Transcript
0:00 Greetings everyone. This is Kathy Wood, CEO and CIO of Arc Invest. It is employment Friday. but there's no employment report. we will have that next week. But given all of the fireworks in the market and all the drama recently, I felt it was important to to do in the no or at least on the in the know part one today just to address the the three topics that we think have really unnerved the markets. AI hype, crypto meltdown, and macro macro statistics, but more macro variables like Fedspeak. so let's go through each one of those. and we'll start with the AI hype. So you can see from this first chart here what our predictions in December of 2024 were for really the tech stack as AI was evolving. and you can see here that we saw rapid growth in all three areas of the tech stack. So the infrastructure layer, the platform layer and the application layer. that was true in the four years ended or five years ended 24 and our expectations for the next five to six years. Now what we also pointed out below is that there were share shifts taking place place in terms of incremental growth among these three. and you can see that the big winner was platform as a service think Palunteer one of the most important companies in this AI revolution.
2:00 and its growth rate US commercial alone last quarter was 142% in revenue growth. no other software company is coming close to that at least in the public equity markets. In the in the private markets of course you've got the frontier model players running away with 250 to 850% growth rates. think open AI and and anthropic in the last year year and a half annualized you can see the big loser we thought was going to be the application layer largely software as a service now if there's something wrong with this chart you can see it is in our projection for software as a service going forward on the top there 20% plus it's not going to be anything like that. In fact, we do believe that software as a service is becoming a victim of this AI revolution. There will be consolidators and and software as a service providers who do survive this route.
3:15 They will consolidate the market. but we we underestimated ourselves. We were saying they that SAS was going to lose share. We didn't realize how much how soon and that G gives you a sense of how quickly this revolution is happening. 142% for Palunteer US commercial in one quarter. we didn't expect that either. In fact, our kagger our compound annual rate of revenue growth assumption which we thought was enormous at the time for the next five years for Palunteer itself is 55%.
3:59 That could be wrong too. Maybe it's too low. so here we are. Okay. Next what about all of these capital spending announcements from the hyperscalers especially? This is unnerving. the the the mag six or investors holding the mag six these investors many of them benchmark sensitive. What does that mean for people who who don't understand what that means? the market since the tech and telecom bust and so that was the early 2000s and the 0809 meltdown has become much more quantitatively driven which means that many portfolios are guided heavily by the indexes out there. Now to give you a sense of that Amazon and Nvidia in the NASDAQ 100 are in the 3 to 4% range in terms of the holdings and what benchmark sensitivity means is portfolio managers will say okay I am betting against let's just say Nvidia for argument sake Nvidia I think is at a 3.4% position in the NASDAQ 100.
5:34 and so those portfolio managers will take their position down from maybe they were optimistic on Nvidia and they were at 3.8. Well, they'll take it down to three. And to them that's betting against Nvidia. and and to them that's also taking a big risk because they're being compared against other managers who are doing much the same thing. as you know Arc Invest doesn't think that way at all. we are focused on the future and we're very focused on pure plays not that I mean we do hold both Nvidia and and Meta in our funds but for the most part certainly in our our flagship strategy we're well below that weight well below in the one to one and a half% range just to give you an example of how how portfolio management has evolved over the years in the traditional asset management world.
6:44 so I think that the shareholder base holding the mag six, they have gotten so used to cash hordes and massive key free cash flow generation that this is a big shock to them seeing these hyperscalers take their capital spending budgets up 100% in one year. I think Amazon announced it would go from roughly 90 billion to 180 billion next year or this year 2026. That's shocking to people and we're seeing some of the mag six raising debt even that has been anathema to this group. so we do think we we're seeing a a shareholder turnover.
7:42 not massive because of what I just described about benchmarks but we don't think necessarily that they are doing the wrong things meaning the hyperscalers we think Google is doing the right thing and all of the Amazon all of this spending we think is the right thing to do but this is not what traditional portfolio managers who are benchmark sensitive are used to grappling with. we grapple with it all the time. But here you can see what we this we put in our big ideas 2026.
8:25 you can see and what we're trying to illustrate here is investment in data center systems. Now, I know you've probably seen the $650 billion spending, capital spending boom that newspapers are highlighting. that includes much more than data center systems. So, just want to make that clear. So you can see here that data center system spending growth was really mids single digits at an annualized rate for many years and it and it kind of stayed in the 100 to200 billion range until the chat GBPT moment and since then you've seen a compound annual rate of growth in at 29% % I think with the announcements today 100% in one year we're moving into overdrive. Now you can see from our forecast that we've been expecting a 30% compound annual rate of increases since 23.
