Updated: Sep 5
By Rishi and Bernard
Cathie Wood provided an update on markets yesterday. In her introduction she provided her insights on the "Value vs Growth" Tug of War. Not surprisingly, she predicts that Growth will come back with a vengeance. We provided our views in a Twitter Livestream last night sharing our partial agreement. In this article we share more color on the current macro backdrop that had many fleeing growth stocks and how we are positioned for the rotation back into growth.
Our takeaway from this analysis is an increase in confidence in our top four #2ndTechBubble strategies (see portfolio, tickers $SSYS, $COUR, $LRN, $ARKG, $ARKK). This week, IntuitEcon positioned for this by replacing some of our stock positions with long dated call options (January 2023) for stocks and ETFs that have reasonable bid-ask spreads and low implied volatility relative to history.
We also own a 8% position in Ark Invest's flagship fund ticker $ARKK from the bottom in May when we released this Twitter Livestream calling bottom. (Click picture below)
In recent months the bond market has been rallying with fervor as 10 year yields have remained below 1.3% throughout the second half of July. The stock market has continued to show unprecedented strength with the S&P 500’s 50 day moving average consistently around 8% above the 200 day moving average since September 2020. IntuitEcon commented on this two weeks back as being driven by exceedingly high levels of liquidity, causing a bidding down of returns on all financial assets.
Despite market strength, fear has still taken over as mainstream media reports and notable investors like Michael Burry predict a stock market crash. Inflation indicated by recent CPI and PPI levels are a big cause for concern. There was more talk of economic stagflation, but this weeks drop in the unemployment rate from 5.9% to 5.4% seems to contradict that narrative. Then there is the seemingly never ending fear of societal and economic pain caused by the resurgence of COVID-19 in the form of the delta variant as we discussed in a prior analysis.
There is an open debate on the question of inflation as well. Chairman of the Fed Jerome Powell maintains his stance on inflation being transitory regardless of criticism from many skeptics, including Cathie Wood, staunchly declaring that the US is in for a period of intense deflation in the long run due to creative destruction from innovation.
Several factors are driving up CPI inflation. Supply chain issues caused by COVID19 are one factor. Labor costs are another ... particularly in the service sector as people are less eager to work in those fields due to a combination of employment assistance and perhaps a shift in the demand for more service oriented jobs that pose higher risks to health because of the pandemic. As a result, there is still a strong disincentivize for people to work at high traffic areas with traditional low wages such as at a hotel.
Another factor is the rising cost of shipping container prices from China. Some analysts argue that this is being caused by excess pent-up demand of goods from the US coupled with a shortage of containers in China. This has pushed the cost of importing goods to unprecedented levels. Political tensions between China and the West may also be playing a role in complicating relations ... indirectly driving up costs as companies bake uncertainty into their cost of business.
Prevailing Narrative ... Tech Bubble Popped
The macro backdrop suggests that the prevailing narrative is pessimistic, especially toward so called "Disruptive Innovation". Arguably the strongest evidence of this is the fall in treasury bond yields despite a very real rise in prices of common goods and services. Investors in Disruptive Innovation have been largely left out of the growth in stock valuations in 2021. Cathie Wood went from being proclaimed as the "New Warren Buffett" to a "Fraud" by some commentators after her funds tanked in February leaving a bad taste in many investor’s mouths and broad speculation that Disruptive Innovation was in a bubble.
True bubbles tend to have multiple rapid price run-ups followed by crashes in which many investors claim that the bubble has popped. The final top is typically characterized by a broad acceptance by many investors in the core narrative. That happened for Tesla and Electric Vehicles broadly in the run-up that started in mid-2019 and ended in February 2021. Ark Invest played a key role in bringing awareness to these other key technologies ... but only really became widely recognized starting around mid-2020 thanks in large part to Tesla ... arguably the most emotional stock in the market.
Electric Vehicles arguably were in a bubble, but not technology generally. Electric vehicles by themselves are not a particularly good business. They are easier to make because they have 10% of the moving parts. Consumers are also generally deriving less status from cars and viewing them as a service...making different cars that much more commoditized. There was never any real justification for a car company like Nio or Plug to achieve such high valuations. Tesla is a special case not because of EVs...but because of autonomy.
