The Breakdown - Innovation vs. ‘The Big Short’: Cathie Wood and Michael Burry's Battle Frames the Potential Futures of Markets

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, August 17th, and I have sort of a fun one for you today. So one of the things that makes being in markets so fascinating and just more enjoyable in many ways is that unlike in, say, politics, When people have disagreements, there is actually a way to tell who's right. Ultimately, it's the market. The market will at some point demonstrate who is correct and who isn't. Right now, there is a

Starting point is 00:00:50 delightful disagreement going on between two figures who loom large in the market's imagination. The champion of disruptive innovation herself, Kathy Wood on the one hand, and Michael Burry on the other, who you might recognize as the main character in the big short. The reason it's interesting isn't that it's just two big personalities going head to head. Instead, it reveals quite a bit about the very different expectations people have about inflation, growth, and what happens next in markets. Let's start with Michael Burry. First, a little background on Burry for those of you who might not know. He's best known in pop culture as the main subject of Michael Lewis's book, The Big Short, and the movie of the same name. He was the guy played by Christian Bale.

Starting point is 00:01:37 Bury ran a hedge fund called Cyan Capital that he started in 2000 with inheritance money and loans from family. Right from the beginning, you'll see a common thread, which is Bury building his whole career in betting on bubbles. When he started Ceyon in 2000, he immediately started shorting internet stocks, which, as we know, the world would soon come to see as highly overvalued. In 2001, the S&P 500 fell around 12% while Cyan was up 55%. In 2002, the second, the world, the world would soon The S&P 500 was down another 22.1% while Sion was up 16%. In 2003, the market turned around and rose 28.69%, but Bury beat it again, up 50%. This was enough for investors to know that something was special here, and by the next year,

Starting point is 00:02:24 Burry was managing $600 million. Now, around 2005, Burry started to shift his focus to the subprime mortgage market. He got convinced that a specific subset of those mortgages would begin losing value. within a couple years of issuance and subsequently persuaded investment firms to sell him, credit default swaps against the deals he considered most vulnerable. This was not a popular opinion at the time. He had numerous withdrawals from the fund, but those who stuck around one big. Burry made himself $100 million, and when it was all said and done between November 2000, when the fund was started in June 2008 when he wound it down, Michael Burry's Sion recorded a

Starting point is 00:03:03 489.34% return. Fast forward a decade. Burry has been sounding the market is overvalued drum now for a couple of years. In August 2019, he said there was a bubble in large U.S. companies due to the growing popularity of passive investing. In December of 2020, he revealed that he was short Tesla. This also showed another curiosity of Michael Burry. He absolutely loves to tweet and then shortly thereafter delete it. So, from December 2020, he tweeted, Elon Musk, yes, I'm short Tesla, but some free advice for a good guy. Seriously, issue 25 to 50% of your shares at the current ridiculous price. That's not dilution. You'd be cementing permanence and untold optionality. If there are buyers, sell that Tesla souffle. Elon Musk, shockingly, did not listen. Burry's tone got somewhat more hostile in January when he taunted, well, my last big short got bigger and bigger and bigger too. Enjoy it while it lasts. In May, the magnitude of his short position was revealed. PC reported, again now deleted tweets, that revealed that Bury had puts against 800,100,100 shares of Tesla worth around $534 million at the time. One of those deleted tweets gave some additional

Starting point is 00:04:16 rationale, saying that Tesla was over-reliant on government regulatory credits to turn a profit, and that that was a red flag. Despite what I tell you next about Burry's take on Bitcoin, let's not forget that that's exactly what many Bitcoiners said when Elon seemed to turn on us earlier this year. Either way, in quarter one of this year, Tesla reported just under $520 million in sales of regulatory credits. Basically, it gets credits from government programs around renewable energy and then sells them to other automakers who need to offset their carbon footprint. Tesla's $1.6 billion in regulatory energy credits were a key part in helping the company achieve four consecutive quarters of profitability, which was a requirement for addition to the

