Facing Down the Bull Market: Why ARK Believes the “Fearless Girl” Should Run with the Bull
To honor International Women’s Day earlier this month, Boston-based State Street commissioned a sculpture of a “Fearless Girl” to stand in front of Wall Street’s famed bull. State Street’s intention was honorable, as it highlighted the superior stock performance of companies with well-diversified boards and advocated for the appointment of more women to corporate boards.
The day before International Women’s Day, one of my daughters texted me the picture of the “Fearless Girl” saying, “Hey, Mom, that’s you!” At first glance, I loved the picture and told her that I was very proud of the women (and men) at ARK Invest who are leaning against conventional wisdom and investing in the future, as opposed to those looking to the past and mimicking or gaming benchmarks.
Taking a closer look at the “Fearless Girl”, I came away with two questions. First, if the purpose of the sculpture was to encourage companies to add more women to their boards, why did State Street commission a sculpture of an 8-12 year old girl? Perhaps more important, why was that seemingly fearless or defiant girl facing down the bull, the symbol of a strong stock market? Given today’s investment backdrop, wouldn’t investors be on the same side of the bull, facing down the bears?
In our view, the sculpture and the overwhelmingly positive reaction to it in the investment community speaks volumes about today’s psychology. The wall of worry that the equity markets have scaled since 2008-09 is still in place. During the last 18 months alone, the S&P 500 has appreciated roughly 25% and the MSCI 16%, overcoming fears associated with tighter monetary policy in the US, collapsing oil prices, major structural and cyclical imbalances in China, earnings erosion, Brexit, and the US elections. Now that those worries have dissipated, the focus has shifted to the high valuation of equities and the ability of President Trump to deliver health care and tax reform. Is the Fearless Girl willing to face down the bull because she believes that its time is up? Is hers a voice of reason and common sense in a world of cock-eyed optimists?
Contrary to those voicing such fears, the bull market has broadened out and gathered momentum during the last six to nine months. Having suffered for a number of years, value stocks shot up in the aftermath of the election, with financials leading the way. Had the market’s move toward a narrower group of yield-oriented and defensive stocks continued, its health and longevity would have been called into question. Instead, it began to discount an acceleration in economic activity and profit growth thanks to the prospects for tax and health care reform, deregulation, and infrastructure spending. If the Fearless Girl is not careful, that bull is going to mow her down!
The new bricks in the wall of worry are the valuation of the US equity market and the political risks to health care and tax reform. To some extent these risks are related. If Congress passes the first phase of health care reform, then the odds of a corporate tax rate dropping to 15-20% as part of the budget reconciliation process likely will increase meaningfully. For that reason alone, after-tax earnings could jump roughly 25-30%, pushing the S&P 500’s price-earnings (PE) ratio for 2017 down from 19X to a much more reasonable 14-16X…which could be just the beginning of the revaluation of the market. If the tax package also includes full expensing of capital goods in the year of purchase, then capital spending – which has a high multiplier on economic activity – should surge in a sustained way for the first time in more than five years. The earnings surprise to the upside could be substantial, perhaps driving the market’s PE ratio down into the low double digits. If Congress gravitates toward positive votes on health care and tax reform, the Fearless Girl should start running now, given the red light she seems to be shining on the bull market.
Another important spur to the bull market could be a peak in the inflation rate, despite surprising strength in the economy. Three forces against inflation seem to be brewing. First, statistically, commodity prices have set various gauges of inflation up for a fall. The oil price, for example, bottomed during the first quarter of last year and is now up by more than 40%, probably its peak inflation rate for the year. Second, increased capital expenditures should boost productivity, as should more rapid growth in economic activity. Productivity, which seems to have been missing in action for the last five years, is a powerful force against inflation. Finally, thanks to the five technologically enabled innovation platforms that are the starting points for ARK Invest’s research, deflationary forces are seeping into every economic sector. These platforms are genomic sequencing, robotics and automation, energy storage, next generation internet, and blockchain technology. If inflation were to stay below 2% on a sustained basis, the equity market probably would experience a multiple revaluation the likes of which we have not seen since the eighties, in which case the bull would trample any bear in its way. Instead of facing down the bull, perhaps the Fearless Girl should be running with the bull!
Catherine D. Wood