In The Know With Cathie Wood: A Change of Tone

The following has been transcribed from the June 4, 2021 In The Know with Cathie Wood. Edits and comments are my own and were done in a way to best preserve the voice of Cathie.

This is a long one. However, it was transcribed and summarized because I feel it signals a change in tone from the past 4-5 months and sets the path for the second half of the year. All the dominant trends of 2021 are now being called into question. Naturally, the market works in cycles and we might be on the verge of a new one.

I've sectioned off the pieces of her talk in case you want to skim. If you only read one section I'd recommend the final, Equities, section.

Sections:

• Fiscal Policy
• Monetary Policy
• Shortages and Inventory
• Housing
• Jobs
• Commodity Prices, the 10-year, and Inflation
• Oil Demand
• Equities

Fiscal Policy

Cathie Wood: "Some interesting parallels to the 1980's and 1990's. It does seem like the narrow majorities, or the lack of a majority at all, in Congress are causing a rethink of spending and taxes, especially now that with vaccinations, the economy is getting back towards normal. Not normal yet, to be sure, but it does seem that the close races, which will take place next November are already starting to weigh on decision-making in terms of fiscal policy, both spending and taxes.

There was a Harris Poll, taken in the last week or so, of 10 Democrat swing states. It was taken during May 18th to May 23rd, and some of the results were very interesting, and I think are factoring into the way that the Biden administration is beginning to think about both spending and taxes.

The bottom line is spending will likely not be as high as President Biden's proposals, and taxes surprisingly, we think are starting to move back into a capital-friendly stance. So as far as the results of the poll...

1. Strong majorities in all 10 districts say taxes overall should either be lowered or kept the same, while between 61 and 71% in each district opposed raising federal taxes
2. By majorities ranging from 66 to 72%, voters in all 10 states opposed raising capital gains taxes.
3. While between 64 and 70% in each district opposed raising taxes by $1.8 billion, so that's very interesting

These are 10 swing states for the Democrats. These are the results, and it does seem as though the talk around spending is starting to sound a little bit like there may be something more bipartisan than otherwise might've been the case.

It does seem like the tax talk is now more around corporate taxes, but not corporate tax rates going up from 21 to 28%, but now, this minimum corporate tax at 15%. So every corporation who has not been paying taxes pays at least 15%. That seems to be the direction in collaboration with the European Union or the G7 so that's very interesting.

This means we may not see a capital gains tax rate increase, which would be phenomenal, and I do believe the market is starting to respond to this, nor a corporate tax rate increase, certainly not to 28%. Maybe a few percentage points, but even that seems to be diminishing in probability, so I would say on the fiscal policy side of the equation, relative to our fears certainly, about capital-unfriendly policies and certainly policies unfriendly to innovation, we are beginning to feel a lot better."

Phil here... on the TLDR, basically what Cathie is seeing is the influence of the 2022 mid-term elections starting to swing policy makers away from making major one-sided (liberal) policy changes. The blue sweep in the fall had many concerned about tax policies that would be unfriendly to investors and businesses. As of now, it looks like those fears may be unfounded.

While reading the rest of this transcript note a theme: all sorts of negatives from interest rates to tax policy that were a driving factor in the slaughter of growth stock prices are turning out, four months later, to be, at worst, mildly negative. At best, they'll be complete non-factors past the mid-term time horizon.

Monetary Policy

"Despite what everyone seems to be saying, the fed is already starting to react. Interestingly, the money growth rates, so M2's growth peaked in February at 27%, and is now down to 18% on a year-over-year basis. I haven't seen it below the 20% range in more than a year. Anyone worrying about inflation will have to take note of that. 18% is still a very rapid rate of growth, but the direction has changed unequivocally.

The other thing that happened this week is the fed said it was going to unwind some of the bond ETF and outright bond purchases that it made during the depths of the coronavirus crisis. Now, this is only $60 billion, which is nothing when M2 is at roughly $20 trillion, and the monetary base close to eight trillion, but nonetheless, its change in tone, again, those worried about inflation have to take note."

Phil here... this is point one of four that indicates inflation fears are probably overhyped.