The crash in Ark was driven by how closely the ETFs became tied to the EV narrative. That's why everything in it sold off in unison. But the other technologies within Ark that we see as leading the second tech bubble only started hitting new highs in mid to late 2020. Genomics took off in mid-2020 because these companies were demonstrating the power of this new technology to save the world...so this initial run-up arguably had nothing to do with Ark. On the other hand...PRNT did not hit a new multi-year high until November 2020.
This arguably was driven in large part by Ark euphoria because that is when all of their small cap stocks started rising in unison before crashing. That is critically important because it takes a lot longer than four months to create a true bubble.
Our views in the Twitter Livestream expressed the "Prevailing Narrative" as believing Disruptive Innovation cannot succeed in a strong economy. That somehow rising incomes and demand for raw material being so high that companies with rapid growth and new technologies will fall out of favor. If true...there appears to be substantive argument to support this view, as we have detailed in prior articles on the #2ndTechBubble.
What really matters when it comes to an investment is the intrinsic value and its relation to price. Understanding the intrinsic value is complex...as is judging the relation to price. But we do have strong conviction that whatever that relation it is likely that the Prevailing narrative is one that has made the price relatively cheap.
So what about the intrinsic value?
Positioning for the rotation...
Our largest positions are concentrated in four areas of Disruptive Innovation. These have some overlap with Ark Invest, but with some significant differences. We address each in turn...
1. 3D Printing
The 3D printing bubble of 2011 was driven by a hope of what the technology may someday deliver. The narrative was that every home would have a 3D Printer to make many of the things that they used to buy at the store. These printers were very expensive and didn't work well, but that has changed.
Today, several products such as hearing aides, plastic braces, and hip replacements are nearly 100% 3D printed because it is a superior manufacturing approach for anything tailored to individuals. Many products can only be produced with 3D printing such as the lightest and strongest bike frames and specialized parts for aircraft and satellites. Many products used to fight COVID19 were created using 3D Printers such as ventilators because they could be produced immediately from 3D Printing factories. Simple organs have already been printed and successfully transplanted into patients. Human tissues are being 3D printed and used to help expedite testing the efficacy of drugs and therapies.
Since the last 3D Printing bubble the technology has improved dramatically...meanwhile the cost of traditional manufacturing techniques just got a lot more expensive. The Trade War increased the perceived costs and risks of complex supply chains. So did the Pandemic which in addition showed that what consumers demand can change rapidly and without notice...unlike a traditional manufacturing assembly line. Inflation in commodity prices is driving up the cost of plastics, copper, and other manufacturing materials making an additive manufacturing approach even more appealing. Moreover, growth in platforms like Etsy and the continued specialization of tastes and personalization continues to make mass produced goods and services look less appealing. Demand for 3D Printers is not just coming from consumers now...it's being driven by manufacturers as well.
CEOs of these companies are all saying the same thing...that 3D Printing is finally hitting an inflection point and rapid adoption. But they are not just saying this...they are buying into it...selling off non-additive manufacturing parts of their business and acquiring smaller private 3D printing companies.
All of these changes and catalysts have occurred...and yet the total market capitalization of all pure play 3D printing companies is only $15 Billion ... or 20% less than American Airlines. That's not much more than where it was three years ago. The reason is because of what I just wrote on the "Technology" channel...investors are confusing the terms "Ark" and "Tech" with the reality of individual companies.
Fears of Covid19 and supply chains with China have re-emerged sending some investors running from "Risk Assets" ... but additive Manufacturing companies are positioned to benefit. They are a solution to supply chain issues caused by rising container prices. Advances have been made in 3D printing for metal parts. Companies like Siemen’s Mobilities, one of the largest global manufacturers of trains, purchased 3D printers from Stratasys ($SSYS) to produce spare parts for their trains in a much more efficient manner. Switching to 3D printing their own parts instead of spending too much time and money to import the parts has further streamlined the production of Siemen’s deliverables.
Many companies like Siemen’s have relied on “just-in-time” production, a common practice for manufacturers that try to reduce costs by avoiding storage and delivering right when it’s being assembled into the finished product. Additive Manufacturing from 3D printing is gaining more traction as large companies move toward a "Just-In-Case" approach that avoids cost of storage...seeing the benefits of this new industry when it comes to meeting their needs in an uncertain global economy.
The power of Gene Editing is hard to over-estimate. People are being literally cured of genetic diseases. Genome sequencing is growing in adoption as as that happens the applications of Machine Learning technology will help to improve diagnosis and treatment outcomes. This video provides a lead into the Education Revolution ... it's a set of research articles produced by kids during the pandemic on the impact of the Genomics Revolution. It's a better summary than we can write here despite being produced by kids ages nine to fourteen.
