on a podcast and getting stoned with Joe Rogan. How do you reconcile a CEO behaving like that, kind of acting out? It doesn’t make the cars any less safe. It doesn’t make the vision any less visionary. But it’s not what you really want to see in a CEO.
CATHERINE: So I listened to that two-and-a-half-hour Joe Rogan interview. And there is no way that Elon was stoned. I really think that was a prank. I really do. And we did a–I believe we did a podcast with him right after. He is the most sober-thinking man, certainly in terms of autonomous vehicles, artificial intelligence, electric vehicles, that I know. We keep our eye on the prize and the prizes here are Tesla’s competitive advantages. And if you, if CNBC and they pulled that, they put that clip up, everyone did—
CATHERINE: Dozens of times, dozens. If anyone at CNBC had listened to that podcast, they would have heard the visionary in action and said, “Wow, you know, when it comes to artificial intelligence, there’s no one who’s going to do better in the automotive space than Tesla.” And that is the secret sauce for autonomous.
- And if we’re going to get to autonomous, you know, the company with the most data—Tesla—has that iterative algorithms, supercomputing power, and the best chip—that’s Tesla—is going to win. And this is not a 20 to 25 percent gross margin company if that’s the case. This is gonna be a 60 to 70 percent gross margin company.
- So now we feel that there’s so much misinformation out there, mostly because traditional auto analysts are following this stock. And, you know, God bless them. They—it’s a hard—it’s a very difficult stock for them to follow because they’re not robotics analysts, which autonomous vehicles are. They’re not energy storage analysts, which autonomous electric vehicles are. And they’re not artificial intelligence analysts. Our three analysts collaborate on our model. There’s no way these traditional auto analysts can analyze this company. This is—talk about a fall through the cracks company—this is disruptive innovation at its finest.
- So we keep our eye on the technology prize and make sure that he’s meeting milestones. We adjust for Elon-time, which is usually a year too early. But he, as he has said himself, gets the job done.
BARRY: So you mentioned a lot of different technology, but I did not hear you mention software, which is, kind of, to me, the thing that makes Tesla so fascinating. It’s a mobile computer as much as it is an automobile. Tell us about the software innovation from Tesla that makes them so unique.
CATHERINE: So inherent in my comments about AI is software. This is software, 2.0, this is going to be transportation-as-a-service. So there is no other auto manufacturer yet, I believe this is still true, who can do over-the-air software updates to improve a car’s performance. They can do over-the-air software updates to improve infotainment, but not performance. And in fact, I think, if I’m not mistaken, in 24 states, something close to that, it is illegal to do that, because guess what? The dealers have a lot of control over their state legislators and the dealers make most of their money from service. Well, Tesla’s idea here is to anticipate when a car is going to have problems and fix it over-the-air before the owner even sees it. Now, the only time—I have a Model Three. I got it in September of ’18 and I’ve had to take it in for only one reason. I had a nail in my tire and they couldn’t do an over-the-air software update to fix that, unfortunately. But otherwise, I have not had one problem with it. And my car is improving weekly, if not daily. They’re going over their software updates all the time. No one else can do that.
BARRY: So last pushback. Here’s the pushback I hear about Tesla, and I think it’s kind of intriguing and I’m curious as to your views. So Tesla has already won, won the war. And the war is, hey, we’re going to move away from carbon-based fuel, from gasoline- based fuel to electronic battery–driven automobiles.
They won. Every major manufacturer was forced fearfully to compete with them. Whether it’s Porsche or Volvo or everybody else, there isn’t an automaker in the world that doesn’t have at least a dozen cars either out or coming out or committed to, and that we are gonna be awash in a world of EVs soon enough—so Tesla has won the war. How can they win the battle for their company and their market share?
CATHERINE: Yeah. This is the question we’ve been facing from the beginning. And in fact, a Bloomberg journalist asked me—probably six months ago—that question. She said, “They’re only now getting started.” And I said, “That’s the problem.” They’re so far behind, there will never be a day—right now, Tesla has 14 billion miles worth of data to feed its artificial intelligence machine, right?
- The most that anyone else has out there is—and I believe Google has released this number about four months ago, twenty million. So 14 billion because it has 600 to 700 thousand robots out there collecting data for it right now. My robot is one of them, right, versus the pilot test that everyone else is doing in this, that or the other city.
