Don't Drive With a Blacked-Out Windshield
One more time (at least) about Cathie Wood and ARK... Pumping the 'exponential growth' line... A correction strikes these ballistic funds... Is a 'death spiral' coming?... The main question about bonds today... Why questions are better than answers... The best I can do... Don't drive with a blacked-out windshield...
I (Dan Ferris) laughed out loud as soon as the words came out of her mouth...
Earlier this week, I discovered a video interview from December between ARK Investment Management founder and CEO Cathie Wood and Bloomberg editor-at-large Erik Schatzker. (If you have some time to waste this weekend, watch the 35-minute piece right here.)
I promise that I'll stop talking about Wood and ARK's portfolio of ballistic exchange-traded funds ("ETFs") eventually. But I'm sorry... "eventually" isn't happening this week.
Maybe that day will come after the bubble pops (which might be sooner than you think).
In today's Digest, I can't resist adding another small chapter to the saga of Wood and ARK – the investment firm whose ETFs most pristinely capture the current bubbly zeitgeist...
At one point in the Bloomberg interview, Wood said – without any hint of sarcasm or irony...
Looking at the portfolios, after [their triple-digit gains in 2020]... we believe our portfolios will compound at an annual rate of something in the low 20% range.
That's when I laughed out loud (the first time anyway). It reminded me of an anecdote from one of my friends back in the dot-com era...
A couple walked into a local financial adviser's office. They spoke with an adviser who talked about putting their money into mutual funds that could return 20% a year.
That's an absurd claim... It's more than triple what any reasonable investor would ever expect from equities over the long term (around 6% or so). But the couple would not be outdone... With a straight face, one of them said, "No, we want to make 100% a year."
During the interview, Wood seems naïve when she says things like...
We think there's a lot of room, or runway ahead... because what we think is not well understood is exponential growth.
Every newbie shareholder in electric-car maker Tesla (TSLA) – a large holding in three of ARK's ETFs – talks about "exponential growth"... So the phrase makes a seasoned professional like Wood seem like she's chugging Kool-Aid with the masses right now.
They need to believe in high growth, though... Without it, Tesla could be the "most overvalued stock in history," if not the "most inevitable crashing sound imminent in a financial instrument."
However, we can't mistake Wood for a complete fool...
With decades in this game, she knows what can happen. As Wood told Schatzker...
I have been around the block a few times, and whenever things have gone this well for me, usually there's a correction around the bend. And I want to gird for it and protect it, and also prepare our investors for the possibility and say, "Just keep some powder dry."
That's sound advice. But Wood couldn't let it distract folks from her real angle for even a millisecond... She immediately returned to pumping the "exponential growth" line.
Wood went on to say that ARK operates on a five-year time horizon and that these exponential growth trends can't be stopped... It reminded me of the Soviet regime's five-year plans – all guaranteed to bring prosperity for everyone, and all failing miserably.
The inevitability of the growth trends in technology might be real. But by now, the painful experiences of the dot-com and housing bubbles should have taught all investors that high – or exponential – growth rates are never unstoppable or sustainable for very long.
Wood is playing with fire right now, betting that the current bubble has more room to run.
But the ARK ETFs have struggled recently, along with all the sexy tech stocks in them...
Like I've said before, ballistic price charts don't correct by going sideways.
They correct by crashing.
As I showed you in the February 11 Digest, all of ARK's ETFs were going bananas. These seven funds all went nearly vertical in 2020 and through the first month of this year.
But now, as we noted last week, the correction is upon us...
The firm's flagship ARK Innovation Fund (ARKK) closed at $117.07 per share today. That's already 25% below its highest close price ever – $156.58 per share on February 12.
If this keeps up, we could see a world-class rout... And ARK might quickly find itself in a situation it can't get out of, with investors calling for redemptions faster than it can sell the stocks that it holds. We don't know what the future holds, but it's not looking good so far...
The biggest loser of the entire bunch is the ARK 3D Printing Fund (PRNT) – down 27% from its February 9 peak. The other funds are down anywhere from 18% to 24% as well.
And as I said, the sexy tech stocks in these funds have taken it on the chin, too...
For example, the top 10 holdings in the ARK Innovation Fund are Tesla, Square (SQ), Roku (ROKU), Teladoc Health (TDOC), Spotify Technology (SPOT), Baidu (BIDU), Zillow (Z), Shopify (SHOP), Zoom Video Communications (ZM), and Crispr Therapeutics (CRSP).
These 10 stocks are down an average of 25% since February 12. Teladoc Health (down 35%) and Zillow (down 32%) are the biggest losers in the group over that span.
