Summary
- Generative AI takes center stage as ARK Invest released its "Big Ideas 2023" research piece.
- ARKK has outperformed the S&P 500 recently, as AI-mania could surpass even the feverish Web3 excitement of 2021.
- Will ARKK seize the moment and bounce back from its two-year slump, capitalizing on the ChatGPT buzz?
ARK Invest CEO/CIO Cathie Wood's flagship ETF: ARK Innovation ETF ( ARKK ), has recovered significantly from its late December lows as risk-on behavior returned to the market.
Fed Chair Jerome Powell & his FOMC colleagues delivered an anticipated 25 bps hike at its meeting yesterday (February 1), lifting the Fed funds rate (FFR) to between 4.5% and 4.75%.
Despite Powell's still-hawkish commentary, as he suggested " a couple more " hikes are still needed, the market doesn't seem to be buying it. Instead, the interest rate swaps market has priced in a peak FFR of 4.9% (expecting one more hike) and expecting a Fed pivot in H2'23.
As such, the market has carried on its remarkable rally from January, as the SPX recovered more than 10% from its December lows to this week's highs.
Therefore, ARKK's recent outperformance (up nearly 45% from December lows) against the SPX from its December lows, as seen above, shouldn't be surprising.
But, within a longer-term timeframe, ARKK's underperformance against the SPX since its highs in February 2021 has been nothing short of a disaster for its investors.
Price action investors might even consider the recent surge as a mere "bear market rally" or mean reversion against a dominant downtrend against the SPX.
Possible? Yes, if the Fed remains hawkish for longer. However, the recent outperformance in consumer discretionary and homebuilders stocks suggests that the market seems convinced about a less hawkish (even if not dovish yet) Fed in H1.
The crunch time will likely come in March when the Fed updates its summary of economic projections ((SEP)) on whether it still anticipates maintaining its 5.1% FFR target exiting 2023.
However, the risk-on behavior has also driven global equity markets out of their bear market momentum, which could augur constructively for forward returns.
Whether ARKK could carry on its outperformance against the SPX might depend on how much more hype it could generate, reversing the momentum of its two-year underperformance.
Hence, investors shouldn't be surprised that ARK Invest's recently released " ARK's Big Ideas 2023 " featured Generative AI as its headline, undergirding this year's update.
Why? Thanks to the rapid adoption through the public preview of OpenAI's ChatGPT, Generative AI is the new buzzword driving hype from the US equity markets to China.
Hence, it would be "remiss" for ARK not to mention Generative AI in its annual research public release, which is fundamental to the underlying themes of the fund manager's research.
As a reminder, ARK believes that "five innovation platforms are converging to create unprecedented growth trajectories," with AI as the "most important catalyst." Notably, it believes that by 2030, "the market value of disruptive innovation could represent the majority of the global equity market capitalization."
With that in mind, it's pretty clear that investing in ARKK is not for the faint-hearted or investors who don't have a firm conviction in Cathie Wood's & team's ideas. Why? Because ARK also cautioned:
Companies that ARK believes are capitalizing on disruptive innovation and developing technologies to displace older technologies or create new markets may not in fact do so. - ARK's Big Ideas 2023
Keen investors should note that AI has always been an underlying theme underpinning ARK's thesis (but not necessarily profitability). With Microsoft ( MSFT ) investing a further $10B in OpenAI recently at a reported 100x projected revenue, it has also driven risk-on bets, as seen in the surge in ARKK.
ARK accentuated that the companies within its portfolio have a strong "proprietary AI" foundation, enabling them to capitalize on their data edge.
Why? Because ARK believes that over time, the cost of training complex AI models will drive down AI training costs by "70% at an annual rate through 2030."
As a result, the "limiting factor will be data," specifically proprietary data, allowing companies that can leverage such data to significant competitive advantage, including Tesla ( TSLA ). Sounds familiar?
Despite a relatively poor performance in a recent survey on its ADAS, Tesla bulls, and bears can argue whether its FSD can reach its full potential all day. Baidu ( BIDU ), China's leading autonomous driving company, believes that L4 autonomous driving could come sooner than the market thinks.
CEO Robin Li highlighted that deep learning could have more widespread implications for society and " would be the fourth technological revolution," bringing "greater efficiency and economic growth than imagined."
Tesla investors should recall in its recent earnings call, management highlighted how Tesla Insurance had improved its design process and software to reduce repair costs. It has also lifted customer satisfaction while also lowering the cost of ownership. Therefore, as it continues to scale, Tesla will likely gain even more significant insights into the data, lifting its edge over its rivals while raising the industry's profitability bar even higher.
Li's comments also brought us back to Microsoft CEO Satya Nadella's recent interview with the WSJ at Davos 2023, when he accentuated how Generative AI could be the "knowledge worker's equivalent of the industrial revolution."
So, is this hype real? We think the potential for advanced AI models could be enormous. But whether they could lead to sustainable profitability and moat is still too early to tell, as ARK also cautioned.
Innovation is complex, but the hype does seem more real than the Web3 hype in 2021. With ARKK's companies in the early stages of their profitability ramp, we believe the hype is critical to lifting investors' sentiments. But, investors still need to separate hype from reality , as many AI-first companies might not move successfully to commercialization.
However, this hype could prove more sustainable as "the demos are unbelievable in AI." Respected strategist Edward Yardeni also articulated:
We've been tracking the rollout of robots and artificial intelligence for years and see more industries than ever using robots to work smarter and more effectively, with increased efficiency, productivity, and agility. - Yardeni Research's February 2 briefing
Can ARKK turn it around this time? We think its December lows could represent the ultimate lows for Cathie Wood's flagship fund. But, keen investors are encouraged to wait for a pullback first, as consolidation seems overdue.
Rating: Hold (Revise from Speculative Buy).
For further details see:
ARKK Needs To Turn AI Hype Into Profitability