- This is a big data problem. And I do believe, with the Coronavirus, that autonomous has an even better shot now than we thought pre-Coronavirus. I think what you’ll also see here so that Tesla can increase that mileage—again, that’s really important—increase that mileage gap is they are going to launch their own ride-hailing service, we believe this year, with drivers. And what they’ll do is they’ll say to these people who are probably out of work, Uber drivers—you saw all the layoffs there. They are going to say to these people, okay, you can buy a Model Three, five thousand dollars down, if you are going to become one of our ride-hailing drivers and you can work down the payments by paying us off as you go. The more you work, the more miles you collect for us, the more you work to solve your financing issue. You know, it’s a win-win. So I think they’re going to do that.
- Think about it. Their gross margins or auto gross margins right now are around 20%. That’s just auto. Ride-hailing is going to be much higher—much, much higher—so most analysts have not incorporated that into their models.
- We have not incorporated it into our models. It is a call option.
BARRY: Quite, quite fascinating. Let me pivot to something innovative that your firm has done, and from really the earliest days of ARK, you have embraced ETFs. You pretty much have eschewed the traditional mutual fund model. You have at least seven ETFs that cover the five major platforms, plus the Israel Innovative Technology ETF. What made you decide to say,“Let’s not do this with the traditional Wall Street mutual funds approach. Let’s go with an exchange-traded fund that is inexpensive to transact and very tax-efficient to have transactions within”?
CATHERINE: Well, we’re students of disruptive innovation. And I mentioned that while many of the new technology platforms were not ready for prime time. After ’08, ’09, we said, “Okay, that’s a major disruption. The world is going to change because of what just happened.”
- And so we started following the financial services industry to monitor what those changes might be. ETF started gaining share against mutual funds at an accelerated rate. Once again, better, cheaper, faster, more productive, more creative in many ways. And I heard—I had heard that the FCC was going to approve fully active, fully transparent equity ETFs. And so I put my hand up at my last firm, and I don’t think they were ready to do it. But I thought, why not? Why not skate to where the puck is going? And so we thought, okay, we’ll start. It’s a very good wrapper. Now, I will say that our partner, Resolute—which, American Beacon is the distributor—we do some advice for a mutual fund for them.
- So, no. Defined contribution plans can’t own ETFs. Now, that might be changing with fractionalization, but right now, they can’t. So mutual funds do serve a purpose. But we said, “Okay, this is a really good deal for the end consumer. This is an innovation. Why don’t we innovate in our own space?” And that was just the tip of it. That was the tip of it. It was active equity, fully transparent. Not only were they fully transparent in terms of disclosing their holdings at the end of the day, but we had to become fully transparent in posting our trades once we completed them, because market-makers were so scared of who we were and would we catch them flat-footed. So when I say radical transparency, we did that.
- And then I said, “Well, wait a minute, this research ecosystem, social media… Let’s use some of the technologies out there that have disrupted other industries and try to disrupt our own.”
- Well, the two and a half years in, we’re sitting at forty million dollars. I had been funding the firm by myself for three full years. And I’m saying, “Okay, we need to pivot, this is not working.” And so I thought, okay, well, maybe that was just a really bad idea.
- As it turns out, being the first truly active manager in an ETF has paid in dividends enormously. We did start managing separately managed accounts for institutions and others, but American Beacon started to find an appetite for our ETFs. And now our ETF complex is over five billion dollars, so more than I ran in total at AllianceBernstein. And our total complex is approaching 14 billion dollars.
BARRY: So I want to talk about your largest ETF, which, if my notes are correct, is over $3 billion and over the past five years has returned 204% versus the S&P 500, which returned 54%. So it’s hard to imagine that that’s a return for five years. Six years ago, you were thinking, hey, is this the wrong idea? Is this not working? Was it just a matter of time for waiting for it to catch on? What was the hesitation in 2014 and 2015?
CATHERINE: If you’ll remember, in 2014, we launched late ’14 in October. And within two weeks, just about the time we were having our launch party, ARK was down seven percent. That’s how we launched the firm. And I was saying, “Well, you know, innovation gains traction during difficult times. And just remember, this is an opportunity.”
- Of course, that’s what I had to say. It was two weeks. We were two weeks old and we went through during the first—I’m going to say until the first quarter of 2016, when the market—if you remember, first quarter, energy prices dropped into the 20s. We had China, many people thought it was imploding. We had more negative sentiment in the market, I believe, than even we had during March this year. So for the first three years, first two and a half, three years after launching, we were going from one risk-on risk-off period to another. And so we were choppy in the beginning.
