Ark's Cathie Wood Sees Deflation Risk, Defends Innovation Stocks

Ark Invest founder, CEO and Chief Investment Officer Cathie Wood reiterated her view that innovation gains traction in turbulent times, even as innovation strategies, including her firm’s Ark Innovation ETF (ARKK), have been hit hard during the recent market downturn.

“With crisis comes opportunity,” Wood said on a webcast Tuesday, also predicting that disruptive innovation will place value strategies “in harm’s way.” More broadly, Wood touched on various “alarm bells” signaling a deflation risk in the economy.

ARKK, which peaked in February 2021 and holds large stakes in Tesla, Zoom and Roku, among other innovation stocks, is down more than 57% year to date and roughly 65% from a year ago. Its recent $38.85 price is far off the 52-week high $132.50.

“I know it’s been a very difficult time for everyone in the markets, every asset class, practically, perhaps except for energy,” said Wood, whose firm loaded up on Coinbase shares after the cryptocurrency exchange’s stock tumbled sharply last month. “And as we know, the problem is inflation and the Fed’s response to inflation.”

The long-admired stock picker said she’s been asked what Ark Invest might have done differently had the firm known in advance about all the factors that have shaken markets this year.

“Had we seen the supply chain issues extending as long as they did with China locking down as late as it has, had we seen Russia’s invasion of the Ukraine, had we known this with full certainty a year ago, what would we have done differently?” she asked during her firm’s monthly market update.

“If we had known exactly what was going to happen, we probably would have evolved our strategies so that instead of concentrating toward our highest conviction names, we would have put more cash-like instruments in the innovation space. And when we say cash-like that would be the Apples, the Googles and so forth, and probably would have avoided some of the carnage. But it still would have been a very difficult period,” she said.

“All of the stocks associated with innovation have ultimately capitulated, so concentrating toward our highest conviction names is what we have done over the last year and a half, and obviously historically that has tended to be a very good strategy and we do think that it will play out again,” said Wood.

Supply chain problems and Russia’s Ukraine invasion have created many problems for equities, bonds and crypto, “and from my experience innovation tends to gain traction during very difficult times. Innovation solves problems,” she added.

Deflation Bigger Risk Than Inflation

More broadly, Wood said she sees deflation as a greater risk than inflation now and cited economic “alarm bells” in declining consumer sentiment, high inventories and fixed income market developments. “We do believe the greater risk now and now more than ever is deflation.”

Inflation measures from the Consumer Price Index and the Personal Consumption Expenditures price index are lagging indicators, while forward-looking indicators suggest a different story, according to Wood. The dollar is up 15% this year — “a huge increase and a powerful anti-inflationary force” – she said.

The Fed doesn’t seem to have picked up yet on various market signals, notably consumer sentiment, the flat yield curve and rising credit default swaps, according to Wood.

“There are a lot of signals out there to the Fed basically saying, ‘Watch out, you’re in dangerous territory here,’” she said.

Consumer sentiment as measured by the University of Michigan dropped to an all-time low recently, which, combined with inflation, suggests the velocity of money will start to slow, according to Wood.

“When consumers lose confidence they are afraid to spend,” she said. Big increases in consumer installment debt suggest small businesses are taking down their credit lines, which always happens at the start of a crisis and leads to a lower consumer savings rate, she said.

“So I don’t think the consumer is going to be rushing out there,” Wood added. 

High inventories at Walmart and Target suggest more widespread problems among retailers, according to Wood, who counts the big-box retailers among the two best supply chain-managed companies in the world. “If they have inventory problems then we think that inventory problems are much broader-based,” she said. 

“There’s a problem out there,” said Wood,  who expects Walmart to follow in Target’s steps and cut prices to move excess inventory.

Price cuts also will slow the velocity of money as consumers wait for lower prices, she predicted. That will likely happen in the gas-powered automotive sector, where disruptive innovation is accelerating as consumers, spurred by high gas prices, seek to transition to electric vehicles more quickly than expected, according to Wood.

The Ark Invest CEO also noted that five-year credit default swaps — essentially insurance policies against defaults and bankruptcies — have more than doubled this year, a warning signal that risks are rising. 

Wood also suggested that a flat yield curve as measured by the 10-year Treasury bond to two-year Treasury yield signals possible trouble. In the past 30 years, the yield curve rose 250 to 300 basis points after the Federal Reserve and fiscal authorities flooded the markets with stimulus, but it climbed only 150 basis points after the most recent stimulus package.

“The bond market has been signaling for some time that something’s wrong, and now the bond market is joined by credit default swaps,” she added. “The fixed income markets are seeing something in the bowels of the fixed-income world that they don’t like.”

While there’s much discussion lately about whether a recession is imminent, Wood called it “a distinction without a difference. If you look at consumer sentiment we are in much more of a recession already, maybe much more than a recession. And I think the market knows this,” which is why fixed income credit default swaps are rising.

“There’s real concern about what’s going on out there,” she said. “I think this has been incorporated into the market. What we need to see is the Fed’s recognition and I think it’s coming. I don’t know what the breaking point will be.”

Wood said she’s never seen deflationary forces this powerful, and for the first time her firm sees convergence in its five innovation platforms: genomic sequencing, adaptive robotics, energy storage, artificial intelligence and blockchain technology.

“It is possible that we are within one market cycle of full artificial general intelligence, which is going to cause transformations that we cannot even dream of right now. … It will also cause productivity increases the likes of which we probably cannot understand now,” she said.

Prediction: Stranded Assets Across Industries

“We do believe because of this disruptive innovation that value strategies are in harm’s way. They are filled with stranded assets,” said Wood, predicting that retail, transportation, energy and financial services all will wind up with stranded assets as industries move toward more e-commerce, electric and autonomous vehicles and digital currency. “We think DeFi digital wallets will completely transform the financial services sector, leaving brick and mortar stranded assets.”