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Broad-based global equity indexes[1] appreciated in the first quarter as the financial markets anticipated less hawkish signals from the US Federal Reserve (Fed). After the Fed’s preferred measures of inflation and wages cooled,[2] Fed Chairman Powell committed to “a couple more” rate increases, signaling that the Fed may be close to the end of its tightening cycle. In response to reports of higher-than-expected inflation and tighter than expected US labor markets, however, Fed members began to telegraph more hawkish sentiments, whipsawing the markets with every public appearance.
In our view, the Fed’s decision to hike the Fed funds rate by a record 20-fold in one year contributed to Silicon Valley Bank’s (SVB) bankruptcy and to the instability and failure of other regional banks. During the quarter, bank deposits dropped 4.1% on a year-over-year basis, the biggest drop since 1948.[3] As the US banking system seized up in response to bank runs, the Fed acted as lender of last resort, increasing its balance sheet by more than $350 billion and reversing five months of quantitative tightening in a matter of days.[4] While regulators were quick to blame crypto for the banking crisis, we believe that they should focus on the central points of failure in the traditional banking system instead of blocking the decentralized, transparent, and auditable financial platforms that have no central points of failure.
While the Fed is determined to squelch inflation by increasing interest rates, the bond market has been signaling that it could be making a major mistake. Since March 2021 and before the collapse of SVB, the yield curve[5] has shifted by more than 250 basis points, inverting from +159 to -107 basis points,[6] the worst inversion since the early 1980s when double-digit inflation was entrenched. Now at -58 basis points,[7] the market seems to believe the Fed will be forced to pivot. In ARK’s view, based on lagging indicators––employment and headline inflation––the Fed is making decisions unanimously and ignoring leading indicators of price deflation. Data upon which the Fed may want to depend instead include:
- Commodity Prices.[8] The prices of gold, copper, and lumber—three commodities that led or flagged the rise in broad-based inflation—have dropped 5%, 17%, and 78%, respectively, from their post-COVID closing prices peak and are flat-to-down on a year-over-year basis, corroborating ARK’s view that deflation is a more significant risk than inflation.
- Consumer Sentiment: US consumer sentiment[9] remains at levels logged during the Global Financial Crisis and the early 1980s, the latter when the economy suffered back-to-back recessions and inflation and interest rates hit double digits. Meanwhile, the consumer saving rate has collapsed from 9.3% pre-COVID to 4.6%,[10] which when coupled with historically low consumer sentiment, suggests little room for solid consumption growth.
- Real Estate: In February, US existing home prices declined year-over-year for the first time since 2012. In recent months, asset managers PIMCO and Brookfield defaulted on commercial property mortgages across major US cities after suffering from a record-breaking increase in rates juxtaposed against lower occupancy rates as the work force shifts to hybrid or remote environments. Falling prices and a broad real estate downturn are likely to chill consumer confidence further, potentially leading to significant cutbacks in spending.
- Bitcoin: In our view, bitcoin’s 40%+ price appreciation during the bank crisis in March confirmed its role as an insurance policy against central points of failure in the US and European banking systems. At the peak of the crisis during the weekend of March 11, the Bitcoin network settled $650 billion, facilitated ~9 million transactions, issued ~26,000 new BTC at a steady and predictable ~1.8% inflation rate, attracted ~13 million new addresses, and generated ~$700 million for miners securing the network.[11] In short, the Bitcoin network did not skip a beat during the banking crisis.
The combination of geopolitical forces and inventory hoarding has pushed US consumer price inflation––a lagging indicator––to 6.0% on a year-over-year basis,[12] a rate that we believe deflationary forces––good, bad, and cyclical––are beginning to unwind. Tesla’s CEO Elon Musk[13] and Doubleline’s CEO Jeff Gundlach[14] have echoed our concerns about the risk of deflation.
Innovation is a potential source of good deflation, as learning curves can cut costs and increase productivity. Yet, we believe many companies have catered to short-term-oriented, risk-averse shareholders, satisfying their demands for profits/dividends “now”. On balance, they have leveraged their balance sheets to buy back stock, bolster earnings, and increase dividends. In so doing, many have curtailed investments and could be ill-prepared for the potential impact of disintermediation associated with disruptive innovation. Saddled with aging products and services, they could be forced to cut prices to clear unwanted inventories and service debt, causing bad deflation.