This could very well be the beginning of the end of ARK...
In his daily e-mail yesterday, my friend and Empire Financial Research founder Whitney Tilson highlighted some research showing that traders are paying as much as 19% interest to borrow shares of the ARK Innovation Fund.
There's only one reason to borrow shares... to sell them short.
In other words, a bunch of folks are planning to profit from the fund's impending doom.
Whitney also highlighted the potential for the fund to get caught in a "death spiral" as funds flow out due to investor redemptions. In turn, these redemptions would cause ARK to sell its holdings – some of which are highly illiquid and could see steep price declines.
These holdings are illiquid partly because some of them are small- and mid-cap stocks, and ARK owns such large stakes in them. And it can be difficult – if not impossible – to sell such large stakes in a steep enough bear market.
A recent Morningstar report noted that the ARK Innovation Fund owns more than 5% of 19 companies and more than 10% of 10 companies. The investment firm also owns several small – and by definition, less liquid – stocks in two or more of its ETFs.
For example, according to an anonymous finance professional who calls himself "Keubiko," three ARK ETFs and a sub-advised fund that mimics the ARK Innovation Fund own 26% of the float of Israeli drug developer Compugen (CGEN). And Keubiko says it would take six months for these funds to sell if their sales accounted for 10% of daily volume every day.
My best guess is... the death spiral that Whitney mentioned yesterday would have come and gone by then. And it would have left ARK investors wiped out with little hope of recovery.
I'm not saying anything controversial – at least not to anyone who knows a little market history...
It would be rather typical if the ARK ETFs' recent all-star performance were followed by a year or more of mediocre – or even lousy – returns. That's the way it goes for all types of funds... Investors chase performance up, then bail out when the fund disappoints.
And if I seem obsessed with Wood and ARK... well, maybe I am.
That's because – as I've said in my recent missives on the topic – I believe Wood and ARK are the "Mother of All Signs of an Impending Top." It's a purely anecdotal assessment based on my own study of past bubbles (some of which I shared on February 11).
However, I bet Wood knew in December when the Bloomberg interview was conducted that the current correction was even more inevitable than her promise of exponential growth.
I wonder what she'll say when ARKK is down 80% in a few years... Only time will tell.
Speaking of stuff that's down roughly 20% from its recent highs...
If the ARK Innovation Fund's 25% decline from all-time highs could be a sign that the tech stock mania is over... what about the 19% decline from all-time highs for the iShares 20+ Year Treasury Bond Fund (TLT) over the past seven months?
I have more questions about this bond situation than answers. That's good, though... because questions keep you thinking. On the flip side, answers can make you complacent.
Seek answers, but be skeptical when you find them. They're rarely what they appear to be.
The main question I have about bonds right now is this...
Is it over?
"It" is the four-decade bull market in bonds that started with long-term U.S. Treasury yields at 15% in September 1981. It's technically still going today, nearly 40 years later...
Interest rates hit their lowest levels in 5,000 years of recorded history last summer, and they're still not far above those levels today. (It's true... Just check out Sidney Homer's classic work, A History of Interest Rates, which is often called "The Yield Book.")
Like the ARK ETFs, Treasurys are issued by an institution with little care about the future consequences of its actions... and thoroughly consumed with managing perceptions in the current moment. And like the ARK funds, Treasurys are bought by a large group of people who fancy themselves as geniuses and whose expectations about future performance are delusional at best.
When Treasurys perform like bubbly tech stocks, people notice – even the folks at the Federal Reserve...
Earlier this week, Fed Governor Lael Brainard said bond volatility "caught [her] eye." And then, speaking yesterday at the Wall Street Journal Jobs Summit, Fed Chairman Jerome Powell said the bond market's action finally "caught [his] attention" last week.
They both said "caught." I doubt that was happenstance...
I can just see the Fed's empty suits on a Zoom call from their second homes, talking about what to say when it starts looking like they don't control the bond market the way the propaganda of the past couple of decades suggests. I imagine it would go like this...
Powell: OK, all... Treasurys look like the frikkin' ARK funds right now. W-T-F?! But we need to seem really nonchalant about this, like it's no big deal. When people ask about it, let's just say we "noticed" the bond market is having a tantrum. Make it sound as important as my wife's haircut, which I haven't noticed since 1994.
Brainard: No, no, no... Let's say "caught" – like "the bond market tanking caught my eye" – like it was interrupting us at high tea or something.
Powell: Ohhhhh, that's snappy, Lael. I like it. All in favor of "caught" say "aye"... Great. The "ayes" have it. "Caught" it is.
