Broad-based global equity indexes depreciated significantly during the first quarter as macro headwinds hurt consumer, business, and investor confidence. Innovation stocks, particularly those not listed on broad-based indexes, were punished disproportionately in response to investor fears of higher inflation and interest rates. Dominating most broad-based indexes, in our opinion, several mega-cap stocks have lured risk-averse investors into crowded trades that appear to be missing many emerging growth opportunities in the disruptive innovation space. Contrary to mainstream view, we believe this dynamic has pushed innovation stocks into deep value territory.
While public equities in what we view as the pure-play innovation space have collapsed during the past year, late-stage private market valuations have soared. Based on our analysis, the median value of late-stage startups announcing new funding rounds in February has soared roughly 180% in the median of 260 days since their prior funding rounds. At the same time, the MSCI IMI Innovation Index has depreciated by 14%. Conversely, some company valuations inflated by excess capital in the private equity market now are experiencing down rounds, in our view, because they have not focused on truly disruptive innovation. In other words, valuations associated with pure play innovation companies in the public and private markets are at odds. We believe that the truth is somewhere in between the two, signaling potential upside to valuations in the public equity markets.
Between March 2021 and the end of the first quarter, the yield curve flattened from 159 basis points to 4 basis points and then inverted one day later, suggesting that if the Federal Reserve raises interest rates, then real growth, inflation, or both will surprise on the low side of expectations. US consumer sentiment is lower today than it was at the depths of the coronavirus pandemic and has dropped to levels last seen during both the 2008-2009 Global Financial Crisis and the early 1980s when inflation and interest rates hit double digits. With the exception of the 2011 European Debt Crisis, this level of consumer sentiment levels has coincided with periods before or during recessions.
The odds of a recession appear to have increased meaningfully after Russia’s invasion of Ukraine. Although inflationary in the short-term, the rise in oil prices has imposed a highly regressive tax on consumers. Highly dependent on Russia for energy, Europe probably has entered recession, while China seems to have erred on the side of restraint and is trying to resuscitate growth.
In our view, long-term inflation fears have been overblown because inventories have begun to pile up in the face of weak consumption. During the fourth quarter, real GDP increased 6.9%, 532 basis points of which was attributable to inventory growth. At the same time, the consumer savings rate dropped to 6.3%, roughly 200 basis points below its pre-coronavirus crisis, suggesting less room for future consumption. As a result, retail sales growth has been lower than inflation. While government stimulus was flowing freely, businesses and consumers seem to have overreacted to supply chain bottlenecks by building “inventories” of goods. In the short term, along with other geopolitical forces, this hoarding has pushed US consumer price inflation to 8.6% on a year-over-year basis, a rate that we believe deflationary forces––good, bad, and cyclical––are likely to unwind during the next year.
Innovation is the source of good deflation, as learning curves cut costs and increase productivity. Yet, we believe many companies have catered to the short-term-oriented, risk-averse shareholders and have satisfied demands for profits/dividends “now”. As a result, many have leveraged their balance sheets to buy back stock, bolster earnings, and increase dividends. In so doing, many have curtailed investments in innovation and could be ill-prepared for the impact of disintermediation associated with disruptive innovation. As a result, saddled with aging products and services, they could be forced to cut prices, service debt, and clear unwanted inventories, causing bad deflation.
If we are correct in our assessment that growth, inflation, or both are likely to surprise on the downside, scarce double-digit growth opportunities will be rewarded accordingly. The onset of the pandemic and subsequent variants generated broad-based fear, uncertainty, and doubt (FUD) in the equity markets, causing what we believe to be indiscriminate, algorithmic selling as a form of short-term risk management. Typically, FUD accelerates the adoption of new technologies as concerned businesses and consumers change their behavior much more rapidly, causing new leadership to surface in the equity market. We believe the coronavirus crisis and the Russian invasion of Ukraine have transformed the world significantly and permanently, suggesting that many innovation-driven stocks could be productive holdings during the next five to ten years.
In our view, the wall of worry built on the back of high multiple stocks bodes well for equities in the innovation space. The strongest bull markets do climb a wall of worry, a fact that those making comparisons to the tech and telecom bubble seem to forget. No wall of worry existed or tested the equity market in 1999. This time around, the wall of worry has scaled to enormous heights.
