If There’s a Bubble, It’s in Bonds: Cathie Wood

ARK Invest takes on hot stock valuations worries in their February webinar, with a word on value traps.

Andrew Willis 10 February, 2021 | 1:49AM
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Cathie Wood and her team at ARK Invest have been on a tear this year. That comes with questions around the sustainability of sky-high stock performance. But she turned the table at yesterday’s ARK Invest Monthly mARKet Update Webinar.

“We have found that the flows into mutual funds and ETFs have been instructive in terms of giving us a sense of whether or not there’s a bubble out there. Equities have been outflowing – pretty regularly – since ‘08/09. There’s been an asset allocation shift towards fixed income which has been inflowing,” said Wood. “As far as bonds, we do believe they’re in a bubble,” she later noted.

Fixed Income Bubble, Equity Bifurcation
“Since 2018, (and I often use January of 2018 as an important marker because 2017 was such a good year for equities that we thought surely there would be nice inflows into equities) there have been equity outflows cumulatively, roughly US$300bn. On the contrary, there’s been an inflow into bonds, approaching US$1 trillion. If there’s a bubble anywhere, it is not on the equity market. It is in the fixed income market,” the former economist added.

Wood also discussed how from a fundamental perspective – from “explosive” profit expectations this year, to stimulus that’s more than plenty, to copper – she sees healthy equity growth ahead. Except that the good news doesn’t apply to all stocks in the post-pandemic world.

With a cultural trend acceleration that’s converged with exponential profit growth unlocked by the latest disruptive innovations – it’s sink or swim out there right now.

“Within the equity market, we do believe there is a bifurcation developing - we think [it] will be impacting stock prices in a much more intense way going forward - between those companies that are on the leading edge of innovation vs. those companies that have not been doing that,” she warned.

The Big Winners – and Lots of Losers
While we’ve been so focused on the volatility of hot stocks, many common ‘shareholder-first’ companies have been far more suspect. “They basically were catering to the short-term investment time horizon of investors who rewarded them for financial engineering,” said Wood. There have been companies buying back stock and doing so by “leveraging up” – and then paying dividends by taking on more leverage, she added “we believe [they are going to be on] the losing end of the massive move towards innovation that we’re witnessing today – their high cash flow margins will disappear over time.”

By contrast, “the companies with the very high valuations – and you’ll find them in our portfolio to be sure – are forgoing short-term profits in order to invest aggressively in the exponential growth trends that we have entered,” said Wood.

For example, platform strategies like Square, Roku and even Tesla are “evolving platform strategies that are winner-take-most, or winner take the one, two, or three slots out there for platforms – that are going to be much more global than has historically been the case,” said Wood. “Amazon has shown the way, to be sure, but now this is moving well beyond retail.”

“Before valuations used to be influenced by a company’s market position in one country, or one region. We think global - especially when it comes to anything digital - is the right way to think about these stocks,” said Wood, “we think that these companies will grow into their valuations – much like Amazon has been doing - as they enjoy enormous scale by going global.”

Global vs. Value Traps
“We do not think stocks as a whole are in a bubble. We don’t even believe the platform companies are in a bubble…at all,” said Wood, “we think instead, that there are a lot of value traps evolving in the market, and value traps as any value investor will tell you, are when stocks become cheap for a reason. And they become cheaper and cheaper over time – as the old world consolidates to just a few players.”

Who survives? Cathie’s ARK Invest believes that five innovation platforms: DNA Sequencing, Robotics, Energy Storage, Artificial Intelligence and Blockchain Technologies, which involve 14 different technologies, will lead the way on exponential growth in the next five to 10 years. “[They] are going to be the big winners. And they are going to create a lot of losers out there.”

The active manager with a portfolio of domain expertise couldn’t help but caution on passive investments at the other end of the spectrum. “This move towards passive investing that we’ve seen during the last 20 years since the tech and telecom bust and the ‘08/09 meltdown - that now is a setup for disappointing returns from the broad-based benchmarks and various indices. And we would implore investors if they are loaded up on very cost-effective investment strategies – again they could be cheap for a reason– at least have a hedge and invest in some of these areas of innovation that we do think are going to deliver outsized returns over time.”

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Amazon.com Inc181.81 USD0.54Rating
Block Inc Class A62.15 USD0.71Rating
Roku Inc Class A57.98 USD4.30Rating
Tesla Inc223.20 USD3.34Rating

About Author

Andrew Willis

Andrew Willis  is Senior Editor at Morningstar Canada. He previously produced content for Fidelity Investments and finance industry events for Euromoney Institutional Investor and has written in the past for Thomson Reuters and CNN. Follow him on Twitter @Andrew_M_Willis.

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