I haven't been listening to the ITK series from Cathie as I've been more focused on trading this market. Growth hasn't been working so sometimes you just have to wait the storm out. However, I went back and listened to a bunch of her stuff from the past month and was surprised, pleasantly, to hear her echoing a number of points I/we have noticed organically.

This leads me to believe that a) we're not the only ones seeing it and b) it's more likely to be correct if more than one of us are stumbling into these conclusions.

Point number two is supply shortages and inventory...

Shortages and Inventory

Cathie Wood: "We are in a little bit of a different camp than many others. We're essentially saying that businesses were behind the curve even before the coronavirus. Businesses were not keeping up with consumer demand, as it relates to inventories, and they were not increasing capital spending budgets. Why?

There were two reasons.

One, China-U.S. saber-rattling, the trade conflict, and the fear of supply chain issues.

Two, maybe more important was the inverted yield curve in 2019, which according to the majority of economists out there and according to post-World War II history, not pre/post World War II, as we've gone through, would have suggested a recession within six to nine months, and so they were poised for a recession."

Phil here... I agree with economists thinking as the data indicated we were headed for a recession as noted in the Dry Tinder post...

Back to Cathie...

"When the coronavirus crisis hit, businesses shut down. They were already behind the curve, and then they shut down, assuming demand was going to be dead for a while."

Phil here... as we recently talked about with supply shortages they were actually amplified by businesses planning for a slowdown before the pandemic. Inventory levels and orders were already low, the pandemic took them to near-zero levels and then a massively unexpected wave of demand for durable goods swept the country...

Back to Cathie...

"What happened instead is the government responded very quickly and pushed out PPPs and the payment programs to help people in a time of distress, and consumer saving rate shot up. I believe it got to 35% plus in April or May of last year, so the consumer had quite a big push and had never had such a big cushion, and the consumer started to spend.

What did the consumer spend on? Goods, non-durable and durable goods, because those were the only items that consumers could spend anything on.

Services were pretty much shut down. Now, what's interesting about this is goods make up only, well, actually less than a third of all consumer spending. Services make up the rest, so for the past year, the consumer, pre-vaccination especially, was focusing his or her spending on goods, just a third of a typical budget, and consumer spending rose as a share of total spending to more than 40%."

So what will happen next?...

"I don't think consumer spending has been that high in the United States in quite some time. As a result, we believe that consumers have actually been building inventories themselves at home with all these goods, many of which they will not need now, that they can go out and start to spend on services, and we are beginning to see that happen.

Now, what we think is also happening is that businesses are still scrambling, trying to catch up. Inventories relative to sales are at a record low, and as a result, that businesses are losing sales and they become a bit panicked about it, and so the scramble continues. Usually, when I hear panic and scramble, it means double ordering, triple ordering to make sure to get those supplies so that they won't lose sales in the future.

Meanwhile, the consumer has already shifted to services. If we look at retail sales in April, they were flat. They were expected to be up 1%.

Now, the prior month they had a huge increase, 10.7%. But nonetheless, a surprise relative to expectations. Retail sales is primarily goods.

Now, if we go to the broader report, which is the consumption report it was down slightly. But if you look at real goods consumption in April, it was down 1.3%.

This makes sense because if you look at the past year, real goods consumption increased 74%. Think about that. In the last year, the consumption of durables has increased 74%, and so now that the consumer is filled up on durables, and I'm sure non-durable goods as well, the spending towards services has begun, and we did see services consumption up 0.6% that month.

That's very interesting. Here, we have businesses scrambling, scrambling, trying to build those inventories when the consumer is no longer focused on goods."

Phil here... the economy is starting to flip away from consuming hard goods to spending on services. This is big on two fronts.

First, and probably most important, this will help keep a lid on inflation. Remember the ship jam we recently looked at? When people are ordering fewer home office supplies or patio furniture there's less import pressure which translates to lower wait times at ports.

Anecdotally, there have been 5 people (5!) in my immediately family that bought a house in the past 12 months. They're all done buying durable goods for them. Patio furniture is in place, new ovens and microwaves, all the stuff that it takes to fill a new house has been completed. And of course this makes sense, you buy that stuff once every 10 years, maybe.