- But I think what happened was this mantra, “innovation gains traction during tough times.” People began to see that it was gaining traction and they began to see in their own portfolios, they didn’t have enough exposure to it.
- And what is this artificial intelligence, autonomous vehicle, genomics, energy surge? What—you know, I don’t have that. And they began to look at us as sort of a niche strategy to generate alpha for them.
- But now we’re getting more and more people understanding, no, no, no, no. This is also a hedge against the value traps that are populating your traditional portfolios increasingly.
- So, traditional value, traditional growth. That’s the traditional world order that these five innovation platforms are disrupting. And just to put that in context, we have never had five innovation platforms evolving at the same time, never. You have to go back to the early 1900s. Telephone, electricity, internal combustion engine, technologically-enabled platforms that were deflationary in nature, that were evolving at the same time, transformed the world completely. We enjoyed the roaring ’20s there, right?
- And here we have five. So I think that one of the reasons that our stocks are so inefficiently priced is this time horizon discrepancy, ours versus the traditional market’s. But also, we’ve never been in a period like this before, so no one really expects much change.
- This all-world, sort of, tried-and-true strategy—benchmark passive worked when the world wasn’t changing that much.
- But now the world’s changing at an accelerating rate and it’s hitting all sectors of the economy. So our strategy is a hedge. And I think this is how people are using it increasingly. And my dream, of course, is to get it to be a core strategy because this is the way the world is going to work. That’s how I use it personally.
BARRY: So let’s stay with the idea of innovation and finance. You have an ETF that looks at fintech, but I want to speak more broadly. What do you think of the future of the old money center banks versus new financial institutions, and I know if I don’t ask about blockchain and crypto, I’m going to get all sorts of emails. So I have to tee that up.
But let’s just start with the big banks. What does the future look like for a Chase Manhattan bank or a JP Morgan Chase or a Goldman Sachs versus some of the more nimble online- only technologies like Venmo and others?
CATHERINE: Well, it’s very interesting, this whole tried-and-true concept, and one of the reasons the banks scaled to the levels they have is because of tremendous customer loyalty. The average lifespan, I may not have the number right, but historically, the checking account is something crazy, like 16 years. No other industry has, you know, has that kind of customer loyalty. That is changing, that is changing. And one of the reasons it’s changing is better, cheaper, faster, and more productive, more creative. You have got the Square Cash App, you’ve got PayPal, Venmo. You’ve got technology entering the space, and these technology providers are enjoying, well, what they’re doing is they’re launching viral networks.
- These are social networks. The banks, their cost of customer acquisition, and they’ve been quite willing to pay this because of the customer loyalty they’ve enjoyed over the years, their average cost to acquire one customer, it ranges—it depends, for checking accounts versus credit accounts, credit card accounts—from $350 per customer to $1,500 per customer. And for Square’s Cash App, and PayPal’s Venmo, it’s twenty dollars because of the viral nature of those networks.
- If you look at what’s happening, how quickly they are going viral, and you compare them to Facebook and the early social networks, you know, in the ’05, ’06, ’04 timeframe, the uptake here is twice as fast and it makes sense. When my children were first getting onto Facebook, they didn’t want me knowing what they were doing on Facebook, right? On a payment app, you bet. They want their parents, both parents on, you know, supporting them and sending their allowance or what have you, especially when they’re at school. So they’re bringing their parents in as well, right? The banks don’t have a shot here. They don’t have a shot at this.
- So we think that the banks are going to commoditize increasingly, and there’s going to be another problem for banks. In the kind of environment we see, this disruptive innovation, deflation-prone environment, what you will see for the next few years, at least, is what we started to see last year. You’ll see a flattening of the yield curve, if not an inversion. And the reason for that is short rates are influenced by economic activity right now. Longer rates—long rates are influenced more by inflation, right, and longer- term growth trends.
- So we think that growth is going to be much stronger than expected. Inflation is going to be much lower than expected. And that is probably already true because our economic statistics do not capture, we think, the digital economy correctly yet. So I think the yield curve will be flat to inverting and that is really harmful to these traditional banks.
BARRY: Now, one of the things I was fascinated by with Venmo is—and you could change this in the privacy settings—but it is a social network and you could see everything that all your friends and colleagues are paying for or getting paid for, which, perhaps, can be horrifically embarrassing. I had to warn some people, you know, that’s fairly public, what you just paid for. They were unaware of the fact that that was being shared.