Threats to Genomics include political risks. Democrats largely took Trump’s value-based negotiating framework for drugs not sold overseas. The price differences between even US and EU sales of major drugs is significant leaving US companies open to margin pressure. Democrats generally seem to discount the power of incentives and the likely decrease in R&D spending that results from reducing profit motives.
Threats to Genomics also include tax policy. Drug companies are some of the worst actors in the tax arbitrage space. This is driven by tax treaties which enable companies to sell product royalties to foreigners who then pay zero tax on the resulting revenue. This leaves drug makers generally at risk of substantially higher tax increases, especially those exploiting healthcare innovation treaties.
Despite these risks we are looking at a technology that has the potential to change the shape of human society ... and biological life on earth as we know it. There are powerful ethical concerns here to be sure, but from an investing standpoint it is hard to find a more under appreciated opportunity.
3. Education Revolution
The video on Genomics produced by children illustrates two realities of the Education Revolution. First, anyone can learn just about anything for free. Second, anyone can demonstrate that knowledge no matter than background ... even children. These are the two problems that brick-and-mortar schools from K-12 through University were created to solve...that and teach our population to be good soldiers if necessary (history is fascinating).
Educational Technology is bringing new opportunities at an exceedingly fast rate since the pandemic in 2020. The world changed ... and its rapidly changing behavior. The traditional 9-5 working model is no longer necessary. Neither is physically going anywhere to learn. All one needs is an internet connection and ambition.
Companies like Coursera and Blue Prism are already taking advantage of this historical movement. They are partnering up to provide top notch online education for young professionals that have an interest in learning the skills needed to take on an intelligent automation role. Through Coursera, Blue Prism is offering an online certificate for Robotic Process Automation as a response to the creative disruption that will take place within the next 5-10 years.
The world is changing fast and the pace is only increasing. According to the World Economic Forum’s 2020 report, half of all employees in the world will need reskilling by 2025 due to technological innovation. That is largely going to occur virtually and using micro-degrees for specific skills. Why? Because Bachelor's degrees are exceedingly expensive and are not tailored to the individual demands of increasingly specific jobs.
The Harvard Business Review highlights the fact that ⅔ jobs in the US require a bachelor degree yet in most of those fields the usefulness of theory in the classroom is considered unimportant in comparison to hands-on work experience. Thus the term STAR or Skilled Through Alternative Routes came to be as plenty of suitable candidates were discarded by many hiring companies for not holding 4 year bachelor degrees. Seeing as this issue is being brought even more to light after the 2020 lockdowns, more employers will be inclined to disregard the arbitrary requirement for their candidates to have 4 year degrees and opt to hire people that demonstrate “STAR” like qualities.
The pandemic has created a radical shift in the mindsets of both employees and employers in the job market. A McDonald’s employee can now quit his/her job, learn the skills necessary to become qualified to take on a role in automation through Coursera for a much more reasonable price and get hired by an employer in the field that sees value within skilled workers that don’t necessarily hold a college degree.
That same former McDonald’s worker can even become the tech support agent for the many automated systems or bots that would have otherwise replaced him/her in his/her previous job. (e.g. Voice Recognition Software in Drive Through, Touch Screen Order, etc.)
Our new global digital economy requires a rethink of education. We no longer need knowledge...we have Google for that...what we need are new learning platforms that can help us quickly learn new skills. Those are the companies we are investing in.
4. Decentralized Finance
Decentralized Finance is our largest best in the Crypto space. We wrote about it already in another piece titled "DeFi Tech" ... a publicly traded security that we believe is positioned to potentially do even better than Ethereum.
Those who wallow in fear and uncertainty will only break free if they open their minds up to change and innovation. In times like these it’s important to not mistake risks for opportunities. When investors panic and lose faith in great companies that are growing fast because they are making the world better...we play the contrarian and buy. The term “Disruptive Innovation” means different things to different people. We are not simply buying and holding a bunch of Ark Invest stocks. We are buying "Value" and where we see value is in companies growing fast and changing the future trading at a 50% discount to prior highs.
Our top conviction stocks are listed in our Twitter bio. Feel free to follow and don't forget to join our podcast every [UPDATED] Monday at 6PM EST. Zoom link is sent out at the Twitter handle below.
Rishi and Bernard