9:39 And I think if we were to push this forward to 25 now and do a five-year kagger, it would be in the 25% range. so these recent announcements certainly are proving this forecast right. And then you can see just to throw in another perspective here, we also see that the chip market is is going to transform or evolve I should say in the next five years a little bit from e GPUs taking share to AS6 t taking share. And so, we've, highlighted that there could be a shift from the likes of Nvidia's chips, AMD's chips, to Broadcom's chips. now, we think that there's going to be a massive appetite for all chips. but did want to highlight this share shift as well.
10:49 much like we highlighted the shift to away from SAS toward platform as a service. now this spending is it justified? This chart Brett Winton our chief futurist prepared for big ideas 2026. it highlights the technology revolution investment cycles here and you can see the railroad in the 1800s.
11:21 Railroad spending as capital spending as a percent of GDP got into that five to six% range. then you go to the automobile in red there. but we have multiple flat platforms evolving at the same time and this is additive. So maybe with telephone, electricity and the automobile we would see capital spending up at that cumulatively up at that five to six% range. and then you get to the internet, the tech and telecom boom, and you can see it looks like it pales in comparison to those other two. but we do have an additive, situation going on here. and you can see that adding all of those together is maybe the equivalent of just the automobile cycle in the early 1900s.
12:27 And then here we are and we we believe the these are our forecasts and they have been our forecasts and we haven't changed our forecast in the last year. but we've got something additive going on here as well. that could accumulate to 12% or more of GDP. Now just to give you a sense of or some perspective I remember in the bubble te te telecom equipment spending on the part of some providers got up to 25% of GDP and as I always say too much too soon and and we ended up with a lot of dark fiber it didn't go live for a very long time. One thing we can say about this cycle is the demand for GPUs is voracious and they are landing in these data centers which are saying we need more capacity, we need more chips. those GPUs are not dark. and I'm stealing that from Brad Gersonner at Altimter.
13:50 I thought that was a very good analogy. The fiber went dark. GPUs are alive and there's a big scramble for them. Now, the risk here is, and you know, I have an economics background and I'm always looking for those risks. Whenever I hear the word shortage, I usually, believe that there's going to be a glut, an inventory glut at some point. And I'm sure there will be in the chip space. but I don't think it's going to be for a long time. you need to listen to Elon Musk who's talking about chips and power as you know for as far as the eye can see u being in short supply and now that he's thinking about putting data centers into space perhaps even more so.
14:50 So on this next chart, this this is getting to investors. so you can see on the left here the the tech sector capital spending as a percent of GDP and you can see that it has gotten up to be bubble days. and that's a little bit unnerving to investors. And here's why. Many of the most seasoned investors today were very young when the Tekken telecom bubble took off and now they are the gray hairs. and I'm friends with a lot of them. and many of them are saying been there done that I'm leading this organization now and I'm going to protect it from this bubble and we understand that but as I just described we have really just started this journey and we expect the capital spending cycle to go much further for much longer.
16:06 and the reason is the technologies are ready. You know back in the '9s we didn't get the cloud even until 2006. but there were visions of you know eyeballs in 10 years being the source of valuation today. we didn't get the cloud till or or back then. We didn't get the cloud until ' 06.
16:38 We didn't get the first big breakthrough in AI until deep learning imageet in 2012. Even bigger and more profound transformer architecture in 2017. And even off of that, we didn't get chat GBT, the aha moment until the end of 22, early 23. So we have just begun this journey. now one other difference very important you can see from this chart is the valuations today are much different than they were at the peak of the bubble.
17:17 so the dash line there you can see are that is the valuation of the mag six. and you can see how crazy the valuations did get at a time when the technologies weren't ready and the costs were too high. so the multiples being paid today are nothing like back then and in fact since this chart was done the multiples have dropped even lower because it is the mag six and and fears around what are they doing with all of this capital spending return on invested capital is going to go down that's why I own this stock and that's why a lot of quants or quantitative research is a little bit I would say a little dangerous here because a lot of it's momentumdriven and here we are there's a great disruption taking place called AI and these companies must invest in it if they want to remain relevant and they must seize the moment but short-term oriented shareholders don't really want to hear that.
18:31 So on this next chart, we're heading into crypto. and we'll loop back to AI at the very end. crypto here I think the disconnect and this is also from big ideas. is hey look at what the gold price has done in the last few years and look at what's happened to Bitcoin. now this is a log chart. So, you can see, gold has had a massive move to the upside. this chart ends in at the end of 25. And of course, I think last night we got down to roughly $60,000 in in Bitcoin.
