Two prominent ETF players faced off in a wide-ranging debate this week on the outlook for growth equities.
Cathie Wood of ARK Invest Management and Rob Arnott of Research Affiliates appeared during the Morningstar Investment Conference Wednesday evening. Following are a few of their key quotes from a wide-ranging, multitopic conversation.
Growth Vs. Value Spreads
Arnott: We always hear the observation that "It's different this time." And the thing that's interesting about that is, it's always true. Things are always different this time; they're just not necessarily different enough to matter. Now, what we've observed over the course of decades is that the spread and valuation between growth and value stocks widens and narrows, widens and narrows.
One of the marvelous things is that when it widens, that's a good predictor for subsequent performance of value relative to growth. Same holds true when it narrows; it was abnormally narrow in 2007. Well, that's when we had the quantum crash, because everyone was piling into value, and value cratered. In fact, to the best of my recollection, the Goldman Sachs global alpha strategy, I think, lost 40% in three days. So yes, I do think they will mean-revert.
Wood: The seeds for [ARK’s main investment themes] were planted during the 20 years that ended in the tech and telecom bubble. As we know so well, too much capital chased too much/too few opportunities, and it all ended badly. But that does not change the fact that the seeds were planted, that they have been gestating for 20, 25 years.
Now we're on the cusp of transformations to every sector, globally, the likes of which we have not seen since the early 1900s. The major technological platforms back then were the telephone, electricity and the automobile. Life as we knew back then certainly changed, and never reverted to the mean, we did not want to go backwards. And I think the same will be true this time as well.
Price Vs. Fundamentals
Arnott: We saw in the internet bubble that there were countless disruptors, and they were radically reshaping the way we communicate, the way we transact, the way we interact with our clients. And thank goodness for that internet revolution, because when COVID came along, all of those innovations turned out to be massively important to all of us.
But the market got ahead of what was likely to happen. Briefly, Cisco had the largest market-cap stock on the planet. Since that time, for 21 years, they've had 12% annual earnings growth, 13% annual sales growth, and their share price is lower than it was at the peak in 2000, with double digit growth for 21 years. So the market was expecting stupendous growth. It got impressive growth. But it was priced to reflect expectations of stupendous growth. And that's where I’m inclined to push back.
Wood: We are looking at exponential growth opportunities that have evolved as these innovation platforms have started to mature and move into prime time. When I say “mature,” I mean from an innovation point of view. These seeds, as I mentioned earlier, were planted probably in the 20 years that ended in 2000. And I think the power of the growth rates, the exponential growth rates that we're going to see, is a function of how long they have gestated. When I throw out a number like 88%, 89% compound annual growth in units, that sounds preposterous, but it is tracking Wright’s law, and gives us a very nice guide.
I think most of the world is used to looking at the world in linear growth opportunities. That's the kind of growth that has dominated ever since the telephone, electricity and internal combustion engine has evolved. We got a glimpse of exponential growth during the internet [bubble], it turned many people off because it was so wrong, the costs were too high, the technologies weren't ready, we've got now 20, 25, 30 years, and the costs are low enough that technologies are ready. And not only are we seeing these five innovation platforms evolve at the same time, we’re beginning to see them converge. And we're beginning to see S-curves feeding S-curves feeding S-curves.
Hype From News, Social Media
Arnott: I was at a conference where the then-CEO of CNBC was one of the speakers, and this was in the early 2010s. Somebody in the audience asked, “Do you feel any remorse or guilt about being a cheerleader for the very industries or the various segments of the market that fit into the crash and the global financial crisis”? And to my surprise, he was very thoughtful. And his answer was not a glib answer. He said, "You've got to understand that we're in the entertainment business. We entertain by producing news, we entertain by producing analysis that relates to that news. But it's an entertainment business, and viewed from that perspective, of course it’s cheerleading something that has nosebleed valuations and has a great story."
Things that are expensive are always expensive, are based on a narrative of everything going amazingly well, of pathbreaking disruption. And here's the trick: narratives are true. The narratives that drive these companies to lofty valuations are, for the most, part true. But the important question to ask is not if this is an amazing narrative; the important thing to ask is, what about this narrative isn't known to the broad market and isn't already reflected in the share price.
Wood: I think what the market is missing is this convergence between and among platforms. I want to get back to this idea of bubble. Are we in a bubble? Well, the tech and telecom bust and the 2008 debacle put such fear into investors that many just became benchmark sensitive and very backward-looking and flight to safety. And that continued until and throughout the first four years of our evolution as a company. It was palpable. That muscle memory is still there, because the word “volatility” puts fear in investors’ hearts and heads. But volatility on the upside is a good thing, as we saw last year.
Did I think that performance or innovation was going to last? No. In fact, if you asked everyone in the firm, I said, “We've got to prepare for the other side of it.” Well, we got the other side of it. The entertainment side of media was all about, how is this ARK Invest up 150% last year? Is it a reenactment of the bubble? How fast is it going to blow up and we'll be rid of it? The entertainment daily on CNBC, and perhaps other channels, was all about that. That does not happen in a bubble.