Cathie Wood on Space, Tesla, and Following Up Her 152% Return

Model portfolios have evolved from a one-size-fits-all solution. In a recent roundtable conversation, Jeffrey Safe of BlackRock and Alessio DeLongis of Invesco break down what's driving the next model moment, discussing how a deeper level of customization is producing a better alignment with investor goals and creating a practice differentiator for financial advisors.

Well, in our strategy, very often we want profit momentum to be lousy in the short term.

Why?

Because we want our companies to be investing aggressively now, forgoing short-term profits, much like Amazon and Netflix did, in what in many cases is a winner-take-most market.

Welcome to the Barron's Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Cathie Wood. She's the founder and CEO of ARK Investment Management and the woman who beat the stock market by more than 100 percentage points last year in multiple funds. Everyone wants to know, can Cathie keep her hot streak going? In a moment, she'll talk about that in her investing approach and what she sees ahead for two of her favorite high flyers Tesla, and Bitcoin. If you're one of Cathie's investors, you'll be delighted. If you're a value investor who feels we're in a bubble, you might be raising an eyebrow, maybe even flaring one nostril. And if you're like me, you're mostly intrigued and fairly jealous and naturally skeptical and just a little bit hungry. Small breakfast. Listening in is our audio producer, Meta. Hi, Meta. Hi, Dick. Meta, please prepare your most joyful sound effect because I have some good news. You have party horns? You have a, like, a choir of angels? You know what, do you have angels with party horns? I'll see what I can do. The news is my kids are going back to school. And I mean real school, an actual building that is not my house. Thank you, party angels. I have many friends who've safely sent their kids to school since the start of the school year. Everyone's circumstances are different. We decided to wait out the winter. And our schools have done a great job, and there's an opportunity coming up to switch from remote schooling to in-person schooling, and we feel ready. I exchanged emails with one of my kids' teachers, and she said she was just about to get her second dose of the COVID vaccine, which I was happy to hear. To all the teachers out there, let me just say you are greatly appreciated. Also, please fix my kids. I think I might have screwed them up with more or less constant screen time over the past 6 months. Sorry about that, and thank you in advance. Now then, my kids going back to school makes me think of Tesla stock. Why? Because normal schooling is part of economic reopening, and reopening means faster growth. And as we talked about last week, faster growth could mean a bit more inflation. And if we do get more inflation, that could eventually mean higher rates and bond yields. And just the possibility of higher bond yields could change how stocks perform and which types of stocks lead the market. That's arguably what's been happening. Look at some 1-month performance numbers from this past Wednesday. Bond yields were still low but up. The 10-year Treasury yield had risen from well below 1.25% to close to 1.5%. The broad U.S. stock market was pretty flat. A pair of exchange-traded funds called Vanguard Utilities and iShares U.S. Consumer Goods were down 5% and 6%, and that's pretty much what you'd expect. Investors buy utilities and consumer staples shares for their relatively large and steady dividends. If bond yields are rising, that dividend income is becoming slightly less attractive by comparison. Okay, now look at Tesla, which was down more than 20% over the same 1-month period, and Virgin Galactic, which was down more than 40%. Those are both high flyers. They don't pay dividends. So why did they fall too? Maybe it was just profit-taking, but you can also make a case based on interest rates. One way to decide how much companies are worth is to add up the cash they're expected to generate far into the future, then calculate how much you'd pay today for that cash. It's called discounting, and the answer you get depends greatly on what else you can do with the money. Could you earn a decent interest rate on a savings account or yield on some safe bonds? If so, you might not be willing to pay that much for distant cash flows. Rising rates have a particularly unflattering effect on the discounting math for high flyers whose cash flows won't ramp up for years. So if you expect rates to rise, there are two groups of stocks really you might want to lighten up on, and they're almost polar opposites of each other. One is those boring stocks with big dividend yields, and the other as exciting growth stocks that won't pay dividends for many years. Now look at a third group of stocks. Delta Airlines was recently up more than 20% over the past month, and so was Las Vegas Sands, the casino operator. These are economically sensitive companies. They stand to benefit greatly from a return to normal spending patterns. The same positive signs for the economy that are making investors worry about inflation and sell both high-yield stocks and go-go growth stocks are making them want to own shares of economically sensitive companies. Maybe all of this is a long-awaited change in stock market leadership where growth stocks end their decade-long dominance over value stocks. Maybe it's the start of a bigger shift to higher inflation and the end of a 4-decade bull market in bonds. The case for these things is straightforward. For inflation, it's that U.S. policymakers are spending massive sums to try to fight the pandemic's hit to the economy, and they might overshoot and set off a jump in prices. The case against growth stocks is simply that they've gotten expensive. But we also might be wrong yet again about these things. Maybe the past month is a blip, and the same stocks that have been working well all along will go right back to outperforming. And I got thinking, who's out there arguing that so I can hear their case? Well, I'll tell you who. Cathie Wood. In late February, when Tesla stock was tanking, Cathie said she bought a lot more of it. What are you doing on a day like today? Are you, are you buying? I mean, the Nasdaq was down almost 4% today. Tesla was down significantly. Did you buy?