19:14 So, really cut in half since its peak in October. What is going on here? Isn't Bitcoin supposed to be digital gold? If it's digital gold, why isn't it behaving like gold? and a couple of points to make here. If you do the correlation between Bitcoin and gold, their returns, since 2019, and and I put this in, my New Year's letter. You can see the matrix there if you'd like. the correlation has been 0.14.
19:55 one is perfect correlation. and here we are at 0.14 very low almost no correlation. so that is very important to understand. what you can also see here though is gold tends to precede a big move in bit in Bitcoin. you can see the circles there and we'd have a gigantic circle around what has happened recently. and and so maybe that will happen again. we actually think it will. I cannot tell you how many bare stories I've heard about Bitcoin in in the last few weeks last few months and just go on to X and you'll find all kinds of reasons why you must sell Bitcoin and these are the the periods that are kind of interesting. we post our trading at the end of every day and you'll say you'll see that we had been nibbling at our our cryptoexposed stocks. We didn't know how far this was going to go and maybe it's not over. Not promising that but there was so much negative sentiment that I I felt okay you know we need to leg in and lean into this if our research is correct. that this this Bitcoin is three revolutions in one. It's a global digital private very important rules-based even more important monetary system. and that's a very big idea.
21:45 the second revolution is it is a technology. It's a a new technology. It's it's really adding another layer I would say to the internet so that we have native currencies native to the internet that will be able to handle agentic commerce and other other such agentic movements taking place out there.
22:16 that's a very big idea and then and it won't be of course just Bitcoin it'll be ether importantly ether Salana maybe hyperlquid we shall see but what's interesting about this period is the big three have been identified and those are bitcoin ether and salana you know the worry historically has How many of these things are there going to be? Is this going to be a very fragmented situation? and we're learning we we're learning who the big winners are are going to be, who the big winners are. and I think that's a very important. And then the third revolution is this is a new asset class.
23:07 Bitcoin is leading the way. It is the mo most secure of all the crypto currencies out there backed by the largest computer network in the world. and so really an anchor to an asset allocator looking to move into this new world. And why would an asset allocator do that? Well, if we're right and well, the it's a fact that at least over the last five years, the correlations have been the correlation has been as low as 0.14.
23:44 the key to successful diversification for asset allocators is adding new assets with very low correlation to all of the other assets in the ecosystem. and this one qualifies. why do they want that? It is because with that low correlation introducing it risk adjusted returns go up over time. and so I do think institutions are serious about this new asset class. They may have been reticent to move in because they were hearing about the four-year cycle, the four-year cycle. And lo and behold, and I'll I'll hats off to Chris Berniski, who has been very right in in calling for whether it's the four-year cycle or whatever just this downdraft. and so it's close to it's closing in on the low point that many technical analysts are suggesting as the place where it should stop. these the these are very volatile moments at at at or near the bottom. but we usually do look back and say, "Wow, I wish I had caught that low. This V-shaped recovery has been quite significant. Not promising. I want to make I want to make sure that there are no promises here. but it does seem like the stars are aligning. and I guess I'll move on to the next one. So what has been the biggest bugaboo in as it relates to Bitcoin or the worry that we've heard about more than anything else in the last few weeks? Because it's all about quantum computing. The last few weeks have been you know lots of stories about quantum computing and I would say the the large shift in Bitcoin the OGs selling or just shifting wallets to more quantum resistant wallets. so I think that's really caused a lot of concern and here's Michael Sailor's answer or I mean he was very reasonable last night in his discussion around quantum. He doesn't think it's going to be an issue for 10 years or more. but he said, "Here's what we're doing in terms of our commitment to Bitcoin security." and and so you can see some of those those moves now. But I also wanted to show our research. Again, this is out of big ideas. and this is when the quantum controversy had quieted down last year as it relates to Bitcoin. so Brett Winton in as chief futurist has has a a a big focus on quantum because we can't miss the next big thing. It's all we do is disruptive innovation. And here I thought was a compelling analysis based on what has happened with quantum computing so far. And you and Google really leading the charge that little black line on that chart.