Investors in broad-based equity indexes seem to be shorting innovation, perhaps inadvertently and, if history is any guide, we believe it will be to their detriment. Amazon invested aggressively to disrupt legacy brick and mortar businesses, for example, and captured a disproportionate share of the retail e-commerce opportunity as most investors assumed it would go bankrupt. Wall Street also missed the potential of Apple’s iPhone to disrupt Nokia, Samsung, and Blackberry, and in the last five years denigrated Bitcoin and cryptoassets as Ponzi schemes. For many years, traditional auto analysts doomed Tesla to failure without understanding that it was a robotics, energy storage, and artificial intelligence company, not an auto company. Controversial and volatile in the short-term, companies focused on innovation that solves problems and disrupts legacy industries can, in some instances, surprise with significant growth.
During the first quarter of 2022, ARK’s six actively managed ETFs and three indexed ETFs mostly underperformed relative to the S&P 500 Index and the MSCI World Index, though one of our actively managed ETFs outperformed the MSCI World Index.
 As measured by the S&P 500 and MSCI World.
 As measured by the difference between yields on the 10-year Treasury bond and the 2-year Treasury note.
 As of March 2022, measured by the University of Michigan.
For information on ARK’s six actively managed ETFs and three passive ETFs, see below.
The ARK Autonomous Technology and Robotics ETF (ARKQ) the quarter. UiPath (PATH) and Tusimple (TSP) were the top detractors. Shares of UiPath fell after the company reported fourth-quarter earnings that beat Wall Street expectations on revenue and non-GAAP EPS but cut forward guidance based on its outsized exposure to Europe. We maintain high conviction in UiPath’s ability to integrate Robotic Process Automation (RPA) into many business processes across large enterprises around the world. TSP traded down following the company’s announcement that CTO Xiaodi Hou, one of the two founders of this autonomous trucking company, will replace CEO Cheng Lu. We are confident in Xiaodi’s ability to execute on TuSimple’s autonomous strategy. TuSimple’s autonomous semi-truck test in January resulted in positive research analyst reviews.
Among the top contributors to ARKQ’s performance were AeroVironment (AVAV) and Deere & Company (DE). Shares of AeroVironment rallied sharply after Russia’s invasion of Ukraine and the Biden Administration’s announcement that it would consider providing Ukraine and European allies with AeroVironment’s Switchblade drones. Because Ukraine is one of Europe’s largest food suppliers, the war has increased food prices and farm profits, which should encourage investment in newer, more efficient farming machinery. Deere also disclosed that its fully autonomous tractor would be available for farmers this year.
The ARK Next Generation Internet ETF (ARKW) underperformed the broad-based market indexes during the quarter. Among the top detractors were Roku (ROKU) and Shopify (SHOP). Shares of Roku gapped down after the company reported lower than expected fourth-quarter revenue growth and guided for further deceleration. Management cited supply chain bottlenecks and inventory shortages that have impacted its OEM smart TV partners. Management also noted that active accounts increased to more than 60 million, surpassing the number of video subscribers at all US cable companies combined. Although US consumers spend 45% of their viewing hours on streaming TV today, streaming TV advertising accounts for only 18% of total TV advertising budgets, a gap we expect to close. Shares of Shopify traded down after the company reported not only a deceleration in gross merchandise value growth for the fourth quarter but also softer than expected guidance and an increase in investment spend for 2022. We believe Shopify is positioned uniquely as an operating system enabling merchants to sell direct-to-consumer across marketplaces and social media platforms.
Among the top contributors to ARKW’s performance were Tesla (TSLA) and Splunk (SPLK). Shares of Tesla finished marginally higher after a quarter of positive fundamental developments, including a fourth-quarter earnings report that beat on both the top- and bottom-lines. The shift from gas-powered to electric vehicles has gained traction, a trend that we believe higher gas prices following Russia’s invasion of Ukraine will accelerate. Tesla also opened its fourth Gigafactory in Berlin, which should help satisfy growing demand. Hertz added the Model 3 to its rental fleet last year and announced in March that it plans to add the Model Y. Shares of Splunk responded positively to BTIG’s upgrade after a selloff related to significant management transitions.
The ARK Genomic Revolution ETF (ARKG) underperformed the broad-based market indexes during the quarter. Among the top detractors were Pacific Biosciences of California (PACB) and Intellia Therapeutics (NTLA). Shares of Pacific Biosciences depreciated during a challenging quarter for genomics-focused companies that was exacerbated by its weaker-than-expected 2022 revenue guidance. Management noted that Omicron caused widespread lab closures on the east coast in the US and in Europe during January, hurting the utilization of consumables. In our view, investors underappreciate the importance of HiFi sequencing, which sequenced the first full human genome in 2021. We also believe fears of competition from synthetic long-read sequencing are unfounded. Intellia released data demonstrating the efficacy of its gene-editing therapy for the treatment of transthyretin-related hereditary amyloidosis (hATTR). A 93% reduction in the concentration of the mutant protein among the trial subjects was an improvement over existing hATTR therapies but the stock “sold off on the news”. During the quarter, Intellia also acquired Rewrite Therapeutics, a biotech company focused on advancing novel DNA writing technologies.