Oh, yes. We bought a lot of Tesla today across any strategy. That holds Tesla.

And at the time, news of that buying might have stopped the stock from falling further. If you've never heard of Cathie Wood, it might be because she only launched her first actively managed exchange-traded fund, or ETF, in 2014. ETFs trade like stocks. Many of them passively track stock indexes, but there are some with managers who pick stocks. Like ARK Innovation ETF, ticker ARKK. The approach there is to invest in disruptive companies, ones with a product or service that Cathie thinks could change how the world works. Another way I describe the approach is that many fund managers own a few super exciting growth stocks along with a lot of steadier companies for diversification. Cathie just pretty much sticks with the super exciting stocks. Her top holding in ARK Innovation is Tesla, followed by Square, the payments company. We had their CFO on the podcast in December. And there's Roku, the home entertainment company, and Teladoc for virtual medicine, and Spotify, where some of you subscribe to this podcast. Further down the list, you'll find Zillow. That's where you go to find out if your house is worth more than your neighbor's house. It is, by the way, and congratulations. And there's CRISPR Therapeutics. They specialize in gene-based medicine. ARK has other even more focused funds that stick to autonomy and robotics, or financial technology, or genomics. In 2017, ARK Innovation returned 87%, and there's nothing that attracts new investor cash like hot performance. By the following year, ARK had reached $5 billion in assets under management. It was growing quickly and it was big, but it wasn't quite humongous. Then ARK Innovation returned 35% in 2019, followed by 152% last year. In fact, ARK had at least 5 ETFs that doubled in price last year. Assets under management ballooned to $60 billion. Now that's humongous. ARK Innovation has sold off with growth stocks over the past month, and the firm has seen some wild fund flows with investors, for example, pulling out close to half a billion dollars one day and then adding close to half a billion dollars another day. Everyone's trying to figure out, can Cathie keep her hot streak going? I figured I'd ask her. Hi, Cathie.

Hi, Jack.

Thanks for making a few minutes to speak with me.

Sure. I—

let me see how I can move this thing away so that I can see you. There we are.

I hope it's not disappointing. This is the best I've got, Kathy.

No, no, I'm so happy to see you.

I said to Kathy, many fund managers pick some of the right stocks. You seem to have picked all of the right stocks. How have you done it? And she said that many fund managers now seem risk-averse. They make some bets, but they also stick closely to major stock indexes. Not Kathy.

We do not have a benchmark and therefore we can go anywhere and we don't have to participate in every sector. There are many strategies where you have to have energy in your portfolio, you have to have banks in your portfolio, or they have constraints like you can't buy anything that is behaving badly, meaning a momentum factor, whether that's earnings momentum or price momentum. Well, in our strategy, very often we want profit momentum to be lousy in the short term.

Why?

Because we want our companies to be investing aggressively now, foregoing short-term profits, much like Amazon and Netflix did, in what in many cases is a winner-take-most Market.

You know, when I watch a movie where the hero hangs off a cliff or off the outside of a skyscraper, my hands start to sweat. And I always think, what kind of biological response is this? I mean, having your hands sweat whenever you think about the exact conditions under which you'd least want to have slippery hands? Thanks for nothing, evolution. I guess I'm not meant to be a rock climber, and I get the same feeling when I think about betting big on one high-valuation stock, let alone all high-valuation stocks. So where does Cathie find the confidence to ignore the valuation scolds and stick to her approach? She says the only companies she invests in are ones with the opportunity for exponential growth from technological innovation. She gave the example of electric vehicles. Last year, she says that out of a market of 75 to 80 million vehicles sold, barely 2 million of them were electric. But over the next 5 years, she expects electric vehicle sales to multiply to over 40 million a year.

Why do we believe that?