Second, consumers still have plenty of money. If they aren't spending it on durable goods they're going to spend it on something else.

So where will it go? Services,  experiences, and I expect to some extent medical care that went ignored during the pandemic.

Housing

Cathie Wood: "Now, the other thing that has happened is housing. Housing and construction generally. They have been falling.

Housing starts and existing home sales. Part of the reason for this is lumber prices. Lumber prices have more than tripled in the last year. Actually, much more than that, and I think some builders can't get some of those supplies they need to finish homes, and so they are just going to take the summer off, and we're beginning to get clues that this shift away from goods to services generally, exacerbated by what's going on in housing, is having an impact."

Jobs

Cathie Wood: "The employment report today, very interesting. It brings us more into May.

In May, nonfarm payrolls disappointed. Expectations were 610,000. It came in at 492,000, and that was after a sluggish, much more sluggish number, 218,000 the prior month.

Average hourly earnings were greater than expected, so 0.5 versus 0.2 expected, but the year-over-year there is only 2%, and I believe the year-over-year now in productivity is more than 4%, so if productivity growth is higher than wage growth on a year-over-year basis, then that's not inflationary.

Some of the productivity gains are being passed on to employees, which is a good thing to do, especially because we believe within the next year, we will be talking about labor shortages broadly. Now, you can see already from the JOLTS report that we have hit a record of jobs unfilled, and that number is 8.1 million. The previous month was 7.4. 8.1 is a record. It is higher than the numbers we saw before the coronavirus when the unemployment rate was at 3.5%.

With today's number, the unemployment rate is at 5.8%, which is a drop from 6%, and well below the 14.8% peak that we experienced last April. We believe that the JOLTS report is pointing to serious labor shortages, and so the productivity gains that we're going to see should flow into wages to some extent. Now, the reason the market is on edge about inflation is some of the indicators are coming through much higher than expected now. There are two reasons. We've been talking about this probably for the last six months, the base effect last year at this time."

Commodity Prices, the 10-year, and Inflation

Cathie Wood: "In the futures market, energy prices had just finished going through a negative session, which of course, is not possible in the spot market, but that just gives you a sense of how much pressure there was on prices at this time last year, and today, oil prices are pressing up towards $70 a barrel.

Food prices are also flaring up. Again, supply chain issues, along with the recent hack in the beef supply chain. Those two numbers, oil and gas prices, especially around the Memorial Day weekend, focuses people on the gasoline price and meat prices, beef, holiday weekend, so forth, this is hurting consumer psychology.

The University of Michigan's Consumer Sentiment survey showed that consumers now expect 4.6% inflation during the next year, and so that's not a good sign. That's a pretty, pretty high rate.

In the month of April, the CPI was up 0.8% and is now up 4.2% on a year-over-year basis. The core, which excludes food and energy, it too is up 0.9%, so this is very broad-based, or it seems like it's broad-based, and on a year-over-year basis, up 3%, but if you look through the details in the CPI report, a lot of the inflation is coming from transportation, hospitality and leisure. Again, these areas of the economy are just starting to open up and they have some pricing power. They need to recoup some of the losses from the last year, and that's what's happening. We do not believe this is going to be sustained.

If we're right ... There are a couple of reasons. One, businesses ... I mean, this is going to be like Wile E. Coyote. Businesses are scrambling, scrambling, scrambling to catch up to the consumer, but the consumer has left, so Wile E. Coyote's off the cliff, and I think we're going to see a pretty serious drop in commodity prices.

We have already started to see some of these. Copper prices peaked at $4.90 and are now down to roughly 4.50. We're seeing lumber prices. They peaked at as $1,711 now down to, about as low as 1,200.

Now, another reason for these price declines is apparently, China is making some drastic moves to curb commodity speculation in China. They're raising taxes and fees, and they're censoring any article about shortages to prevent the scramble there, so there could be some impact from China.

But one other indicator, very important to us, is beginning to confirm that this might be a little bit more real than the skeptics would suggest. The treasury bond yield has dropped from 1.75% to 1.55%, and today, we got the wages higher than expected. We've seen inflation indicators higher than expected, as I just mentioned, and yet the bond yield is going down."

