• Cathie Wood’s Ark Invest was hit by its biggest outflow on record last week amid a bond sell-off.
  • Skeptics zeroed in on Ark’s concentration and liquidity risks as Wood’s major stock bets flopped.
  • In a webinar on Friday, Wood explained why she was unfazed by the three big worries in the market.

When rising bond yields hit high-growth tech stocks last week, Cathie Wood’s Ark Invest was the subject of scrutiny. 

Analysts dissected the holdings of her largest funds and raised issues of concentration and liquidity risks. Investors withdrew money, cutting the assets of the Ark Innovation ETF (ARKK) by almost $5 billion to $23.5 billion as of Monday, according to Morningstar data. 

Amid the market turmoil, ARKK’s performance was dragged by a slump in top holdings including its biggest bet, Tesla. The fund declined 14.55% last week, the Morningstar data shows. However, investors poured $464 million into the fund Friday, the second-biggest inflow according to Bloomberg, ahead of a marketwide rebound this week.

Wood was not only unfazed, having bought the dip on Tesla during the correction, but also apparently had a “very comfortable” week as her long-held views on the bond market and ETF liquidity played out in real-time. 

"The volatility in the bond market is beginning to outpace that in the equity market," Wood said in a Friday "In The Know" webinar. "And I think one reason for that is bonds have been in a bubble and the search for yield became extreme," she said.

She added that short-term traders have been placing record bets against the bond market and there was simply "too much bearishness out there."

As for the equities market, despite the pressure of rising interest rates on long-duration growth stocks and the continued rotation into value and cyclical stocks, Wood believes that the bull market is alive and well. 

"... the bull market is broadening out to other sectors and that can only be a good thing for us," she said. "What would be very negative for innovation-based strategies is if the market continued to narrow so that only innovation strategies worked because that's what happened during the tech and telecom bubble."

Walls of worries in the market 

Still, investors have to climb the walls of worries over whether Ark can sustain its head-turning success last year, so Wood sought to address the three biggest worries that she saw in the market. 

She dived into the crypto space first given the wild swings of bitcoin last week after Treasury Secretary Janet Yellen called bitcoin an "extremely inefficient way of conducting transactions" and warned investors of the potential losses from trading the "highly speculative asset."

"She doesn't understand the crypto space. And I say this with all due respect, I just don't think it is what she does," Wood said. "She's responding to a movement in price, that I understand, which has been very rapid."

Bitcoin surged from $20,000 in mid-December last year to as high as $58,000 in February before dropping back to just over $49,000 on Monday.

Contrary to common beliefs, Wood said the energy used to mine bitcoin is actually just a fraction of the energy needed to mine gold, according to Ark's research. 

On a broader scale, Wood said the bitcoin blockchain and other blockchains are going to enable much more rapid settlement of trades and transactions than the traditional financial institutions. 

"Think about the energy consumption of the traditional financial world," she said. "What bitcoin is using in terms of energy right now, which is mostly renewable, hardly measures up at all to that."

Another worry is the impact of rising interest rates on price-to-earnings ratios, which is believed to be what drove down high-multiple stocks last week. 

Wood said she observed that as inflation and interest rates continued to fall over the past decade, S&P multiples tended to hit a ceiling somewhere in the 20 to 25 times multiple range. That meant the market corrected every time multiples hit that range.

However, she believes that the structural growth in the economy has slipped from the 4% to 5% range to somewhere between the 2% to 3% range. If investors bake in this normalized growth rate instead, there should be "serious valuation support" especially for companies that are able to grow rapidly over the next few years, she said.

ETF liquidity concerns 

Wood has also seen a lot of worries over liquidity in the ETF space. 

Specifically, analysts have raised concerns over Ark ETFs' outsized ownerships of a number of small-cap companies whose shares are fairly illiquid and could be hard to exit if and when investors redeem in droves. 

To counter that, Wood invoked the liquidity of bond ETFs during the 2008-2009 bond crisis during which bond ETFs were providing liquidity even though the underlying bond market stopped functioning.

"There were a lot of investors [who were] very fearful and just wanted to get their money out of bond funds," she said. "And the only liquidity provider out there during that time were the market makers and authorized participants in the ETF space who made markets."

The fact that bond ETFs provided price discovery at a time when the underlying bonds were not even trading should help alleviate investors' liquidity concerns, Wood said, because the equity world is much more liquid in comparison. 

"A portfolio manager in the ETF space does not have to worry about flows. It's the market makers, the authorized participants; it is the ETF ecosystem that is accommodating the activity," she said. "I'm just making investment decisions."

What happens after the tech rout

Markets recovered quickly on Monday, with the S&P and Nasdaq rallying up 2.38% and 2.89%, respectively. 

Over the long-term, Wood still sees major deflationary forces evolving in the global economy despite the broader market view that massive global monetary policy ease is going to ignite inflation. 

She believes that this inflation-centric point of view is going to be "in a dueling match with the two deflationary forces," which are good deflation and bad deflation. 

"The good deflation has to do with technologically enabled innovation. It is deflationary by nature," she said. "It rides down cost curves, gains efficiency, gains productivity."

The "bad deflation" is associated with companies that have leveraged up to buy back their shares and pay dividends, Wood said, pointing to IBM and General Electric as two of the examples. 

"What's going to happen now, we believe, is they are going to be forced to cut prices in order to service their debt," she said. 

Wood said these two "powerful deflationary forces" were what have kept inflation at bay since the 2008-2009 financial crisis and are likely to continue doing so against the inflationary forces brought on by global monetary easing.