27:42 So you can see that it has been able to double the number of cubits over four years which is slower than Moors law in the semiconductor space and of course there there is an error rate consideration lowering that as well over four years. so if if Google does not pick up speed, the red line tells you how long it will take Google to and and quantum computing to really threaten Bitcoin, the Bitcoin blockchain as we know it now. so we go into the60s there. Now, if you make the assumption that Google is going to pick up the pace, and that's an interesting assumption because typically we learn a lot in the early years of a new technology, you know, how how quickly are the units increasing and driving costs down? That's the learning curve associated with new technologies. but let's assume it assume it does pick up the pace doubles the pace to Moore's law. Okay, then we have a problem in the mid40s.
29:05 so I don't want to make light of it. I do think it has caused movement among of Bitcoin between wallets between and among wallets. Are they leaving the crypto ecosystem? Some say yes. Maybe they're diversifying into other crypto assets as as the DeFi ecosystem evolves here. I don't know how likely that is because these are Bitcoin OGs. They've been there forever and so we'll see. maybe they're diversifying because they were hodddlers and now they're 10 15 years older and they have families and you know their risk profiles have gone down.
29:57 they should they should diversify. Any financial advisor would say so. we'll find out. but I thought Brett added some good perspective here. now going into economics and again I'll I'll whip through this last part because I'll do a a more in depth in the note next week when the employment numbers do come out. So here you can see the liquidity index. this is Dan Rodriguez's chart and you'll can you'll see liquidity dropped to dropped to a low level in November. Why was that? It was the government shutdown and we thought okay this is going to be shortterm liquidity will pick back up and the market will will take off again and that is what happened.
30:55 but recently you can see that it is back down and what's happening there? Well, we had the threat of the shutdown and now we actually have the shutdown, partial shutdown. and in midFebruary, I think it's I think it might be February 14th, there's going to be a vote around the Department of Homeland Security's budgeting and you know, it may shut down more completely then. So, I do think there is somewhat of a liquidity drain. And then the other thing that's happening is the the Fed was supposed to stop quantitative tightening in early December and it and it did for the most part. but its provision of liquidity to the system is lower than many analysts expected. in recent days in recent days it has started to pick up. You're seeing some of that now. and I do think the Fed and the Treasury are beginning to respond to what has happened to the financial markets. This administration does think does believe that the financial markets provide important signals and so they are probably assessing the liquidity liquidity conditions out there and and moving accordingly. So I do think this one is probably moving in the other direction.
32:30 here you go. you've seen this chart many times. Metals to gold. we've learned something very important and I'll spend more time on this in next week. but what surprised me and this is up to date up to date is with the fall off in gold recently that the metals to gold ratio has not picked up. That is really surprising to us. we've learned in recent weeks why the treasury yield has been levitated.
33:07 this very tight correlation between the metals to gold ratio and the Treasury yield broke down starting with the Fed tightening and you know it's still gaping wide. we're learning and believing more and more that this is the yen carry trade unwind. What are they doing? Selling treasuries and buying Japanese bonds. Why? because Japanese interest rates have gone up and so the the US Treasury bill is less of a less less interesting. It's still above the short-term rates in Japan, but less so much less so actually and could continue in that direction if the current prime minister I is she just called a snap election. and I think it's for this weekend. And if she gets a a large majority, larger majority, she will amp fiscal spending even higher and that will probably take their interest rates higher.
34:15 nonetheless, the purple side is puzzling. I think it has to do with deflation coming out of China and impacting the global ecosystem. Sure, we've seen some metals go up, but this ratio going down even further as gold goes down is most surprising here. I just want to go through I I presented this chart at the last in the no. So we'll we'll just give you a sense of how crazy it got a couple of weeks ago. gold going parabolic as a percent of M2 and many people pushed back on our use of US M2. You can't get global M2 back into the 20s and the US still is the reserve currency. I don't think the message would be much different with a global M2. so you can see it hit an all-time high, higher than the Great Depression at 1.6 6 versus 1.76 versus 1.71 in the Great Great Depression in the 20s. Today it's at 1.54.
35:28 So we do think the bloom is off the rose, but it's still at very extended levels. and we wouldn't be surprised if gold continued to come down to Bitcoin's benefit. We shall see. And also I think Bitcoin has been hurt by all of the funds flowing into AI that became the interesting investment opportunity and that one is has become a little shaky. So I think you know these three gold AI and Bitcoin are interrelated in that way. Now, gold is a hedge against inflation. Look what trueflation is telling us. it's telling us inflation is resolving to the downside. It is not moving up. and there are a few things going on.
36:25 gasoline prices until very recently, maybe housing prices, and that's going to continue as rents come down. and even potato chips, Pepsi, Fredo, Doritos cutting prices 15%. And hims and hers although the FTC or no it's yes I think the FTC is going after them cutting the price of GLP1s to 40 I think at $49.
