Investors Beware: Stay On The Right Side Of Change
ARK’s research suggests that the global economy has entered a period of convulsive changes, some exceptionally good and others devastating, that will shape financial markets for years to come. Thanks to seeds planted during the tech and telecom bubble more than 20 years ago, record-breaking technological changes are creating not only exponential growth opportunities but also black holes in global economies and financial markets. Staying on the right side of change will determine success and failure not only in investment portfolios but also in careers, companies, and countries.
Where are the black holes associated with technologically enabled innovation? In our view, any company not investing aggressively in one or more of five major innovation platforms and 14 technologies evolving today will lose its way. In harm’s way are companies that have spent the last 10-20 years engineering their financial results to satisfy the short-term demands of short-sighted investors. Those that have leveraged their balance sheets to buy back shares and pay dividends are at particular risk because deflation can ravage debt holders: technologically enabled innovation is deflationary. Stretching for yield, fixed income investors have enabled this behavior and, at some point, will have to pay for it.
The five innovation platforms that we believe will transform the global economy are: DNA sequencing, robotics, energy storage, artificial intelligence, and blockchain technology. These platforms involve 14 technologies including gene therapies, 3D printing, cloud computing, big data analytics, and cryptocurrencies. Importantly, they cut across economic sectors, posing problems for research efforts that are short term, siloed, and highly specialized. In our experience, most research departments in the financial world are structured in that way and have created inefficiencies to exploit as “convergences” create the new world order.
According to our research, among the siloed sectors at risk of disintermediation are energy, industrials, consumer discretionary, communications services, health care, and financial services. As autonomous transportation evolves, for example, autos, rails, and airlines are likely to capitulate to the convergence of robotics, energy storage, and artificial intelligence. Combined, they will collapse the cost structure of transportation. Traditional health care is likely to give way to the convergence of next generation DNA sequencing, artificial intelligence, and gene therapies, the combination of which should boost returns on investment significantly, creating a golden age of health care likely to rival that of the eighties and nineties. Meanwhile, traditional financial services are likely to commoditize, thanks to application programming interfaces (APIs), social platforms, and blockchain technology that will enable the convergence of business and consumer marketplaces, disintermediating the middlemen dominating today’s financial ecosystem.
The convergence between and among innovation platforms and technologies seems to be throwing economic and company forecasts for a loop, particularly in the developed world which is saddled with mature infrastructure. Broadly defined, the sectors at risk of disintermediation account for more than half of the S&P 500. Though at small bases today, in our view most of the platforms mentioned above are entering exponential growth trajectories thanks to the falling costs and increasing productivity associated with technologically enabled innovation. For example, in response to the 28% cost decline in lithium-ion batteries for every cumulative doubling in units produced globally, prices will continue to fall, “turbocharging” electric vehicle (EV) sales. According to our research, EV sales will scale 20-fold globally during the next five years, from an estimated 2 million and ~2.5% of the market this year to 40 million and ~45% in 2025. If we are right, the good news is that EVs will generate exponential growth in the auto market for the first time in 100 years. The bad news is that, just as rapidly, the more expensive gas-powered cars that dominate the market today will lose almost half of their sales base. Moreover, if transportation goes autonomous, as we believe it will, the auto market will continue to shrink as the capacity utilization per car increases.
In other words, as measured by statistics born in the industrial age when the sector was nascent, auto-related GDP will drop dramatically in the years ahead as unit sales and prices suffer, all to the benefit of consumers. Not for four to five years should the exponential growth of EV sales stabilize the industry, albeit with a new cast of characters. Meanwhile, consumers stand to benefit as the cost of transportation declines. Based on our research, as autonomous vehicle networks scale during the next five years, transportation costs will drop more than 50%, from the $.70 per mile in personal cars to $0.25.
More broadly, if our forecasts for the five innovation platforms are near the mark, nominal GDP growth in the US is likely to slow from 4.1% at an annual rate during the past five years to 2-3%, regaining momentum only after new technologies and solutions gain enough critical mass to move the economic needle. Both volume growth and inflation are likely to surprise on the low side of expectations as market share shifts to the mismeasured digital world and as the “good” deflation associated with technology takes hold. We believe the winners will win in a big way but losers, particularly those that have levered balance sheets to satisfy certain stakeholders, will unwind. While risk-free interest rates are likely to remain low, credit spreads could respond dramatically as disruptive innovation – the likes of which we have not seen since the telephone, electricity, and the automobile burst on the scene in the “Roaring Twenties” – causes significant dislocations.
So, investors beware. According to our research, innovation is evolving at such a rapid pace that traditional equity and fixed income benchmarks are being populated increasingly by so-called value traps, stocks and bonds that are “cheap” for a reason. Critical to investment success will be moving to the right side of change, avoiding industries and companies in the crosshairs of “creative destruction” and embracing those creating “disruptive innovation”… and perhaps another shot at the Roaring Twenties.