Brainard: And if we say it caught our eye, it gives a nice visual of us watching the bond market fall apart on TV, just like everybody else. It makes us seem kind of normal.
Powell [laughs]: Oh, that's priceless... "Us, normal?" I'm worth $100 million and fly private. And the only thing like a real job you've ever had was with the smug, deluded jerks at McKinsey. Hey, speaking of everybody else, where is that stupid boy with my drink? It's been five minutes...
I'm just speculating that such a meeting took place, of course. But it seems realistic to me.
We won't hear much from the Fed's leaders over the next 10 days...
The central bank is in a quiet period until its next meeting on March 16 and 17. Powell's comments yesterday were his last chance to calm the market before then.
And he seems to have failed, at least as of yesterday's close...
The benchmark S&P 500 Index fell 1.3% yesterday. The tech-heavy Nasdaq Composite Index gave up all its year-to-date gains... It was down nearly 10% from its February 12 high. And the 10-year yield has surged to 1.57% – its highest mark since February 2020.
(Remember, bond yields and prices move in opposite directions. So with yields soaring to levels that we haven't seen in more than a year, it also means that prices are going down.)
Powell's latest comments didn't prevent the prices of stocks and bonds from falling yesterday. And today's rally – with the S&P 500 gaining around 2% and the Nasdaq climbing roughly 1.6% – only took a little bit of the sting out of the recent correction.
So maybe nobody cares what Powell says anymore. If only...
As eloquent market expert Jim Grant of Grant's Interest Rate Observer likes to say, the celebrity enjoyed by the chair of the Federal Reserve is the equivalent of splashing a baseball umpire's picture across the cover of People magazine. It's absurd.
So what does it all mean? Has the bond bull market of the past 40 years finally ended?
It seems irresponsible to answer "yes" or "no" at this point...
I'm confident about the meaning of ARK's ballistic ETFs and the recent 20%-plus routs that they've all suffered. But I'm less confident that I can fathom the depths of the $28 trillion U.S. Treasury debt market... or that anyone else can, for that matter.
In fact, I have no answers about the action in the bond market. But as I said earlier, questions are always better than answers...
Good investors never stop asking questions. They accept all answers the way a good scientist does – as provisional and subject to revision or complete falsification.
So at least for now, my main question stands... Is the four-decade bond bull market over? And if it is, that leads me to another question...
Has inflation taken hold, due to trillions of new dollars in stimulus spending?
I'm skeptical about answers to that question, too...
For example, I heard it suggested that the big jump in jobs data reported this morning is why U.S. Treasurys continued to sell off today. But that's a little strange to me...
About 10 million fewer people are working today than just before the COVID-19 lockdowns hit. It's not like there's any shortage of labor (which is traditionally a sign of inflation).
But if you're still holding out for an answer, here's the best I can do on both questions...
And frankly, it's probably the most you should tolerate from anybody right now...
It's too early to tell.
Yes, the 10-year U.S. Treasury yield has roughly tripled since last summer – from its low of about 0.5% back then to 1.5% today. That's a huge move in percentage terms... but it's really only around 100 basis points ("bps").
I believe the big percentage move is just a quirk of the currently low nominal level. An identical-sized move of 100 bps at a higher nominal level – from 7% to 8%, for example – would probably get a lot less attention. If the bond market has topped out and is heading into troubling territory, we'll have to wait longer to know for sure.
Here's the bottom line... Despite Powell being more famous than Lindsay Lohan these days and having his hand on a printing press that spits out legal U.S. dollars by the trillions, the markets will still do what they do without asking "His Grace" for permission.
With that in mind, I see no reason to abandon my mantra today...
If your investment strategy is based on predicting the path of interest rates – or worse yet, what the Fed will do – you don't have a strategy... You have a gambling problem.
The closest I can come to answering the question of whether bond yields are headed even higher from here is to point this out... For 40 years, the answer has mostly been "no."
But at the same time, accepting that as gospel for your future expectations seems about as wise as navigating freeway traffic with your windshield blacked out, focused solely on the rearview mirror. (I've never tried it, but I wouldn't recommend that you do either.)
People like the past. Its immutability gives them comfort. But the future is constantly unfolding in the present... And you'll earn all your investment returns there, not in the past.
In the end, you must play the hand you're dealt if you want to participate in the stock, bond, and other financial markets. So with that in mind, by all means...
Keep holding stocks and bonds. But also hold plenty of cash (20% of your overall portfolio, if not more). Don't forget gold and silver, too... and maybe consider buying some bitcoin.
That will allow you to stop guessing the direction of interest rates and sleep well at night.