If we are correct in our assessment that growth, inflation, or both will surprise on the low side of expectations, scarce double-digit growth opportunities should be rewarded accordingly. The adoption of new technologies typically accelerates during tumultuous times as concerned businesses and consumers change their behavior much more rapidly than otherwise would be the case. As a result, stocks of innovation-oriented companies tend to perform better and emerge as new market leaders toward the end of a bear market. We believe the coronavirus crisis and Russia’s invasion of Ukraine have transformed the world significantly and permanently, suggesting that many innovation-driven strategies and stocks could be productive holdings during the next five to ten years.
In our view, the wall of worry bodes well for equities in the innovation space. The strongest bull markets climb walls 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.
While the recent bear market has obscured many disruptive breakthroughs, innovation continues apace thanks to artificial intelligence (AI), genomics, and space exploration, among others. OpenAI’s GPT-4 model highlighted the power of AI by achieving top-percentile scores across a range of standardized tests from law to calculus. On the Uniform Bar Exam, it scored in the 90th percentile, leaping from GPT-3.5’s 10th percentile. In the UK, a research hospital used an advanced version of gene-editing called base-editing to cure a 12-year-old girl with leukemia who had failed dozens of therapies. SpaceX launched 61 Falcon9 rockets, reusing the last one within 21 days, compared to 356 days for the first one. In our view, companies sacrificing short-term profitability to invest heavily in innovative technologies have exponential and highly profitable long-term growth opportunities.
During the first quarter of 2023, five of ARK’s actively managed ETFs and one indexed ETF outperformed relative to the broad-based global equity indexes, while one actively managed ETF and one indexed ETF underperformed.[15]
The ARK Autonomous Technology and Robotics ETF (ARKQ) outperformed broad-based global equity indexes during the quarter. Among the top contributors were Tesla (TSLA) and UiPath (PATH). Shares of Tesla surged after the company reported strong fourth-quarter results. Elon Musk also confirmed that the Cybertruck is on track for production this year and announced that Tesla could produce up to two million vehicles in 2023. During Investor Day in March 2023, Tesla shared its Master Plan III, which includes a low-cost next-gen vehicle in line with ARK’s autonomous driving thesis and announced plans for a gigafactory in Mexico. These initiatives are part of Tesla’s ambitious goal to produce 20 million vehicles annually by 2030. Shares of UiPath appreciated after the company reported fourth-quarter revenue growth of 6.5% year-over-year and annually recurring revenue growing 30% (34% in constant currency). During its March 2023 AI Summit, UiPath introduced several new products that leverage generative AI to help organizations create and customize automation.
Among the top detractors from ARKQ’s performance were Markforged Holding Corp (MKFG) and Deere & Co (DE). Shares of Markforged traded down after the company reported fourth-quarter gross margin compression from 56% to 47% based both on supply chain pressure and on initial start-up costs associated with its new FX20 machine. Management also issued disappointing full-year revenue guidance. Shares of Deere & Co declined amid a broad-based sell-off in industrial stocks.
The ARK Next Generation Internet ETF (ARKW) outperformed broad-based global equity indexes during the quarter. Among the top contributors were the Grayscale Bitcoin Trust (GBTC) and Coinbase Global Inc (COIN). The Grayscale Bitcoin Trust gained during a broad-based cryptocurrency market rally as bitcoin rose above $17,000 for the first time since mid-December 2022. By the end of the quarter, bitcoin had surged to ~$28,000 in the aftermath of historically oversold technical and on-chain conditions during the fourth quarter of 2022. In addition, Bitcoin seemed to have been a safe haven asset amidst the US national banking crisis that unfolded during the month of March. Shares of crypto-related companies, including Coinbase, also surged during the quarter. Despite the SEC’s threat to end its staking operations, Coinbase appears well-positioned to navigate the regulatory environment following the downfall of FTX, which eliminated one of its primary competitors.
Among the top detractors from ARKW’s performance were Veracyte Inc (VCYT) and Adobe Inc (ADBE). In the absence of meaningful news during the quarter, Veracyte’s clinical reputation, broad evidence base, vertical integration, and expanded menu gives ARK confidence that the company will remain a leader in evidence-driven molecular prognostic testing. Shares of Adobe fell after news that the U.S. Department of Justice will file an antitrust lawsuit aimed at blocking the company’s acquisition of Figma. The European Commission also indicated that it would “assess” the acquisition.