Because of the cost curve trajectory that battery pack systems are following. For every cumulative doubling, in the number of vehicles sold, the cost of these battery pack systems, the largest cost component in those cars, is dropping by 28%. Think about that. Think about that. Already electric vehicles' total cost of ownership is lower than gas-powered vehicles on a like-for-like basis when all in. On a sticker price basis, by 2025, the average electric vehicle, say the, like for like for a Toyota Camry will cost $18,000 according to our estimates, whereas the Toyota Camry, very mature technology, will still be in that $25,000, $26,000 range. No-brainer what's going to happen here. We believe electric vehicle unit growth will compound during the next 5 years at an 82% annualized rate.

Shout out to Camry drivers, but Camrys aren't the main focus of Cathie's electric car bullishness, of course. Teslas are. Tesla stock is up so much that the company is already number 6 in the U.S. by stock market value, behind only Apple, Microsoft, Amazon, Alphabet, and Facebook. I asked Cathie, what kind of upside do you see from here for Tesla?

We're about to put out that forecast, but let me just give you a hint. Our minimum hurdle rate of return for any stock to enter our portfolio is 15% at a compound annual rate for the next 5 years. That's a doubling over 5 years. Our bear case for Tesla, which means they don't go autonomous, that is the next big wave for the stock, by the way. Our bear case for Tesla will deliver, we believe, substantially more now from these prices than that 15% compound annual rate of return. So stay tuned for our bull, bear, and base case model. It should be out within the next few weeks.

Tesla, I kind of get. I mean, the stock seems too expensive for my tastes, but I totally understand why electric cars will take over. It just makes sense from an efficiency standpoint. Your electric toothbrush doesn't have its own power plant. It uses power that's generated at scale in a faraway plant and distributed to your home and stored in your toothbrush's battery. Your current car might have its own gasoline-burning power plant under the hood, but battery-powered cars aren't especially new. Thomas Edison had one. The reason gasoline cars took off back then was that we didn't have a mature power grid, to say nothing of modern battery technology. And that's changed. I'm not much of an early adopter. Last year I got a new car that burns gasoline. I leased it for 3 years. With technology changing this quickly, I like the thought of my car's residual value being someone else's problem. I'm guessing my next car will be electric because that'll become the mainstream choice over the next few years. Now Bitcoin is more of a mystery to me. I understand the main arguments people make about it, For example, that regular currency is at risk of losing value because some governments are creating so much new money to spend, and that Bitcoin is differentiated by its finite supply. What I don't get is how we know whether something that was priced at half a penny a decade ago and sells for around $50,000 today is overvalued or undervalued or appropriately valued. I mean, there are no dividends or cash flows. There's just a lot of people hollering on Twitter and in my email box every time I mention Bitcoin. Folks, I'm not the guy in charge of whether Bitcoin goes up or down next week, I promise. I'm just someone trying to figure it out. Anyway, the bear case is easy. Bears say it's make-believe internet money that has become a target of speculative excess. On this podcast, we've also heard from a few thoughtful Bitcoin bulls who've talked about its value as savings technology or an inflation hedge. Now, Cathie is a Bitcoin bull. In her ARK Next Generation Internet ETF, ticker ARKW, which last year did even better than her flagship ETF, Bitcoin is the number 3 holding behind Tesla and Square. It's held indirectly in the form of something called Grayscale Bitcoin Trust, ticker GBTC. I asked Cathie, what's the basis for your belief that Bitcoin is going higher?

So Bitcoin is trading today at roughly, if you were to think in market cap terms, roughly $900 billion. Now that sounds like it's a very big, big idea.

And it is.

But Apple is $2 trillion. Apple's a big idea, but Apple is not the first global digital reserve currency ever.

Cathy says Bitcoin can transmit value anywhere within 10 minutes for a fraction of the cost to do that in the traditional financial world. She says the light bulb for her went off in 2015 when she and economist Art Laffer were studying whether Bitcoin can serve as money in 3 ways: as a means of exchange, as a store of value, and as what's called a unit of account. That's a way to measure the value of other goods and services. Here's Cathy.

When we learned that it could indeed serve the 3 roles of money, the second 2 better than the first, I said, Art, how big could this be? And he said, well, how big is the US monetary base? If you believe this is going to be the reserve currency of the crypto asset ecosystem, how big is the monetary base? And at the time it was about $4.5 trillion. Today it's closer to $8 trillion given all the monetary ease.

Cathie doesn't own a lot of stocks that you could argue are value stocks, but there are a few. I saw Deere in one of your portfolios. I thought, is that a Cathie Wood stock? Deere. What else do you have like that that even like a value investor could love?