Starting point is 00:04:55 S&P 500. Bury, however, hasn't just been vocally short Tesla, as I just hinted, he's also reserved some ire for Bitcoin and crypto. In February, he tweeted, and again, at this point you can assume that unless I say otherwise, he's deleted these tweets just a little while after posting them, he tweeted that Tesla had bought Bitcoin only as a way to distract people from Chinese regulatory concerns around Tesla's quality and safety. In June, he went even more ham going after crypto directly. He tweeted, all hype and speculation is doing is drawing in retail before the mother of all crashes. When crypto falls from trillions or meme stocks fall from tens of billions, Main Street losses will approach the size of countries. History ain't changed. The culprit, he says,

Starting point is 00:05:39 is leverage. Quote, if you don't know how much leverage is in crypto, you don't know anything about crypto, no matter how much else you think you know. Now, interestingly, Burry portrayed this as though it was some great secret, and certainly leverage is a hugely important part of the crypto market structure. That's why, every time we've dipped down or ripped up this year, you've heard me do a show dissecting the role of leverage in the moves. Leverage and the role of leverage at this point isn't even an open secret. It's just one of the parts of the raw free market experiment of crypto that people understand has a significant impact and a significant volatility increasing impact on the markets. And yet somehow, even with all this leverage, significant crashes and

Starting point is 00:06:18 retraces this year, with, for example, the world's second most important economy out and out banning us and running us out of the country, we've been just fine. It's also worth noting that when it comes to leverage, centralized exchanges have a lot of agency to shape markets. Last month, FTX, who, as I've disclosed before, I work with on marketing, reduced max leverage from 101x to 20x. In his thread about it, CEO Sam Bankman-Fried also said that the average leverage used on FTCS was only 2x.

Starting point is 00:06:47 Finance followed suit within hours, reducing their max leverage to 20x as well. Anyway, the point for our story is that, You now see a bury who has come after Tesla with his wallet and who is vocally against Bitcoin and crypto and who knows what bets he's making there. Who would make sense then for him to turn his shorting ire towards next? You guessed it, the perennial champion of Tesla, of Bitcoin on Wall Street, and of disruptive innovation in general, Kathy Wood.

Starting point is 00:07:20 The breakdown is sponsored by Nidig, the institutional-grade platform for Bitcoin. As longtime listeners know, Nidig is a major force in the Bitcoin. space, and they're now making it possible for thousands of banks who have trusted relationships with hundreds of millions of customers to offer Bitcoin. That mainstream access is critical for all of us, and you can learn more about it at nydig.com slash nLW. That's nydig.com forward slash NLW. Kathy Wood founded Arc Investment Management in 2014 with an intention to support technology innovation in the public markets through actively managed ETFs. In the 7th years since founding, Kathy has been through it. As I mentioned, she has been one of the most ardent

Starting point is 00:08:09 supporters of Elon through thick and thin. In February 2018, she told CNBC that Tesla could grow around 1100% from its price at that time to reach a price of 4K per share within five years. People chuckled and chuckled harder when she doubled down a year later on that prediction after Tesla had dropped 29%. However, two years on from that, in January 2021, Tesla hit that target on a split-adjusted basis. Overall, 2020 was the breakout year for Wood and her ARC funds. They started the year with around $3 billion in assets under management, and by the end of the year, their flagship innovation ETF alone had become the world's largest actively managed ETF, with $17 billion in assets under management and a 170% return that year.

Starting point is 00:08:57 Overall, the firm now manages over $50 billion in assets under management spread across its ETFs. They've also continued their engagement in Bitcoin and crypto-adjacent things. They've gobbled Coinbase and Robin Hood stock this year, for example, contra the markets. They've also co-hosted with Square the B-word event for institutional investors to learn about Bitcoin, where Elon Musk declared a tant, more or less, with the Bitcoin community. What's more, ARC has been interesting to watch as a sort of macro-reference point for the crypto-markets. If you look at just that flagship innovation ETF, Arc peaked in Feb and then came down through March, April, and May before coming back up again in June into July and staying somewhat rangebound

Starting point is 00:09:37 for the last month or so. What has been shifting throughout that time is people's beliefs and expectations about the future of monetary policy. That first leg down for Arc was characterized by a larger market shift in expectations. The economy was starting to heat up. Inflation was going up, and despite assurances that the Fed was going to keep the gas flowing when it came to asset purchases and zero interest rates, markets were getting more convinced that inflation would force their hand. In the scenario where the Fed did have to hike rates, the first thing that would be hit were risk stock valuations. Since then, the macro landscape has gotten a lot more blurry. Delta variant has confused things. Certain economic indicators are weaker than expected, like the

