I want to begin this way by rewinding
the tape. To February of 2021, Kathy, at the time,
your flagship ETF ARKK., was up 350 percent from the pandemic low and
cash, as you may recall, was pouring in so quickly, people wondered if you could
deploy it all and Ulrike Tutor doesn't run ETFs
So I can imagine I must imagine that your return profile is different than
Kathy's. But you're a technology specialist and
so you were enjoying some of the same tailwinds.
And since then, as we all know, it has been a bloodbath for investors in
innovation. And of course, we think we know why.
Right. We think it's about inflation.
We think it's about the Fed. We think there's some Ukraine in there.
But, Cathy, I want to start with you, because you're often a contrarian and
unconventional thinker. And I just gave you the conventional
reasons for why what has happened happened.
From your perspective, what happened? Well, I mean, we agreed that if
inflation and interest rates took off, that would be a problem for high
valuation stocks. But I do think what is happening now.
We saw a dry run of it before Covid. So if you remember before Covid, as we
realized what a what a problem we had on our hands, the globe had, I think the
markets were down in one month's time. Twenty five percent.
We were down 46 percent from those lows. As you just said, we went from April 20
to 21, 350, 360 percent since then. Just to keep the
keep the perspective here, down 75 percent at our low in May.
Now we're probably testing it today as we speak.
So we shall see. I think one of the things that has
happened is during risk off periods, we see a rush back into indexes.
Even so, a lot of the market has gone passive.
But when we move into risk off this idea of career risk, business risk surface,
it is in discussions and there is a movement back into benchmark stocks.
We don't own the big benchmark stocks. Only one of our stocks has made it into
the benchmarks and that's Tesla. And believe it or not, Tesla's held up
better than our portfolios. Right.
So I think there's been a lot of algorithmic trading.
I felt it pre Covid the variables, algorithms focused on cash burn, cash
cushion. And yet at the time we were saying, wait
a minute. This makes no sense.
This is Covid and we need to solve this problem.
Innovation solves problems. And so that was one of the reasons we
had that switch. Right.
We were solving problems, global digitalization, figuring out how we
sequence the corona virus and so forth. I think the same thing now.
We've had this incredible decline. We have so many more problems now.
Supply chain, Russia's invasion of Ukraine.
Innovation solves problems. And yet these algorithms and very short
term time horizons are just five years. The market in risk off goes to one
quarter. You know, algorithms are dominating the
market. You know, it's very interesting.
Most people don't know what our companies do and they don't know the
kinds of problems they are solving. But we as we've gone through this
period, the 75 percent decline, we've concentrated from 58 names to 33 names
to our highest conviction names. Typically, that's a very good strategy
for the turn in the market. Ulrike, would you agree that this isn't
simply a matter of using a different rate to discount future cash flows and
there are flows helped to explain what's happened to innovation names and
technicals, help to explain what's happened to innovation names and the
arrival, or at least the super charging of certain kinds of other strategies in
the market. Well, I would say the biggest difference
is at that rate, we were an environment of almost zero rates.
And in that environment, a lot of things get funded.
Moon shots, more shots, maybe more for your shots.
But when the opportunity cost is no longer a zero.
That's a very different investment environment.
And I think we have to brace ourselves for that.
You know, as much as I'm excited about investing into innovation, A.I.
and data infrastructure, if I actually apply exactly those vast amount of data
like the last seventy five years of economic data and machine learning, you
come to the conclusion that federal funds rates might have to go to well
above 5 percent to get to the 2 percent P.C.
inflation that the Fed is targeting. And then that in turn is the second
point that GDP growth will have to decline next year.
So I think where the point where the economic cycle and the innovation cycle
are turning in opposite directions. And that's very different from the last
decade where those two wheels have been turning in unison.
The innovation wheel is still turning. That's the good news.
But it's going to be throttled by the economic slowdown that we are
experiencing. The prevailing view in the second half
of 2020 and early 2021 was that the pandemic had brought the future forward,
that the digital economy was on a different trajectory, a trajectory that
was independent from the rest of the economy forever.
And that. The valuations of stocks like Pelatine
and Zoom, Shopify and Crisper and Twilio were not extreme, but rather justified.
Why? We'll recap the things that seem so
right then that made sense, then turned out to feel so wrong.
Now those explanations don't work any longer.