Among the top contributors to ARKG’s performance were Ionis Pharmaceuticals (IONS) and Signify Health (SGFY). Ionis and Biogen terminated their amyotrophic lateral sclerosis (ALS) treatment but committed to continued research on the disease. Signify Health beat revenue expectations for the fourth quarter and guided first quarter revenues higher than consensus estimates. At the JP Morgan Healthcare conference in January, management provided updates on the company’s transition-to-home service, which included more than a 10% reduction in readmission rates relative to the industry status quo.
The ARK Fintech Innovation ETF (ARKF) underperformed the broad-based market indexes during the quarter. Among the top detractors were Shopify (SHOP) and UiPath (PATH), for reasons discussed above.
Among the top contributors to ARKF’s performance were Discovery Limited (DSY SJ) and Silvergate Capital (SI). Shares of Discovery traded up alongside other insurance-focused businesses that fared relatively well in a market highly sensitized to the risks associated with higher interest rates and inflation. Discovery uses the convergence of artificial intelligence and behavioral science to underwrite its insurance and digital banking ecosystems. Shares of Silvergate Capital dropped after the company reported lower than expected margins in its fourth quarter earnings report. Notably, however, the company reported a 35% sequential increase in transfer volumes on the Silvergate Exchange Network (SEN), bolstering our confidence that it is and will remain a prime beneficiary of increased institutional crypto adoption. President Joe Biden’s much-anticipated Executive Order on digital assets suggested a net-positive regulatory outlook for crypto and sparked a rally in shares of Silvergate. The Order outlines a “whole-of-government” approach to crypto and underscores the importance of US leadership in technological innovation.
The ARK Space Exploration & Innovation ETF (ARKX) had mixed performance relative to broad-based market indexes during the quarter, underperforming the S&P 500 Index but outperforming the MSCI World Index. Among the top detractors were UiPath (PATH) and Trimble (TRMB). Shares of UiPath detracted from performance for reasons discussed above. Trimble, a leader in advanced global positioning solutions with a focus on autonomous technology, reported better than expected fourth-quarter revenue but missed earnings expectations, citing supply chain backlogs.
Among the top contributors to ARKX’s performance were AeroVironment (AVAV) and L3Harris Technologies (LHX). Shares of AeroVironment appreciated for reasons discussed above. Shares of L3Harris Technologies rallied following Russia’s invasion of Ukraine, bolstering the outlook for defense spending by the US and Europe.
With some of the highest conviction names from the Funds discussed above, the ARK Innovation ETF (ARKK)
underperformed the broad-based indexes during the quarter. Among its top detractors were Roku (ROKU) and Zoom Video Communications (ZM). Shares of Roku detracted from performance for reasons discussed above. Zoom surpassed consensus expectations for the fourth quarter but disappointed on guidance. ARK retains high conviction in Zoom’s leadership in the video communications space with increased penetration in the enterprise as companies shift increasingly and permanently to hybrid work.
Among the top contributors to ARKK’s performance were Tesla (TSLA) and Signify Health (SGFY), for reasons discussed above.
ARK’s self-indexed ETFs, The 3D Printing ETF (PRNT), ARK Israel Innovation Technology ETF (IZRL), and ARK Transparency ETF (CTRU), depreciated and underperformed the broad-based indexes during the quarter. Performance against their respective benchmarks was mixed, with IZRL and CTRU underperforming and PRNT outperforming. Shares of BICO Group (BICO), a producer of bio-inks and bioprinters, were the largest detractor from PRNT’s performance, as supply chain issues and other market forces prevailed. Velo3D (VLD) was the top contributor to PRNT’s performance after the company surpassed fourth-quarter earnings expectations. Shares of Nayax Ltd (NYAX), a point-of-sale fintech company, traded down alongside the broader market and were the largest detractor from IZRL’s performance. Shares of Gamida Cell (GMDA) were the top contributor to IZRL’s performance, rallying after the company announced it began the rolling submission of a Biologics License Application for Omidubicel, a treatment for blood cancers requiring stem cell transplants. Roblox (RBLX) was the largest detractor from CTRU’s performance after the company reported disappointing fourth-quarter results based on back-to-school headwinds in the US and Europe. That said, the company has paid $500 million to its young developer community and continues to lower barriers to creation for developers and gamers with Roblox Studio. AeroVironment (AVAV) was the top contributor to performance in CTRU for reasons discussed above.
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