Starting point is 00:10:21 1.1% drop in retail sales in July that we learned about today. And in general, there is just a lot up for debate about what happens next. That's the context in which yesterday it was revealed via SEC filings that Michael Big Short Burry was short ARC's innovation ETF to the tune of bearish puts on 235,500 shares, a position worth around $31 million. That same filing also revealed that Burry has increased his bets against Tesla, from 800,100,100 shares before to 1,75,500 shares now. Unlike in the past, a soon-to-be-t deleted tweet did not accompany that disclosure reporting. Initially, the market sided with Bury. Arc dropped 2.6% yesterday as part of a broader tech stock dip,

Starting point is 00:11:08 and Tesla, meanwhile, was down around 4.7% as the U.S. opened a formal investigation around its autopilot system. Today, though, Kathy bit back, and she did so on a Twitter thread that I believe will not be later deleted. Let's actually read the whole thing, retweeting the news that Bury was making bets. against Ark, she writes. Most bears seem to believe that inflation will continue to accelerate, shortening investment time horizons and destroying valuations. Despite what we believe has been a supply chain-related slash short-term burst in inflation, both equities and bonds have appreciated since March. Unlike the tech and telecom bubble, this equity bull market has broadened beyond the innovation strategies that boomed last year to value in other stocks that had trailed. The bull market has strengthened,

Starting point is 00:11:53 setting the stage, we believe, for another leg up in innovation strategies. The equity market is likely to reward disruptive innovation strategies once again, when headline inflation breaks and or fears of recession increase. If the bond market is correct, one or both will be obvious during the next three to six months. Since mid-May, a number of commodity prices have been breaking down. Lumber down 65 to 70%, copper down 10 to 15%, oil down 10%. An unexpected increase in the dollar also is negative for commodity prices. Now, the Mannheim-use car index, a leading index for new car sales, is slipping. The deflation in commodity prices is cyclical, but is adding to the secular forces caused by technologically enabled disruptive innovation, i.e. good deflation,

Starting point is 00:12:39 and creative destruction, i.e. bad deflation. If we are correct, GDP and revenue growth will diminish until the opportunities in nascent technologies begin to move macro-needles. In this environment, innovation-based strategies should distinguish themselves. In our view, the seeds for the innovation explosion that ArkInvest is dedicated to researching were planted during the 20 years ending with the tech and telecom bust. Having gestated for more than 20 years, these technologies should transform the world during the next 10 years. To his credit, Michael Burry made a great call based on fundamentals and recognized the calamity

Starting point is 00:13:12 brewing in the housing and mortgage market. I do not believe that he understands the fundamentals that are creating explosive growth and investment opportunities in the innovation space. So, to briefly summarize, would an arc are arguing something similar to the Fed's line of transitory inflation, although it's not exactly the same? For her and ARC, their meta-framework is long-term structural and technology-led deflation with short-term inflationary pockets. As evidence, she's pointing to commodity prices, which have been coming down significantly since their peaks earlier this year. She also points to what she argues is a bond market bet that this

Starting point is 00:13:47 inflation is passing, and in fact, fears of a recession could increase. In the context of either inflation concerns dwindling or larger fears around growth, markets will again turn to disruptive innovation companies as the only reliable drivers of growth and as the biggest beneficiaries of Dovish policy tailwinds. So, you have on the one hand Michael Burry making bets that suggest we're in the mother-of-all-bubbles that these valuations can't possibly be sustained. And through his actions, he seems pretty clearly in the camp that the first thing to get nuked will be tech valuations.

Starting point is 00:14:20 Kathy and Arc are making a very different bet, and it's a totally different way of looking at fundamentals. In their estimation, the fundamental shifts of long-term technology-driven change in secular market shifts away from growth are the things that matter. In that context, what will matter more than considerations evaluation is the fact that people have to look to disruptive innovation as the engine of economic growth. It's actually a much larger argument than just a market pricing argument. Who will be proven right? Well, that's the great thing about market-based battles. Ultimately, the numbers will tell us whose conviction is born out. Anyways, guys, I appreciate you listening, and until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Innovation vs. ‘The Big Short’: Cathie Wood and Michael Burry's Battle Frames the Potential Futures of Markets

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