Phil here... I agree. The bond market isn't dumb money. But, in addition to that, there's two sides to the bond market: buying and selling. If interest rates rise there is always natural pressure from those seeking risk-free yields (which are  hard to come by right now) to buy bonds and get those rates. So, in my opinion, there needs to be a a lot of momentum to get over the current 1.75% level for a move higher to 2%.

We looked at the 10-year chart early last week...

Does it break up or down? Well, it broke below the 50-day late last week. Could reverse but odds are currently tipped in favor of breaking down.

If we're right about inflation being temporary and the fed not raising rates in the short-term it's going to be hard to get to 2%. Once the fed raises rates we'll need to revisit this but for now it stands.

Back to Cathie...

Cathie Wood: "This reminds me a lot of 2006.

The bond market got that one right as well. Energy prices soared from 2006. I think they were at $60, all the way to $140 in the spring of '08, even though the writing about housing was on the wall. Maybe it wasn't on the wall in 2006, but that's when the bond market began to see it, so we believe that the bond market is recognizing here that inflation is not a problem and that [inflation] growth may slow down, especially on the goods side of the equation.

I think we're going to see quite a bit of drama during the next year."

Oil Demand

Cathie Wood: "I've gotten a lot of questions about oil prices. Last year, we took the position that oil demand had peaked in 2019. Let me give you some numbers here...

In 2019, oil demand was at 99.7 million barrels per day, and dropped to 91 million on average last year with ... At the dips, it was down to 80. The second quarter, we're back up to 94.6, but something interesting has been happening during the last six months: oil demand forecasts for the second quarter have been coming down

In December, they were at 95.4 million barrels per day. April 9th, which was just a month before this last report, 95.1. Now, the estimate for the second quarter, and we're in June, is 94.6, so demand is disappointing relative to expectations. In the first quarter of '20, before the coronavirus hit hard, the oil supply was up to 100.2 million barrels per day.

Back then, China was already being hit by the coronavirus, demand was only 93.8, and so we were able to produce. Broadly, the global oil industry, was able to produce 100.2 million barrels per day in the first quarter of' 20. In the second quarter of 2021, production is up to 92.3, so not quite up to demand. Which is one reason why oil prices are going up. But we know, between OPEC and others out there, that there could be another five to eight million more barrels pulled up pretty quickly.

We do believe if OPEC sees that demand is disappointing expectations, as it seems to be doing in the second quarter, that it will conclude, demand destruction is back again. Prices are hurting demand, and we also know that prices are being elevated by some of the Biden administration's policies, shutting down the oil leases in Alaska. The ANWR region would be one reason.

We're also seeing the activists on boards like ExxonMobil's, and of course, they're advocating for capital spending in the oil industry to come down dramatically and to shift towards the renewable space.

On the other hand, what happened during the coronavirus crisis, we saw an accelerated shift towards electric vehicles. Last year, gas-powered vehicle sales were down 13%. Electric vehicles sales globally were up roughly 33%, so there is an accelerated shift towards electric vehicles, and that also means at the margin, the demand for oil should come down.

So you've got the Biden administration's forces, which are hurting supply, coming up against the innovation forces, which are curbing demand, and I would say prices themselves are beginning to curb demand. While we potentially could see an increase from 94.6, all the way back to 99.7 is going to be close.

We maintain our point of view that oil demand peaked in 2008. That's when oil prices hit roughly $140. If you look at the pricing since then, it's been lower highs. I think the last high in 2018 was at $77, so we would be surprised to see it go beyond $77, or even up to $77, especially if we're right, that demand destruction is underway."

Phil here... We could be nearing a good point to put on a short oil trade for a bounce off previous resistance which, as Cathie mentions, sits right at $77.

Equities

Cathie Wood: "Even with the shocks we've been through during this first half of the year, oil ... I mean, interest rates doubling, the 10-year government bond yield doubling in three months, that's never happened. Never happened before. We got through that, and the market was up at the end of the first quarter. Now, bond yields are coming down. That's very market-friendly.

We also had the fears around Archegos, the domino effect associated with leverage. That did not happen.