The ARK Genomic Revolution ETF (ARKG) underperformed broad-based global equity indexes during the quarter. Among the top detractors were Twist Bioscience Corp (TWST) and Beam Therapeutics Inc (BEAM). Shares of Twist Bioscience traded down after the company issued light fiscal second-quarter revenue guidance based on a weaker-than-expected biopharma outlook. Twist left full-year and long-term top-line guidance intact based on 30% growth in quarterly order bookings. Historically, Twist has generated ~55-60% of its revenue in the second half. In our view, Twist Biosciences is a preeminent provider of synthetic biology reagents and tools—particularly oligonucleotides—to the translational research and clinical markets. Thanks to the capture efficiency of its oligos, Twist’s next-generation sequencing (NGS) business is gaining momentum. Shares of Beam declined in a broad-based sell-off in gene-editing names on no meaningful company specific news. Beam Therapeutics is focused on applying its novel base-editing method to rare disease indications.
Among the top contributors to ARKG’s performance were Exact Sciences (EXAS) and Pacific BioSciences of California (PACB). Shares of Exact rallied after the company guided to 28% year-over-year revenue growth as part of its fourth-quarter earnings preview. Full-year 2022 revenue, excluding COVID-19 testing, grew 28%. The company also achieved positive adjusted EBITDA[16] in the fourth quarter, a full year ahead of schedule. As its diagnostic capabilities continue to expand to indications beyond colorectal cancer, we expect Exact Sciences to replicate the standard-of-care status that Cologuard has achieved in other testing areas. Shares of Pacific Biosciences appreciated after TD Cowen upgraded the company to “outperform” and noted “robust demand expectations for the Revio and long reads…and an improving story in years to come (more product lines, improving margins, and profitability),” aligning with ARK’s thesis. Pacific BioSciences recently launched its breakthrough Revio platform, providing the highest accuracy long reads at 15x the throughput of its predecessor system, the Sequel IIe.
The ARK Fintech Innovation ETF (ARKF) outperformed broad-based global equity indexes during the quarter. Among the top contributors were Coinbase Global (COIN), for reasons discussed above, and Shopify (SHOP). Shares of Shopify appreciated after the company announced increased pricing plans and a platform integration with Google Cloud’s Discovery AI solutions. The latter will enable AI-driven solutions in search, personalization, and recommendations. Shopify also plans to integrate Deliverr, an eCommerce fulfillment and storage system, as it builds a more cost-effective distribution network with elastic warehouse capacity that should lower fixed costs.
Among the top detractors from ARKF’s performance were Silvergate Capital Corp (SI) and Bill Holdings (BILL). ARK exited its position in Silvergate Capital in early January—except for a minor number of shares for ETF operational reasons—after losing conviction in the company. In March, Silvergate Capital announced that it had entered Federal Deposit Insurance Corporation (FDIC) receivership and would liquidate assets and wind down operations. Silvergate catered to institutional investors seeking to transfer government issued (fiat) currency to crypto exchanges. Taking fiat deposits and routing them through its Silvergate Exchange Network (SEN), Silvergate grew crypto-related deposits more than six-fold in two years, from less than $2 billion in early 2020 to ~$13 billion in 2022. After the collapse of FTX last November, its customers began to draw down deposits, which Silvergate honored initially by liquidating assets on its balance sheet and tapping the Federal Home Loan Bank of San Francisco for a credit line. In early March, citing audit procedures and regulatory inquiries, the company delayed its 10-K filing, and one week later wound up in FDIC receivership. Prior to its demise, several crypto firms, including Coinbase, had moved their banking from Silvergate to other crypto-friendly banks, one of which–Signature Bank—also entered FDIC receivership. Shares of Bill.com traded down after the company reported second fiscal quarter earnings. Growth in total payment volume (TPV) decelerated from 34% year-over-year to 15%, which management attributed to macroeconomic pressures. We believe Bill.com will continue to catalyze the digitalization of B2B payments.