There are a few areas like that. Traditional biotech.

Many of these stocks are selling for 10 to 12 times And some of them are embracing aggressively the convergence that is taking place among a number of our platforms, DNA sequencing, artificial intelligence, and gene editing, a technology which has been launched because of DNA sequencing. So the convergence of those three technologies, we believe, is going to create the new golden age of healthcare.

One of Cathie's top holdings in her Genomic Revolution ETF— Madam, am I saying genomic or genomic? How would you say that? Genomic, like economics?

I don't know.

I was thinking genomic like garden gnomes.

You make a strong argument there.

Well, one of her top holdings in that fund is Regeneron Pharmaceuticals, Now, we talked with Regeneron Chief Len Schleifer a year ago about the outlook for COVID treatments and vaccines. It was the first episode of this podcast. Meta, has it really been almost a year?

Wow.

Anyhow, Regeneron trades about 10 times this year's projected earnings. Now, the same fund has Novartis and Roche which go for 13 and 15 times earnings. Cathie says returns on investment in biotech were high in the 1980s and '90s, but now they've fallen, and she thinks they could soon rebound to higher levels than ever as the combined capabilities of DNA sequencing and artificial intelligence and gene editing cause drug trials to accelerate and success rates to rise. If that's not space age enough for you, how about actual space? Cathie doesn't have a space fund, but she's launching one soon. I asked her to explain what's so exciting about space.

If there were ever an area of convergence of technologies, all of which have exponential growth trajectories, it's space. The costs of everything having to do with getting us ultimately to Mars are collapsing. The cost of launching rockets, the cost of satellites, the cost of antenna.

Kathy says the most important killer app for space is hypersonic flight. Hang on to your snack-sized honey-glazed peanuts while she explains.

So getting from New York to Japan in 2 hours instead of 12+ hours. Many people are going to be willing to pay a lot for that, and we think that opportunity alone is about to scale, not immediately, but You know, the first flights like that will probably cost $100,000. And looking at those who own private planes and are willing to pay first class to Japan, we have sized that market at a $270 billion revenue opportunity as it scales during the next 10 to 20 years.

That sounds like a lot to figure out, but don't worry. Kathy says machines will do the hard thinking for us.

So this idea of artificial intelligence, machines learning how to do something, human beings setting the objectives, how to get from point A to point B as safely and quickly as possible, and machines using big data, massive data, as well as iterative algorithms and massive computing power, teaching themselves how to achieve these objectives. The biggest breakthrough in the last 10 years is effectively We were taking the human programmer out of that part of the equation.

One more thing. I liked hearing Cathie's predictions about the future, but my hands did get a little sweaty when we talked about valuations. I'm happy to be an ARK spectator, maybe too chicken for now to be an ARK participant. I remember a mutual fund called Munder NetNet, which is no longer around, but which set the world on fire more than two decades ago. It returned 175% in 1999 alone, and it swelled to $11 billion in assets the following spring. And then the dot-com bubble popped, and Munder NetNet lost 90% over the following 3 years. Now, this isn't 1999, and I don't expect ARKK to experience anything like that. Cathie says she's been able to use recent volatility as a buying opportunity But what about the concern I raised earlier that a hot economy and rising interest rates might create a shift in stock market leadership? Cathie doesn't seem worried. She points to what she calls similar conditions in 2016.

So what did I say back then? I said, I am thrilled that value took off, value stocks took off, and we went down. We went down during that period a little bit like this recent period. And the reason I was thrilled was because it said the bull market is broadening out. The worst thing that could happen to our strategy is a narrowing of the bull market to just our strategy, right? But what happened in 2017, bull market broadening out, value having its day, we took off again. And as I always say to our analysts, truth will win out. We know what our 5-year projections are for our portfolios. Now, there are estimates and we could be be wrong, but they're based on rigorous research centered on Wright's law. Given the recent sell-off, you know, according to our estimates, the compound annual rate of return for our portfolios during the next 5 years should be roughly, maybe more now, than 20% on average per year. Now, we could be wrong, and in the short term, anything can happen, but we are very confident in our research.

Thank you for listening. Meta Lutzoff is our producer, and sometimes she helps me pronounce things like genomics. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts, and if you listen on Apple, please write us a review. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @jackhowe, or is it Huff? Anyhow, it's spelled H-O-U-G-H. See you next week.

Jack, it's genomics.

Gnomenomics?

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