ARK Invest’s CEO, Cathie Wood, believes that the Fed’s fears about inflation are misplaced and deflation should be the central banks’ main concern, while the key to growth lies in innovation in AI.
With many US company’s short-term profits now at risk following last year’s 24-fold surge in the Fed funds rate from 0.25% to 5.5%, Wood (pictured) calls the move “one of the biggest mistakes in monetary policy history”.
“The Fed’s moves did arrest the price shock caused by COVID-related supply chain bottlenecks and pushed commodity prices, as measured by the Bloomberg Commodity Index (BCOM), back into the deflationary trend that has been in place since the Great Financial Crisis (GFC) in 2008,” says Wood. “But today, BCOM is trading at the same level as it was more than 40 years ago in the early eighties, suggesting that the Fed’s fears are misplaced.”
Wood feels that adjusted for inflation as measured by the Producer Price Index (PPI), BCOM is lower than its level when the US abandoned the gold-exchange standard in 1971. And as the Fed observed the deflationary strains on housing, autos, commercial real estate, and capital spending, it paused its tightening moves last summer.
“At the same time, in the technology realm, ChatGPT began to dramatise the seemingly miraculous breakthroughs that are likely to tip the scales even further toward broad-based deflation,” she said.
She believes that although creative destruction—the transition from gas-powered vehicles to electric vehicles, for example—could obfuscate the boom associated with AI and other disruptive technologies evolving today, the waves of growth associated with the convergence among the 14 technologies involved in ARK’s five major platforms—robotics, energy storage, AI, blockchain technology, and multiomics sequencing—should start moving the needle on macro metrics increasingly and significantly during the next five to ten years.
Wood continued: “Because the Fed still seems to be fighting the inflation war, that we believe ended in 2008, the equity market has been somewhat unsettled this year. Deflation would punish companies with leverage, and reward those with cash piles. In our view, the deflationary ramifications of current Fed policy are already surfacing through bankruptcies in commercial real estate, both office and multi-family, and could culminate in another round of regional bank failures.
Short-term, profits are at risk
Wood says after boosting profitability with higher prices during the supply-chain-related bottlenecks in 2021-22, and again as unit growth disappointed in 2023, corporations now seem to be losing pricing power, to the detriment of profit margins. As measured by Bloomberg, the S&P 500’s gross profit margin dropped from 34.8% on average during the past five years and 34.6% during the fourth quarter of 2022 to 33.5% during the fourth quarter of 2023.
Wood says, “this setback will intensify until the Fed cuts interest rates significantly and until companies harness innovation like artificial intelligence aggressively, not only to drive productivity growth but also to create new products and services that replace legacy solutions.
To limit the damage to margins in the interim, after hoarding employees in the aftermath of the severe labour shortages caused by COVID, companies are likely to lay them off during the next year and to lower the rate of wage gains, further allaying the Fed’s concern about underlying inflation.
“After what we have characterised as a ‘rolling recession’ in the last few years, the damage is not likely to cascade uncontrollably. Both in the US and the rest of the world, much of the damage has been done.”
Meanwhile, Wood believes the global weakness in commercial real estate is likely to hit several groups disproportionately: private equity, private credit, and other large investors who leveraged up while reaching for yield before and during COVID. Importantly, as prices and speculative excesses unwind, key decision makers at companies are likely to assess and reassess capital spending plans, including the boom in spending on artificial intelligence.
Management teams are likely to focus strategic plans on artificial intelligence
She also believes that given the lessons learned from internet history, the capital that has plowed into all-things-AI during the past year could get a reality check as companies become focused on the need to develop strategic plans for a breakthrough technology that is likely to separate winners from losers in the years ahead.
“Based on ARK’s analysis from both a business and investment point of view, management teams are facing a number of decision points: they will have to assess the competition among cloud providers and AI companies that the capital markets are funding, map workflows in extensive detail, and find/integrate data from far-flung divisions—all daunting and time-consuming tasks—before activating AI strategically and effectively. If the loss of pricing power does pressure corporate margins, as we anticipate, then management scrutiny will intensify, perhaps delaying the decision-making process, but also heightening the sense of strategic urgency.”
Innovation solves problems and could generate super-exponential growth
“Once the cyclical correction is complete, AI should continue to take off and catalyse other technologies—including robotics, energy storage, blockchains, and multiomics sequencing—creating convergences that we believe will lead not to exponential growth, but to super-exponential growth—already rapid growth rates that accelerate over time,” says Wood.
ARK’s Big Ideas 2024 report, details the likely impact of these convergences on each of the technology platforms and on global economic growth between now and 2030. The upshot is that real Gross Domestic Product (GDP) growth is unlikely to decelerate from 3% on average during the past century to the consensus expectation of 2.6%, but instead should accelerate to 6-8%+ growth, an expectation that Wood says “we have found in no other economic forecast. Moreover, if the five innovation platforms evolve as our research suggests during the next seven years, the equity market cap associated with them should scale ~40% at an annual rate, from $USD 15-20 trillion today to ~$USD 220 trillion in 2030.
We are privileged to be researching disruptive innovation at the crossroads between the old world and the new world. Innovation solves problems, of which we have no shortage in 2024”.
