Can ARK Invest Weather the Storm of Inflation?
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Chapter 1: ARK Invest’s Strategy Under Scrutiny
ARK Invest is known for its exchange-traded funds (ETFs) that focus on innovative, disruptive technologies. Founder Cathie Wood is drawn to exponential growth prospects, investing in companies that may not yet be profitable or that have extraordinarily high price-to-earnings (PE) ratios. While traditional fund managers often criticize this approach as overly risky, ARK sees these investments as future leaders in technology that will yield substantial returns.
However, many of ARK's funds have faced significant declines over the past year. For instance, ARKK, their flagship Innovation ETF—home to Tesla as its largest holding—has fallen nearly 50% from its peak in February 2021. Similarly, the Genomic Revolution ETF, ARKG, which was heavily promoted in 2020, has dropped 54% from its earlier highs.
This downturn has intensified criticism of ARK's aggressive strategy. Given the coinciding period of record-high inflation, some critics argue that ARK's struggles are largely due to inflationary pressures, which have driven investors towards a more cautious approach.
"We do not believe that most asset allocators have enough allocated to innovation… Because of these innovation platforms — DNA sequencing, robotics, energy storage, artificial intelligence, blockchain technologies — because those are going to rip through the traditional world order, and disturb it mightily, those benchmarks are probably where we're seeing the bubble today," said Wood.
It’s clear that Cathie Wood is convinced that the market underestimates the potential of emerging technologies. She asserts that rather than conforming to traditional fund management styles, these managers should adopt her perspective.
Section 1.1: ARK’s Value Perspective
Wood has countered the narrative linking her funds' underperformance to inflation, stating, "What I find so interesting about movements in the market today is, the fear of interest rates and inflation picking up really started in February of this year when people were starting to get vaccinated, and the markets went after our strategy to express the risk and basically shorted our strategy."
She suggests that the backlash against her funds was an overreaction to broader economic conditions, particularly inflation and the Federal Reserve's anticipated actions. Wood emphasizes that her investment horizon spans five years or more, contrasting with many investors who focus on short-term gains. She believes that over a five-year period, her funds hold significant upside potential.
"In mid-February this year, as we did our 5-year forecast — and we assume massive multiple compression during the next 5 years to something like FAANG multiples: EV to EBITDA in the 18 to 20 range — the compound annual rate of return we expected from our portfolios was roughly 15%. Today doing that analysis, some of our projections have increased. The compound annual rate of return we are expecting is close to 40%," Wood explained.
Subsection 1.1.1: Deflation Over Inflation?
ARK's investment strategy is not the only unconventional viewpoint Wood holds. As many economists and investors raise alarms about inflation, she argues that deflation is more likely in the near future. In a Twitter post from October 25, 2021, she stated, "Now we believe that three sources of deflation will overcome the supply chain-induced inflation that is wreaking havoc on the global economy. Two sources are secular, or long term, and one is cyclical."
The first long-term source of deflation Wood identifies is the falling costs driven by technological innovation. She frequently cites the plummeting costs of DNA sequencing and AI training, which are decreasing by 40–70% annually. She believes this will lead to a decline in money velocity as consumers and businesses postpone purchases, anticipating lower future prices—a scenario she refers to as "good deflation."
The second long-term source is what she considers "bad deflation," stemming from companies that have failed to innovate. Instead of investing in growth, these companies have opted for share buybacks and dividends, which will force them to sell outdated products at reduced prices.
The third source of deflation, which Wood admits is controversial, involves the cancellation of excess orders as supply chain constraints ease. She points to corrections in the prices of commodities like lumber, copper, and iron ore as evidence of this trend.
Despite Wood's assertions, current indicators show few signs of deflation. This minority view conveniently aligns with a positive outlook for her investment strategy, raising questions about whether her approach may overlook the arguments for sustained inflation voiced by figures like Peter Schiff and Ray Dalio.
Chapter 2: The Velocity of Money and Its Implications
The video titled "Markets Betting Against The FED Again?" explores the dynamics of inflation and monetary policy. As Cathie Wood expressed in December 2021, she acknowledges the prevailing sentiment that inflation is not just a transient issue, noting the persistent supply chain bottlenecks and shifts in consumer purchasing behaviors.
Wood’s perspective on inflation and the velocity of money has evolved since 2021. After Jack Dorsey's tweet about hyperinflation, which sparked significant debate, Wood countered with her observations on the relationship between money velocity and inflation. She highlighted that a decrease in money velocity could counteract inflationary pressures.
However, as inflation rates remain high, it raises critical questions about the accuracy of inflation metrics and the ongoing relevance of Wood's deflationary thesis. If inflation continues to rise, it could pose significant challenges for businesses across all sectors, particularly for those that cannot keep pace with inflation rates.
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