Well, I think back to the two wheels. I think the economic cycle has had
almost a multiplicative effect on the innovation cycle.
And so now we're just at a very different economic climate.
And if we look at past stock market corrections, especially rates induced
ones, that typically two stages. The first stage is where valuations, you
know, extreme valuations that we have seen take a hit.
We have seen this in the first and the first two quarters of this year.
The good news is we can check that box, we through that.
But we are just about to enter the second phase.
We actually the economy is starting to weaken.
We will see companies miss earnings negatively preannounced.
Know we heard FedEx, also AMC last week. So we'll see more of that.
And at the same time, they'll still see more multiple contraction going forward
because there's more economic uncertainty.
So it's unfortunate that unfortunately, unfortunately is not a straight path
down, because often, you know, you see bear market rallies and results are
better than feared. And the reason for that is that it just
takes time for these rate increases to put their claws on the economy.
The half life is about 2.5 quarters. So we are still seeing the brunt of
specific economic malaise. Next year is the core species to
innovation investing still in? Yes, we, like Kathy, have a very long
term horizon and our investments in a five to 10 years.
But my take as an innovation investor right now is the short term is the
medium term. So in the short term, right now, for me,
it's all about hedging. And I know hedge funds tend to get a bad
rap because apparently we're so short term is that to hedge actually means to
protect and hedging allows us staying power in those companies that we believe
have the best growth prospects over the next five to 10 years.
Kathy, you were. Oh, I'm sorry.
I'm going to keep going. But I think, you know, there is some
really bright light at the end of this tunnel, which is that we will have a
once in a decade opportunity, I think, in the next in the next few quarters.
Right now, we have to be patient where we will almost like time traveling back
to 2001 and buying Amazon at less than one dollar a stock.
Only that this time around it's going to be the next generation of the facts that
for now, prudence, patience and hedging. Kathy
This is more of a matter of curiosity for me than anything.
You weren't blind to the risk of a correction, in fact, when you and I
talked in December of twenty 20, I remember vividly.
You. Saying this for a really good chance
that the correction is just around the corner and of course it did turn out to
be just around the corner. Well, Ulrike just mentioned the
importance for her of hedging that you run an ETF or a series of ETF and they
are, for the most part, fully invested. There is occasionally a little bit of
cash and very little, but very little. I would like to know and I think people
here might like to know if you were running a different kind of a view.
Would you be managing it differently, would you be investing differently,
would you be hedging? Would you be allocating more to cash?
Would you be buying protection in the options market?
So we so you're asking about the wrapper separately managed yoga.
We do run other accounts like that, but we're very clear about what we do and
what we don't do. We are not an asset allocator.
We are focused exclusively on disruptive innovation, transformative innovation.
And and and I think we're fulfilling an unmet need out there.
We are doing research and giving it away to help educate people on how our world
is going to transform. And I think the underlying premise in
your questions, and Ulrike's is that inflation is the problem and we're and might
remain the problem. We actually think there are signs all
around the world that deflation will be the bigger problem.
And as I understand from this conference, I don't think the word
deflation has been mentioned here. So I kind of like that if everybody is
sure something's happening and you have evidence brewing that that might not be
true. Those are great calls.
Now, I have a macro background. If I were running a macro fund, I think
it would have done pretty well this year.
But that's not what we do. We do have a point of view, though, on
deflation two to two from two angles. Cyclical in the pipeline.
Commodity deflation is is proliferating. And then at the end, then downstream at
the consumer end and this is globally, we are being overwhelmed by inventories.
So there is we believe in this holiday season that will become clear.
It was interesting to see the online expectations for this holiday season,
only two and a half percent. That doesn't allow much room for real
growth or inflation, right. Something's wrong out there.
No one. And then the other thing is innovation,
especially the amount of innovation that is evolving today is inherently
deflationary. There are massive deflationary
undercurrents and the base of these new ways of doing things is getting high
enough to start moving the needle. So I believe in the next three to six
months, you're going to hear more talk about deflation.
I want to point out one thing, which is that you've been very consistent in my
experience with Cathy. She is consistent.
If you go back 10 years, if you go back 12 years, you you will have heard her
saying many of the same things she's saying today, but specifically on the
subject of deflation. You were talking about deflation a year
ago. Now it's true.
We look through an awful lot of inflation since then.
I'm curious to know why not just that you believe inflation, deflation.