The ARK Space Exploration & Innovation ETF (ARKX) outperformed broad-based global equity indexes during the quarter. Among the top contributors were Kratos Defense & Security (KTOS) and Iridium Communications Inc (IRDM). Shares of Kratos Defense & Security Solutions traded up after the company reported higher-than-expected fourth-quarter revenue and earnings and announced a new contract with the U.S. Navy to procure 55 aircraft, mission kits, flight consumables, and technical data. Although the initial contract value is ~$50 million, it could scale to $228 million if the Navy exercises options for maximum production quantities. Additionally, Kratos announced a partnership with XipLink, which specializes in optimization technology for wireless networks. Shares of Iridium surged after the company announced a partnership with Qualcomm to provide satellite service for smartphones. The company also announced promising full-year guidance, pre-announced better than expected revenue growth of 24.4% year-over-year, and reaffirmed its liquidity position and free cash flow growth.
Among the top detractors from ARKX’s performance were Markforged Holding Corp (MKFG), for reasons discussed above, and L3Harris Technologies (LHX). Shares of L3Harris Corporation declined along with other industrial names on no meaningful company news. L3Harris Corporation is a provider of electronic systems with applications in defense, civil government, and commercial activity.
Invested in the highest conviction names in the Funds discussed above, the ARK Innovation ETF (ARKK) outperformed broad-based global equity indexes during the quarter. Among the top contributors were Tesla (TSLA), for reasons discussed above, and Roku (ROKU). Shares of Roku advanced after the company announced that its active accounts had increased 16% on a year-over-year basis to ~70 million globally, and that it would release its own line of TVs this year. Furthermore, management delivered a fourth-quarter earnings beat, thanks not only to the increase in its active annual accounts but also 23% growth in streaming hours and 85% growth in Roku Channel engagement. Finally, the company reaffirmed its commitment to positive adjusted EBITDA in 2024 through a combination of operating expense control and revenue growth.
Among the top detractors from ARKK’s performance were Beam Therapeutics Inc (BEAM), for reasons discussed above, and Ginkgo Bioworks Holdings Inc (DNA). Ginkgo Bioworks surpassed expectations in the fourth quarter with core cell engineering revenue growth of 27%. The company nearly doubled the number of cell programs on its platform from 31 in 2021 to 59. Shares traded down, we believe, in response to Ginkgo’s low 2023 revenue guidance based on the end of broad-based COVID testing which should not have been a surprise. Importantly, Ginkgo expects its core cell engineering business to grow 65% in 2023, powered by 100 new cell programs, many of them in the biopharmaceutical and agricultural spaces.
ARK’s self-indexed ETFs, The 3D Printing ETF (PRNT) and ARK Israel Innovation Technology ETF (IZRL), underperformed the broad-based global equity indexes.[17] Shares of Altair Engineering Inc (ALTR), were the largest contributor to PRNT’s performance, appreciating after the company reported strong fourth-quarter earnings that surpassed expectations thanks to 14% revenue growth on a year-over-year basis. Management also issued stronger than expected revenue guidance for this year. Altair Engineering is a global technology company offering software and cloud solutions for product design, high-performance computing, and data analytics across various industries and technologies, including 3D printing. Shares of Xometry (XMTR), the biggest detractor from PRNT’s performance, traded down after the company reported fourth-quarter results that missed expectations for revenue and EPS and guided to disappointing revenues for 2023. Xometry is an on-demand industrial parts marketplace based in Maryland using 3D printing and traditional technologies.
Shares of Hub Cyber Security (HUBC), the largest detractor from IZRL’s performance, went public on March 1, 2023 through a SPAC[18] merger with Mount Rainier Acquisition Corp. Shares declined on no meaningful company news. Hub Cyber Security is a cybersecurity solutions and services provider. Shares of Perion Network Ltd (PERI) were the largest contributor to IZRL’s performance, appreciating after the company reported record financial results for the fourth quarter and full year. In 2022, revenue for the global advertising technology company increased by 34% year-over-year, net income by 156%, and adjusted EBITDA by 90%.
The Personal Consumption Expenditures (PCE) Core Price Index, which excludes food and energy, rose 4.6% year-over-year in February, following a downward trend since the peak year-over-year rate in February 2022, when the PCE Core Price Index was 5.4%. The Employment Cost Index for the fourth quarter rose 1.0% or ~4.0% at an annual rate, slowing from the prior quarter and below expectations.
Exactly, this is neither subtle nor secret
— Elon Musk (@elonmusk) September 14, 2022
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