But let’s stick with alternative fintech and talk about Blockchain. What is Blockchain going to do for finance? And how can one of any of us invest in that technology, short of buying Bitcoin-type speculative trading vehicles?
CATHERINE: Yeah, and it gives you these, this cost of customer acquisition and lots of other stats that help make the point I just made.
- In terms of bitcoin and Blockchain technology, we were the first public asset managers to gain exposure to Bitcoin through GBTC, the Bitcoin Investment Trust in September of ’15 when Bitcoin was $250. And we rode it up all the way to twenty thousand dollars. We didn’t sell. It started to fork on us and delivered what we learned the hard way was unqualified income. Grantor trust cannot be diversified. And so there were tax ramifications. We were able to maneuver out because of the ETF structure out of Bitcoin. Better lucky than smart because that was the peak in the market, right? So we got out of most of it.
- Today, in our discretionary accounts SMAs, we don’t own the ETFs because they’re ’40 Act and have this unqualified income problem. In discretionary, we have a six percent position in Bitcoin and our confidence—since it dropped from $20,000 down to $3,000, $3,500 earlier this year—has actually increased in Bitcoin, this global digital currency, one of the reasons is it’s an insurance policy against confiscation of wealth and the odds of confiscation of wealth have gone up.
- They’ve gone up in two ways. Inflation, regardless of whether you think velocity is falling now and might continue to fall for a while, it will stop falling at some point if the kindling is lit. So that’s one reason. But the other reason is you, you watch Saudi Arabia and you watch a prince basically confiscate the wealth from his own cousins.
- So everywhere in the world, there is this issue, much more so than in the United States. So we believe that the insurance policy that Bitcoin provides, you know, keep your code, your key code in your head and just walk across the border and access it, you know, without anybody knowing, that the reason, that reason is worth, could create anywhere from a one- to two-trillion-dollar market. Right now, we’re at about $175 billion in Bitcoin. So that right there is a tenfold increase.
- And that’s just one-use case, though. And you know, when India went through its demonetization, you can see what they did right away. They banned cryptocurrencies and they basically said, you go to jail if you use Bitcoin. They have changed their mind on that. That’s very interesting to us.
BARRY: So John and the folks at SIC have given us a couple extra minutes, and I want to go to take some of the questions from the audience. They’re stacking up there, and the one that seems to really move to the top is the following. Mark Yusko made the case for value stocks and real assets as opposed to high PE stocks, which one day might crash.
If so, how will this impact ARK stocks? How does this affect your thinking about traditional value versus growth?
CATHERINE: Okay. So we think very carefully about this because we’re looking at stranded assets in the value world, that’s basically what innovation is going to do. You can think about our cars as a stranded asset, you know, we have to prepay a lot for transportation. We’re going into a world where you won’t have to do that anymore and most of us won’t want to. We might want one high-end, pick Tesla, one high-end car that’s really fun to drive.
BARRY: Just one?
CATHERINE: Well, you know, you might have a hobby and might want to collect, I don’t know, a—one high-end car and then just go autonomous the rest of the way.
- So, you know, the entire internal combustion engine world and all the infrastructure built around it is at risk here. I mentioned banking is at risk, energy very much at risk.
- Now, after energy has done what it’s just done, we don’t make that point too much because now we’re seeing capital spending is collapsing in the energy space.
- So what usually happens with a dying asset—and we think this is the equivalent to whale oil as we were moving over to kerosene—what would happen with the whale oil is there was a collapse in investment in whale oil. And so you saw very volatile whale oil prices as kerosene was making its way, but was very low penetration.
- We think the same thing is going to happen to oil. You have a lot of volatility, but the trend is down. The trend is down. So we think large parts of the value space are at risk here of innovation disrupting it, and we’d pick our spots carefully, just with that knowledge in mind.
- Look at the research on our site and even rails, for example. Most people think, okay, that has got to be a protected area, if there ever was one. Now, autonomous truck platoons are going to come in and undercut rails in pricing. So right now, it costs 12 cents per ton-mile to transport freight by truck. Sort of point- to-point, you’re paying a premium for that, whereas it costs four cents, so just a third of what it costs for autonomous truck platoons.
- And by our estimates, it is going to enable freight transportation for three cents per ton-mile. So by our calculation, there’s a half a trillion dollars of stranded assets in the rail sector (in play).
