12-15-2021: Planes, Trains and Automobiles
(A Brief History of Disruptive Technologies)
We’ve heard a lot over the past 2 years about Cathie Wood and her ARK Invest strategies. Her investment thesis is to find “disruptive innovation” which her team defines as “the introduction of a technologically enabled product or service that potentially changes the way the world works.” Her flagship ARK Innovation ETF (ARKK) was the darling of the markets last year, and has been rudely thrown to the curb this year. It’s currently down almost 25% for the year and down over 40% from its high this year.
What’s the problem? How did she go from the smartest investor on Wall Street to underperforming the market by almost 50%?
While she may still be one of the sharpest knives in the drawer, nobody knows what will happen in the future. But to answer the above question, let’s look at a little history.
With apologies to Steve Martin and John Candy, their movie (Trains, Planes and Automobiles) from almost 35 years ago could have been about “disruptive technologies” that lost a lot of people a lot of money.
After the Civil War, railroads were the hottest technology in the history of mankind. We could connect markets and move goods and people at speeds never seen before. The stagecoach and wagon trains were a thing of the past. In the 1870s, there were over 350 different railroad companies…. and almost half of them went bankrupt by the end of that decade. J.P. Morgan, Cornelius Vanderbilt, Jay Gould and James Hill are just a few of the names that were responsible for consolidating the railroads (while bankrupting the smaller companies), with 2/3 of the rail lines being controlled by just six companies.
Then, after the turn of the century, the automobile became the newest disruptive technology. Cars gave individual workers and the growing middle class freedom that had never been experienced. Of course, everyone had to have one. By the 1920s, there were more than 1000 automobile manufacturers in the US alone. Most were wiped out by the Great Depression. Today, there are just a handful of companies operating, with Tesla being the first new automobile company in decades to build cars in the US.
The airlines were next in line to prove disruptive to the status quo. As with the railroads and autos, there have been many airlines appear and go bankrupt. Warren Buffett wrote in his 2007 letter, “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down. The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.”
Here in Austin, we saw the 1990s growth of Dell Computers which was one of the most successful computer manufacturing companies ever. Throughout most of the decade, the stock traded at a high P/E multiple and the stock price soared. However, when Wall Street realized that building computers was not much different from farming, the multiples contracted dramatically, causing the stock price to plummet even though the company was making more money than ever.
Take a look at the P/E ratios of the top 10 holdings in the ARKK ETF and the S&P 500.
Half of the stocks that make up ARKK have a P/E of “N/A”. That means they have a negative P/E. They don’t currently make any money. Eventually, they’re going to have to prove themselves by turning a profit. People won’t invest in a company forever if it’s not going to make money. We’ve seen that time and again.
No matter what the disruptive technology might be, it will eventually be eclipsed by another newer disruptive technology. In the case of ARKK and other similar funds, this doesn’t mean there aren’t potentially some great new companies that will become household names over the upcoming decades, but they won’t be able to trade at a high P/E forever.
As an investor, it’s exciting to invest in the latest, newest, brightest and shiniest stocks. But remember, every new technology becomes a commodity. And the stock prices will ultimately reflect the commodity valuation. Nobody knows when it will happen, but when it does, the fall will be swift and hard. That’s why I always have an exit strategy for every stock because the last thing I want to be disrupted is the value of my investment portfolio.
While the Warren Buffett’s, Cathie Woods, and many, many others depend on guessing right about the future, I take a different path and it’s one my clients believe in, as well. The path I am on does not depend on guessing right about this or that next innovation. In fact, it doesn’t depend on guessing right about the future market or the future price of any stock or ETF. I have not been fooled by the Siren song of the promise of a future, when in reality, the future is a complete unknown. Here are the facts:
No one knows if a stock, ETF, technology, commodity or new innovation will be worth more in the future than it is today; indeed, it could be worth a lot less.
The current pricing trend of any stock, ETF or Index will continue on its current trend exactly until it doesn’t.
The key to making serious, life-changing money in the stock market is not WHAT you own as much as WHEN you own it; and, more importantly, WHEN you don’t.
Shares of any tradable security are just pieces of paper. I want to own those pieces of paper as long as “the market” has an increasing demand for those pieces of paper. As long as that demand is growing the price of those shares is growing. When the demand shrinks, the price shrinks. I have developed a methodology that focuses on measuring the demand (via trend-lines) to determine upward or downward slope of the trend(s). When the trends are moving from lower-left to upper-right, I want to hold on to those shares. When the trends flatten, I sell those shares and move safely to cash. When the trends turn bearish (particularly in shares of major indexes), I switch to inverse ETFs that are designed to move up as indexes move down.
This is a simple concept, but it is non-trivial to manage. You have to be willing (and I am) to let the trends tell you when to act (buy, sell, hold) and not let your emotions, hopes, ego, opinions, talking heads, etc. sway you into holding onto a down-trending equity.
I had a client say this to me, just yesterday: “Mike, I will never forget the day I heard you speaking to a large audience at the MoneyShow. You said something that I had never heard before and it stunned me. Someone from the audience asked you what you thought the market was going to do next year and you said, “I don’t care.” I wondered how you could not care when everyone else was trying to tell us what they thought would happen to the market in the next year. Then, after talking with you and reading your books, I realized that none of us have to care about the future of the market or the stocks that we own; we only need to care about when the pricing trends move from bullish to neutral to bearish. And, now I know that can all be measured and not have to guess about the future.”
If you are not a client of mine and want to get away from guessing about your stock market investing, give me a call. Think about this… My clients actually look forward to a bear market. Do you?