Excuse me, is important to talk about, but why you've brought this up in a very
open way. You wrote an open letter yesterday that
Federal Reserve speaking to the risk of what you called
a policy error. The only person, by the way, who
suggested the Fed may be going too far, too fast.
Why throw it out in the open like that? We were struck at the unanimity of the
vote among the Fed governors. And that tells us that this discussion
is not getting out there broadly enough. And so we wanted to raise some points,
specifically the commodities I just mentioned downstream used car prices,
used car prices were one of the first indications that the supply demand
imbalance was going to become extreme. They went up 54 percent year over year,
tested to 45 percent. Now they're down year over year.
And we think they're actually going to go down a lot more.
Why? Because of the shift, consumer
preference shift to electric vehicles. The residual values of gas powered
vehicles, we believe is going to fall apart.
Many people inventoried a car because they did not want to take mass transit.
They didn't need that car. Mass transit is back now.
They were looking at prices saying, oh, my gosh, I could get a nice profit.
Now they'll have an inventory loss. Maybe they won't take it.
They keep the car. But we think the dealers are going to be
in a lot of trouble. They already are.
The stock market is telling us. Ulrike, there are important linkages
between economic conditions, the capital markets and the innovation cycle.
Do you worry that the rising cost of capital demand, destruction from
monetary policy and the risk of a recession we aren't already in one will
damage the funding model and maybe even the business model for transformative
technology? Yes, for sure.
Very, very briefly, to your inflation find, if I may.
If we look currently at the composition of RTS inflation, about half of it is
demand driven and half of it is supply driven.
So even now that we have seen these supply chains loosening up, even if we
were to go back to your pre call that level from the supply side, we would
still get to see about 4 percent. So I think you just also tying this into
your point. Right now, the Fed doesn't seem to have
a choice but to go and target the demand side inflation, which means bringing GDP
down and raising rates further. So, yes, I just think it will impact the
cost of capital, will impact what's getting fund that that innovation is
slowing. But the question is, you know, there is
bright light at the end of the tunnel. Every recession in every rate cycle
ends. And typically, the data shows that one,
two, three quarters after the peak in rates, we see a bottom in the equity
market. So I think what we are going through,
it's transitory and open up an incredible investing opportunity sets
into innovation as we are coming out of that be careful transitory has
become a four letter word. I think history will judge this.
Transitory just took a little longer. I'll also make a point that what we have
in the Fed is is really a Keynesian fed that does believe that inflation and
demand are positively correlated. The history of in the 80s, 90s and and
the 2000s is that is not true. When growth picks up, productivity picks
up. Right.
And that is an anti potent anti inflationary force.
The other thing that's going on and it's been interesting to watch the surprise
around the dollars increase 25 percent in the last year.
That's another powerful inflationary anti inflationary force.
So in this country anyway. In this country.
But you know what? The problem in the emerging markets.
It's crushing them. What I remember, I've been in the
business for a while, as most of you know, in the early 80s, the dollar did
the same thing in response to monetary policy.
And we ended up in the Plaza Accord and the Louvre forward, where all of the
treasury ministers around the world, including our own, decided to sell
dollars and buy those other currencies because that dollar increase was
becoming deflationary. Why dollar denominated debt?
Right. As their currencies are falling apart,
their ability to service dollar denominated debt is disappearing.
And that's why many of them are going to the IMF.
You've got the IMF, the World Bank and one other organization
basically saying, do you understand what's going on out here?
Most the US doesn't, really doesn't. We are somewhat myopic and we are the
strongest economy in the world. But it's going to come back to bite us
if we're not careful. Ulrike on Friday.
As many here will have noted, the US government imposed a de facto ban on the
exports of advanced technology to Chinese buyers.
How much of a factor has geopolitics become in the innovation equation?
We are headed to a bipolar world where the US and China are battling for global
leadership. And for sure.
They then die, which is our investment thesis.
Maybe there is no surprise because data and I yield power.
And in the geopolitical context, it means industrial and military power.
So that announcement did not necessarily come as a surprise.
Clearly, in that context, the US has an incentive to slow down the advances in
semiconductors and China to also store more advanced artificial intelligence.
We can talk about the semiconductor sector maybe in a little bit more
detail, because I think it's an interesting industry to showcase the
geopolitical interdependencies that technology has created.
And I think it's going to be a big factor if you think about the next few
decades. Well, where are we in the semi cycle?