- You see what’s happening to the airlines? Well, if we’ve got autonomous driving, I can tell you, I do not want to go to the airport to go fly to Washington, DC, or to Boston. I would much prefer to go point-to-point in my autonomous car and work, talk to the office, conduct business. So I think it’s going to hurt short-haul airlines. Not only the Coronavirus but this move toward autonomous.
BARRY: Interesting question about AI and autonomous vehicles. Do you see China winning the AI autonomous vehicle game, and if so, why should we invest in Western companies in that space?
CATHERINE: I think China will win in China. I do not think China will win in the rest of the world. Now, what is interesting is they’ve been so welcoming to Tesla. Tesla’s the first manufacturer of any kind allowed into China without a local partner.
- And, you know, the suspicious types will say, well, of course, they’re just going to reverse engineer with the Chinese employees in there and that that could very well be.
- We’ve talked to Elon about that, and he says that they’re not going to get the secret sauce. I remember at AllianceBernstein, there was a venture investment in a mapping company in China with the thought that, you know, this company would map out China. Are you kidding? They stole that and basically, you know, wiped it off the face of the earth. So, no, they’re not going to let a foreign company dominate China. But China is not collecting miles on us or European roads, to our knowledge, whereas Tesla is.
BARRY: Here’s another, very interesting question. Does being limited to public markets limit your ability to invest early enough in the truly disruptive, innovative companies to reap the full gains?
CATHERINE: A very interesting trend happened, starting with the tech and telecom bust and even more so after ’08 ’09, the meltdown.
- And that was the move to passive first and then even for public/private players, a move away from innovation in the public space and they got their exposure to innovation in the private space, which, in the early days, was fine. I mean, the rewards were enormous.
- The private space has been overvalued, and, I mean, we’re writing a white paper about venture capital and liquidation preferences and all the concoctions that have developed over the last few years, which tell us that it is just way overvalued. And of course, the SoftBank Vision Fund was sort of the exclamation point, the aha moment for a lot of people.
- So what we’ve been watching is, take Moderna. Everybody knows about Moderna now because they’ve just developed—they’re in phase two for—phase three, actually, for a Coronavirus vaccine. We own Arcturus. We don’t own Moderna. They’re both wonderful companies. Moderna came out in December of 2018 at thirty times sales.
- Arcturus, in our portfolio, same space: RNA vaccines. But Arcturus has a better delivery platform, we believe. They’re both fine companies.
- Arcturus was somewhere in the three times sales range, it was somewhere, two to five, it was around three times sales. 30 times vs. three times. That’s a big discrepancy.
- I asked our analyst, why is there this discrepancy? Why? And she said, “I don’t know.” I said, “Okay, well, buy more Arcturus and let them have Moderna as it’s going public.” Moderna got cut in half within its first six months. And that was public market investors doing a little more comparative work and saying, I don’t think so. That valuation is too rich. Recently both Arcturus and Moderna have been on fire for the same reason. I think Arcturus has gone up more than Moderna since the Coronavirus hit.
That concludes the Catherine Woods interview. Hat tip to friend Barry Ritholtz. Excellent job.
Here is the link to the audio interview. I find I like to both read and listen. It helps me retain information better. If you are up for it, put your sneakers on, plug in your headphones and head out for a walk.
July 8, 2020
S&P 500 Index — 3,153 (open)
Notable this week:
TINA? How about gold? My friend David Rosenberg tweeted this morning (July 8, 2020), “Does TINA (There Is No Alternative) really exist? Over the past year, the S&P 500 total return index is up 7.5%. But the long bond has returned 29.4%. And gold has returned 26.8%.” What he didn’t say is the equal weight S&P 500 Index (same stocks but equal-weighted vs. cap-weighted) is down 6.44%. What this means is just a handful of stocks are driving the S&P 500 Index higher.
Here is a comparison of two S&P 500 Index ETFs (SPY is the cap-weighted ETF and RSP is the equal-weighted ETF. Same stocks, different weighting scheme). SPY is up 5.66% in the last 1-year. RSP is down 6.44%.
Gold is up another 2% today:
There are no changes in the signals this week. Investor sentiment remains neutral. I could be wrong, but I suspect a short-term top when sentiment reaches extreme optimism.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Click here for this week’s Trade Signals.
Wishing you a fun filled weekend, a cold IPA, a fine glass of wine, and time with the people you love most. Stay safe. Stay healthy. And trust that this virus mess will pass.
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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