We had the fears of capital gains tax rates nearly doubling, introduced into the equation in the second quarter, and still, the market continues to move forward.

We believe, as we've been saying for quite some time, that the bull market is alive and well, and it is broadening towards value and cyclical sectors, or maybe I should say it has broadened. This has happened, and we thought it would, and we thought it would hurt innovation-oriented strategies. It has done that as well."

Phil here... adding my own emphasis on the past-tense: "maybe I should say it has broadened"

"Now, if we're right and everything I just suggested based on the evidence we're seeing occurs, then these cyclical sectors are setting up for a fall, and that should accrue to the benefit of innovation.

Why is that?

Well, when we get into a recovery, the early stages of a recovery are when the cyclicals see a burst in revenues and earnings, and they give more growth-oriented and innovation-oriented stocks a run for their money. These growth rates are competitive. They're not sustainable, but at least they're competitive in the short-term, and very much of the market is short-term-oriented.

As you know, our investment time horizon is not one quarter or one year, it is five years, so our innovation-based strategies are suggesting that the returns available or likely, can't promise anything here of course, to innovation-based strategies have increased.

I mean, it's just arithmetic. Our price targets have not changed. The prices have come down short-term, and so our rates of return over the next five years have gone up fairly dramatically, and we think that innovation is due for a catch-up. We think this cyclical reset will be that opportunity. "

💡 Phil here... definitely read this next part about demographics...

"Now, what's also interesting though, is there are demographics that are supporting a number of markets. One of them being equities.

I read this week from Fundstrat, Tom Lee's firm, a very interesting piece about demographics, and it was a flashback for me. I remember a strategist at Merrill Lynch in the '80s, Stan Salvigsen, did one very simple thing. He calculated the percent of consumption that baby boomers would account for in the '80s, and it looked like it was going to go up through the '80s and the '90s, and concluded that therefore, that this young workforce, as it evolved and gained more wealth, would be very good for stocks and would probably not be as beneficial for bonds, but it would be helpful for financial assets generally.

Well, Tom Lee just did that same study, and what is he studying? He's studying the echo of the baby boom, of course, and so I started my career during those 20 years. I am a baby boomer and I enjoyed that swoosh. I don't think anyone at the beginning of the '80s could have believed that would be possible.

Well, Tom has done a similar study and has concluded, based on demographics, that the market won't peak until the number of millennials peak in 2038, and he believes that the equity markets should enjoy a 20% compound annual rate of return through 2028, so the next seven years, lucky seven years."

Phil here... Holy s@!#, 20% through 2028. This, amongst many things, means that if you aren't deeply in the market starting now you'll be massively surpassed in wealth terms by those that are.

My hackles can go up when I hear this kind of thing. However, there is also a part of me that aligns to things that sound crazy but are backed by data. It can be hugely beneficial to be able to set aside preconceived notions about what is possible and think objectively.

Objectively, I'm a millennial, so are my siblings and so are my friends. Our purchasing power has dramatically increased over the past five years. Neither I nor them come from any type of money. The exact opposite. So if purchasing power has increased 10x for me and the ten people I'm closest to over the past five years, why wouldn't this be true for a large swath of my generation?

Millennials account for 24% of the US population. This is the largest generation segment. Bigger than Gen Z and Boomers.

Back to Cathie...

"Well, having watched how powerful that variable was in the '80s and '90s against all expectations, there was a lot of bearishness in the '80s, and most of it was around inflation interestingly, but he throws out some statistics...

Millennials will account for more than 50% of spending during this period from 2018 to 2028, they will account for 78% of children born, 44% of auto sales and 40% of home sales.

Now, we would argue that innovation is changing spending and that you can't use the same ... You can't assume that this is going to play out exactly the same way this time around, and especially, if we're right on autonomous vehicles, we think auto sales are going to come down. We think they peaked. Just like oil, we think they did peak in 2019, but that said, that's even more interesting because there would be more purchasing power for other goods and services.

When I was growing up, I had to prepay for my transportation in California, which did not have a very good mass transit program. Now, millennials and Gen Zers not going to have to prepay that much for transportation. They can pay as you go. We thought that was a very interesting analogy and appreciated Tom's study.