On the one hand, some of the TV makers, notably Tesla and Pollstar, are still
having trouble getting enough chips. But in other parts of the semiconductor
industries, I would point to V. We're moving from shortage to glut.
Very, very, very quickly. And in fact, companies,
manufacturers are talking about supply destruction.
So it's complicated pictures isn't? Yeah, it's really complicated.
Like I said, there's lots of inventory build in certain parts in memory of the PC
data that just came out again overnight.
So there are certain parts that I got that I would supply right now.
And then there is still the golden screws on the analog side, on the
microcontroller side. It'll take some time to work out that
clearly. Ultimately, when the cycle is over, all
of these different components will be in a glass situation.
That's how it always works. I'm curious to know, Cathy, whether.
There are stocks you won't own now because of this growing China risk.
Well, we won't own Chinese stocks for in the flagship fund.
We started pulling them out when Jeff Ma was vanished in November of 2020
after after building up Chinese exposure quite significantly, because we like the
way China had responded for fiscally and monetarily to the Covid crisis.
Had not gone crazy. But we've pulled out pretty much.
I mean, there's anti capitalist, you know, policy actions.
And I think common prosperity suggests to us in China that any company.
Now some of our more specialized fund funds, we do have very low gross margin
companies. High gross margins are not compatible
with common prosperity as we're as we're discerning and and we're looking for
companies that that do fit this common prosperity
theme. So logistics getting getting goods out
to Tier 3, Tier 4 cities, electric vehicles getting transportation,
especially if they go autonomous. The costs for transportation will be
much lower. So but in terms of the semiconductor
side of this, you know, we've watched the league tables for years and we were
watching because of their their surveillance economy.
A I they they they were making more breakthroughs.
So we were watching the league tables. But I've been watching China since the I
was there in 1994. And one of their primary objectives was
to become, you know, one of the leaders in Global Semiconductor.
There's there's some DNA reason. I don't know what it is, why they're not
there. The closest they've gotten is is with a
I. In terms of your question about
semiconductors generally and our actions, the risk to innovation
generally is regulatory and other actions.
Sanctions can slow innovation down. Why we we we base all of our modeling,
our top down modeling on something called rights law, which is a relative
of Moore's Law, but it's a function of units and unit growth.
So if unit growth is going to slow down, then innovation is going to slow down.
The other thing I'll say about bringing it the industry back here, by some
estimates it will take a trillion dollars at a minimum.
We know that Micron just announced a 100 billion dollar plant in New York.
That's over 20 years. So it's going to take a very long time
to reorient the supply chain. The X Factor in the meantime, Ulrike is
Taiwan. What if China were to invade or simply
put, an economic blockade around Taiwan? Is that a Covid like shock or is that
something worse? Yes, as you said, Taiwan is the choke
point and the semiconductor supply chain.
Over 90 percent of leading edge ships are being manufactured there and they go
into the most powerful process. Whether it's on the service side and the
cloud pieces, mobile devices. And I bought five companies like Apple
and Video, AMG, Qualcomm and others. So if something were to happen to Taiwan
and its boundaries so that they would be fully compromised.
The economic impact would probably be pale in comparison to what we have seen
with Covid. Maybe actually look like a benign cold,
we estimate even though semiconductors only 30 basis points of U.S.
GDP, they are critical to 34 percent of U.S.
gross output. So we estimate that the economic impact
could exceed a negative 6 percent of GDP and also last for a longer period of
time. I mean, the coldest crisis was very
short lived. So I think it's a real risk that Kathy's
point now companies really countries realize that companies realize that,
too. And the incentive here is to start to
localize supply chains. And that ship that is obviously for a
step in that direction. But we'll see that over the next years,
decades. It's going to take a long time.
Ultimately, that's going to be successful.
Countries are going to be more resilient.
But I think the one thing that happens is that costs are going to go up.
And so all these deflationary benefits that we have read over these decades of
globalization, they'll be reversed. You're both big believers in the power
of innovation and disruptive technology. While we still have a few minutes left
here, I'd like to ask you both, irrespective of price.
Mean, that's a fantasy land, right? But irrespective of price and
irrespective of valuation, what excites you most right now?
Covid. What excites us most is the convergence
between and among technologies. That that means that s curves are going
to be feeding s curves and we're going to see some explosive growth
opportunities. You asked the question earlier about
recession. Toward the end of a bear market.