36:59 whereas I think Novon Nordisk has cut its entry price or introductory price to $149 and then it's going to move them up to $199. These this is deflation. This is deflation. and we we're going to see a lot more of it. We believe unemployment rate. and of course all of this is is trying to figure out, okay, what's the Fed going to say next? I was very surprised that Federal U Federal Reserve Governor Bostik said employment is very strong and he's looking at the overall unemployment rate and when you have 1.3 million baby boomers leaving per year you know the overall unemployment rate is probably going to stay fairly low And we've also got immigrants who are exiting and we don't have as much of an inflow of immigrants. So the unemployment rate is going to stay low overall. but you can see what's happening to the 16 to 24 year olds.
38:17 their unemployment rate has gone up from roughly 7% to more than 10%. The last time I presented this it was 12.2% 2% but I think there were downward revisions and we'll we'll get to the bottom of that but still 10% and the duration of employment almost a half a year. so I do think that the the concern about employment will build as more and more fed governors understand entrylevel jobs are disappearing and so a very important demographic is not getting jobs. we do think that's going to change as a lot of these young people go out there and go for it in terms of starting their own businesses because the barrier to innovation, the barrier to starting new businesses is dropping precipitously with AI.
39:15 I'm just going to end on two charts. once again, we're very optimistic about GDP growth. We think we're going into a super a productivitydriven boom. And just reminder the step function change in GDP growth when we had the last big technology revolution which was the early 1900s. That growth rate stepped up from 0.6 to 3% five-fold. and we're saying 7 to 8% by the end of the decade. so I think that's conservative given all of the well given the technology revolution underway.
40:00 And finally, this is how we think that that innovation is going to play out in the equity markets, the market cap. on on the right hand side there you can see what happened to railroad stocks as a percent of as a percent of the total global equity market cap 65%. you can see where we are now and we think this revolution is is even bigger as I mentioned and really just starting in its first few years at least and you you can see where we think innovation is going to go as a percent of global market cap again we've just begun we don't think AI hype is where we are at all we do not think we're in the equivalent of the tech intell telecom bubble. We're very happy that many people are worried about it. In the tech and telecom bubble, nobody was worried about anything. In fact, I'll remember clearly Jeff Bezos at Amazon and I think this was in 1999.
41:16 he with some glee announced on on Amazon's earnings call that Amazon was going to lose so much more money in the next year because Amazon Jeff had decided this opportunity was so much bigger than anyone understood and by the way he was right it was going to take much longer that he had to up the capital spending budget it. and what happened that day? The stock just soared. Soared. and one of our panelists on our brainstorm this week reminded me that that a a journalist asked Jeff, "Well, what is how do you spell profit in this new world? What does that mean?" and he spelled it P R O P H T. so that's how Cavalier CEOs of innovation-based companies were back then, those driving the innovation and then of course they paid a heavy price for that over the next three to four years. the fear in the market today when I see Microsoft going down 12% because it's doubling its capital spending over the next year or Amazon going down 8 n 10% because it's doubling its capital spending over the next completely different response completely different investor mindset I think there's real fear out there that was one of the reasons gold went up, fear of everything. And I just think, and this is why I wanted to do the call today, I just think we're in a completely different era. No resemblance to the late 90s. I was there. and, I think we're in for very exciting times. And don't underestimate, the growth rates that these new technologies are going to spur. we think they're going to be super exponential growth rates and Palanteer is a very good example of that. No one expects the 142% US commercial revenue growth to be sustained. We don't either. But you know if it were able to sustain you know 70 80% which is higher than what we have in our model that stock would be a screaming buy today. so we are assessing all of this as everyone else is in the financial world. It's a really exciting time. It's a confusing time. There's going to be a lot of chaos. You saw a lot of auto manufacturers basically shutting down their EV efforts. They couldn't scale them quickly enough to capture the cost declines. They're giving up. And one of the most interesting ideas I heard on our brainstorm today was the idea that well who's going to roll the auto sector up? Normally you think it'd be an auto company, one of the big ones. someone suggested no maybe it's Google. They need cars. so with that I know we have a we have a relief rally today in Friday. and no one knows what the future really holds. but I just wanted to be in front of everybody because I know how harrowing it must have felt over the last week. and just wanted to reinforce our point of view. because we think a lot of the data that has come out recently does just that.
45:20 So, I'll see you next week.