The one thing that is flying in the face of demographics to some extent is China. In the '80s, despite the one-child policy, the population was still growing. It appears that the population is peaking and that the Chinese government is somewhat concerned. This week, they announced that they were loosening up rules, that it would be okay to have up to three children. That is quite a leap, I must say, so we're very interested in that."

Crypto

Cathie Wood: "One other thing on demographics... the three areas where we believe millennials will spend and I believe Fundstrat would agree with this, is certainly stocks. Housing, yes. But of course, this demographic is very interested in crypto as well.

This week, we learned that Stablecoins had crossed $100 billion, 20 billion of which is USDC, and that's up tenfold in just one year. We also got an update that DeFi now accounts for $67 billion, roughly $70 billion of the value locked on in Ether, so that also is up at least tenfold, probably more than that.

NFTs, we're hearing a lot about that, so it seems like Ethereum is finding a lot of support. Certainly those three are built on top of Ethereum. Of course, Bitcoin is, which we still believe is the reserve currency of the crypto-asset ecosystem, understanding that Stablecoins could be giving it somewhat of a run for its money.

But we also saw through his tweets that Elon is maybe not as high on Bitcoin as he once was. We don't know. We don't know if he's sold, what he put on the balance sheet as a diversification from cash, so we have seen a little bit of indigestion from all cryptos because of this, and yet, when I look at where it is right now, it seems to be weathering well.

This Bitcoin 30 to 40,000 range seems to be a good testing zone, and frankly, I feel better that we are in the midst of a correction and everyone's doing a reality check and trying to figure out all the risks and the opportunities associated with the various cryptos.

Dogecoin is amusing. Our analyst, Yassine Elmandjra is going to be writing up some of his thoughts about why it will not become the reserve currency of the crypto-asset ecosystem, and in fact, a lot of this is based around network effect and the security of the network, which is all important when it comes to transferring large sums of value, and so our confidence in Bitcoin has not diminished at all.

Our confidence in looking at the Turkish Lira and in some of the emerging market currencies is diminishing, and I think that will continue to be a very fertile area of [cyrpto] growth with individuals diversifying into crypto assets. As well as those of us who just want insurance policies against any confiscation of wealth, whether it is inflation or something else. And as you know, we don't think inflation is the problem in this country, but if we're right, it could mean that inflation in other countries, meaning emerging markets currencies especially in unstable regimes especially, could become more of a problem."

Deflation

Cathie Wood: "We do think now we have three sources of deflation.

First, I described the cyclical one. We think commodities are going to go through a period of weakness during the next six to nine months, and it could be a period of significant weakness.

Second, we think that innovation, our innovation platforms are not only in primetime, they are all these 14 technologies underlying the five major platforms, DNA sequencing, robotics, energy storage, artificial intelligence and blockchain technology. They are moving into the sweet spots of S-curves and the convergence between and among these technologies, is going to cause some explosive growth, but is also going to cause what we call creative destruction, so the traditional world order is going to change fairly significantly, much more rapidly than we believe investors now anticipate.

Finally, we believe that the pricing power in the old world order will diminish, especially because so many companies leveraged up to satisfy short-term-oriented shareholder demands for their profits now and their dividends now as opposed to sacrificing short-term profitability to invest in innovation, so we couldn't be more excited about innovation first, but also, thinking about how the equity market is powering through all of the risks that it has faced during the last year.

I am becoming more optimistic that we're in a very strong bull market, that will once again be very good to innovation-based strategies, as well as many others."

Phil here... in summary, I've had a thought that keeps looping in my head: markets climb a wall of worry. The early summer market appears to be playing that out. While I'm still remaining somewhat cautious, compared to the past three months, I've become far more aggressive in my trading and allocation.

The only remaining concern I have is business-as-usual risk: an existential shock to the market. That's what it's going to take to unseat this bull market. Look at everything it's shrugged off the past six months.

Growth is poised for a comeback after being thoroughly trounced. Watch for Q3 earnings to come in well ahead of expectations in sweet spot areas where tech is married to the real world.