Just remember to get the proper help if you're getting in too deep as a gambler.
New 52-week highs (as of 3/4/21): American Express (AXP), Cheniere Energy (LNG), and Texas Pacific Land Trust (TPL).
In today's mailbag, feedback on yesterday's Digest about the state of the airline industry. What's on your mind? Tell us at feedback@stansberryresearch.com.
"You mentioned that the reason airline travel is down was because people fear being near others due to COVID. I would like to offer another explanation. NO ONE I KNOW except for a very few like being mandated to wear a mask for this over-politicized and phony so-called pandemic.
"Don't get me wrong, I believe Americans have a right to wear one if they feel they are susceptible, but it is unconstitutional to mandate the damn thing. I would think 50% or more of the people not flying (among other things) just don't want their civil rights violated by a politically-charged mandate.
"Give an inch and they'll take a mile. Thanks." – Paid-up subscriber Randy B.
"Yesterday my daughter and I flew to Houston to visit a college. At our airport they had closed two of four parking areas, but now the third is back open. The plane was full and had standby passengers. In Houston, we waited 20 minutes for the bus to take us to the travel center. The sign on the bus door said limited to 18 passengers, but with so many in line they let as many people as wanted on the bus. The people packed our bus.
"We then waited in line for 30 minutes to get a rental car. There were two families behind us taking their kids to a weekend baseball camp. The rental car lot where we picked up our car was almost empty. Both airports were very busy. Our hotel in downtown Houston is almost empty with very limited services. A very sad case.
"The company I used to work for (pre-COVID, they let go of all their contracts after COVID) did audits by traveling. They have now developed a methodology of collect the data remotely, so they will never go back to travelling. From my friends that used to travel, all had to figure out how to get their job done without traveling and they don't think they will ever go back to the travel.
"It appears that personal travel is getting closer to normal, but it will be a long time before travel would pick up for business." – Paid-up subscriber Fred R.
"Since our tax dollars are paying airlines billions upon billions of dollars to keep their employees on the payroll, I assume they are sitting at home getting their full pay? Since they aren't going to work at the airline, they have time to work other jobs and double-dip.
"I wonder how the airline employees that are still working and getting paid, I assume the same as their counterparts that are getting paid while sitting at home, feel?... I would love to be able to sit at home at get paid my full salary." – Paid-up subscriber Randy T.
Corey McLaughlin comment: In fairness to the thousands of airline employees not working today, we're not sure anyone wants to be furloughed...
I was furloughed early in my career (not in the airline industry), and it stinks to be told you're not needed when you thought you were the week before. Plus, in my case, I was furloughed without pay – which is usually what happens – so it was worse.
You're right... Major airlines that have received government bailouts are paying a lot of employees not to work. It does sound like a good deal if you can get it... Although as you also note, every taxpayer will pay for these decisions in the end.
Here is a good article with more on the topic from travel-industry website View From the Wing. Published in December, it comes from Gary Leff, the chief financial officer of a research center at George Mason University in Washington, D.C.
The article describes internal communications to American Airlines (AAL) employees about "Payroll Support Program 2" – the $15 billion in relief that major airlines received in December under the condition of continuing to pay furloughed employees. As Leff writes...
The intention of this legislation was that employees would actually work, stay current and ready to support more flying when people are ready to fly. That was at least the argument used to support giving U.S. airlines $15 billion, even though only 40,000 workers had been furloughed ($375,000 per worker for just four months).
The reality is very different. United Airlines has already told employees to expect to be re-furloughed effective April 1. American Airlines, in internal communications ("Returning to American – Top FAQs") reviewed by View From The Wing, is telling employees they're going to be paid but for the most part many won't be working. In other words, American is taking the government's $3.5 billion and complying with the terms by paying people.
What's more, in the case of American Airlines at least, employees who were convinced to take a voluntarily leave of absence last year to lower the number of employees who would be furloughed are not getting paid by the airline while not working.
If you were an employee thinking you were "doing the right thing" for the company by voluntarily taking leave, or even if you took leave while hoping to find another job, that sounds like a raw deal, not knowing the government could be paying your salary anyway.
On top of all of this, there is no guarantee that furloughed employees will have their jobs back once things return to "normal." More from the View From the Wing report...
While payroll support funds require the airline to pay people they don't actually get their old jobs back. The airline has reduced the number of employees based in various locations, and those stay reduced.
In any case, it looks like more money – $14 billion – is on the way to the airline industry soon in the third COVID-19 relief bill. The airlines weren't originally in this round of proposed stimulus, but they made it in last month.
Good investing,
Dan Ferris Vancouver, Washington March 5, 2021
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