And during recessions, our growth is far superior to that of the broad based
indices in terms of revenues and so forth.
But some of the convergences. So genomics.
So we have the intersection of DNA sequence sequencing, RNA protein
sequencing, plus artificial intelligence, plus crisper.
We're going to be curing disease. It's already happening.
Sickle cell disease, data thalassemia, ATTR and there are now attempts at
at diabetes as well, crisper therapeutics.
Another thing is autonomous mobility. Zero in revenue today.
We believe that we'll scale to 9 to 10 trillion in revenue by 2030.
And that's the convergence of robotics, autonomous vehicles, our robots, energy
storage. They will be electric and artificial
intelligence. And in a I in particular, A.I.
is the glue that's causing all of these convergences just in the last few weeks.
We're seeing text, image and text to 3-D.
We've got Metta and Google, you know, kind of putting papers out there and
open sourcing this world. And the and the advancements are
unbelievable. So that we're going to lower the
barriers to entry in the whole gaming world.
User generated content is going to do that as well.
But our lives are going to change completely.
And if TI's even with fluff, Jane a i n NFTs the creator community, the art
world is going to change it in a way much more quickly than I think people
now understand. Ulrike What are you most excited about?
Yeah, you're probably going to be a surprise.
One word data. So there's one certainty I think in this
economic environment and maybe in life that the amount of data is going to grow
and we like to invest in the picks and shovels that translate that data into
dollars. So data, infrastructure, A.I.
and also semiconductors. And Kathy, you talked about these
platforms, exciting new platforms like dynamic robotic energy storage.
I think you've talked about as well. And like you said, I think A.I.
data and I are the foundational layer that are key to the success of all of
these platforms. If you think about robotics, the brain
of a robot uses census data and artificial intelligence to behave
optimally. Then we have on the economic side,
that's actually the biggest of big data that 40 exabytes of data a year.
We need to understand which genome sequences are responsible for diseases,
and that's when we can start to think about gene editing.
And then finally, energy storage. We need cheaper batteries, more
performing, safer batteries and again, data.
And I can help us test different chemistries that performance and also
see how energy is going to be distributed within a battery and in
between battery pack. So for me, this is the most foundational
edge. Invest in that, then drive innovation
that that that you have laid out. So if people want to get behind those
ideas, what kind of time horizon should they be prepared to invest on?
What kind of risk tolerance should they be prepared to?
Yes. Yes.
I think our time horizon is five years. And in a risk averse market.
That's not most people's time horizon. However, we believe that most people are
true. Most investors portfolio's asset
allocators are truly short innovation unless they're highly involved with the
private markets, because we believe and just to give some numbers, that
innovation, truly disruptive innovation will will scale from 7 trillion in
market cap today to two hundred and ten trillion by 2030, from less than 10
percent of the broad based public equity market to more than 60 percent.
And so if you're short innovation, you're going to be missing some of these
unbelievable opportunities. Ulrike, time horizon, risk tolerance.
Yeah, we have the same time horizon. We probably don't have quite the same
risk tolerance, but we do try to be partners to our portfolio companies.
We actually shared our bleak economic outlook with our portfolio companies
early in the year to try to brace them for this environment, but they can only
control so much and that's down execution.
And I think it's on us as portfolio managers of an innovation portfolio to
see how we can insulate that portfolio from macroeconomic conditions or changes
in interest rates, which is really something the management team can't
control. And for my last question, a fishing
expedition. Kathy.
Do you want to see Elon Musk by Twitter? Or are you worried that if he does,
it'll be way too much of a distraction for other companies you do care about,
like Tesla, for example, and Space X? I am excited to see what he does and how
he open sources. The whole thing, I think he's going to
change the model completely and the risks that people cite.
Well, we've watched him. How how he.
He's our renaissance sounds, man. You know, space X.
Boring. Tesla, of course.
And, you know, I think he's been able to not
not only multitask, but actually he's he's he's doing these things because he
wants to protect us from ourselves in terms of the environment and also wants
to prevent censorship in the case of of Twitter and open source and take the
bias out and I love that Ulrike do you have a view on Elon and Twitter?
Well, I I think he has said that he is not going to decentralize the protocol,
but that would be something really exciting to experiment.
I think we need a new form of social media.
And so who knows? I'm open minded.
