Mentioned in Video:

#Tesla (#TSLA), #ARK Invest's BIGGEST holding by a large margin, is now in two major indexes, the S&P 500 and the NASDAQ. What does this mean for how #CathieWood and #ARKInvest manage their risks, since Tesla is the biggest holding in 3 of their 5 actively managed ETFs: #ARKK, #ARKQ, and #ARKW?

Video Transcript:

Hey there. Alex here, and this is Ticker Symbol: You, the channel that invests in you. In this video, I'll talk about what Tesla's inclusion in the S&P 500 means for ARK Invest, now that their biggest holding is represented in two major market indexes. And then we'll dive into what Cathie Wood thinks is a four point three trillion dollar problem and growing. I put a ton of research and effort into each one of my videos and all of my sources can be found in the description below.

So, I'd appreciate the early thumbs up and let's dive right in. So let's talk about Tesla's inclusion in the S&P 500 and what may be the start of the biggest financial mistake in the history of the world. As of December 21st, 2020, Tesla will join the S&P 500. It'll be the largest company to ever be introduced to the index, accounting for about one percent of the total S&P 500. These are the top holdings of the S&P 500 today. One percent puts it right above companies like MasterCard, Disney and Verizon.

This is a huge change in the S&P 500. In fact, it's so big that the S&P is thinking about adding it in two parts to help fund managers deal with the about 51 billion dollars in trades they'd have to make to account for Tesla. If you didn't know, Tesla is also the number five holding in the Nasdaq 100. Another big index that follows technology stocks specifically. This means that a lot of investors that would describe themselves as safe, traditional or passive investors are about to be holding one of the most volatile and disruptive advanced technology companies ever to exist.

And make no mistake, there's going to be a lot of these types of investors since index funds account for over half of all fund based strategies in the U.S., with almost four point three trillion dollars in passive index funds. That's about one eighth of all shares in the U.S. market and up 100 percent from where it was just one decade ago. That means one of every eight dollars in the market is passively invested, and that share is growing. Active fund managers like ARK Invest account for another one eighth of the market.

So this is a huge problem in the stock market. In Cathie Wood's opinion and in my opinion, this massive trend towards passive index investing is the single biggest financial mistake in history. Stick around to the end and I'll explain why and share my prediction for how these four point three trillion dollars will move in the future. For now, let's get back to Tesla. Tesla is the number one most shorted stock on the planet by an incredibly huge margin. It's more shorted than the next two companies put together.

A very large portion of the world is still betting against Tesla, and Tesla has made it very clear what it thinks about these shorts. So what effect does ARK Invest's biggest holding by far joining the biggest index have on their investment strategy since they try not to be correlated to the major indices? Is ARK Invest about to sell a lot of Tesla stock? Well, actually, yes. ARK Invest will sell a lot of Tesla shares. And here's why.

We've been asked quite a bit about our trading activity. Well, we've been in a volatile market, especially when it comes to innovation and disruptive innovation is inherently volatile itself. We take advantage of trading opportunities that this volatility presents. So if a stock is down for what we believe are very short term or short sighted reasons that have no impact on our five year time horizon, we typically will be buying a stock like that. On the other hand, when a stock reaches 10 percent of our portfolio, we cannot buy any longer.

We can let it run up to 12, 13. Sometimes we let it go a little above that. But typically because by that time the stock has run 30 percent, has done 30 percent better than all of the other stocks in our portfolio, we will take profits. This is simply portfolio management.

ARK Invest is Wall Street's biggest bull on Tesla. When Elon Musk was thinking about taking Tesla private in 2018, they wrote him an open letter saying that by taking Tesla private, he'd be depriving many investors the opportunity to participate in its inevitable success. When the model 3 was in production hell, and Wall Street was predicting bankruptcy, ARK Invest was buying shares. And while GLJ Research had a 2021 price target of eighty seven dollars on Tesla, ARK has moved their 2024 price target from 4000 to 7000 dollars.

It's important to remember that ARK Invest is a research firm, active research knowledge. This 7000 dollar price target is not pulled out of well, you get it. ARK Invest does a lot of research into the core of Tesla's technologies and ideas and predict their future costs and demands using Wright's law. They also have a very deep understanding of the adoption of battery electric vehicles in general and how the market is changing year over year. ARK Invest definitely considers the bear case for Tesla, not just blindly following its bull case.

In fact, ARK Invest is considering 10 different scenarios for Tesla in 2024. That 7000 dollar number is the expected value of a lot of possible outcomes that ARK's analysts have put together over time. These 10 possible outcomes range from the golden goose scenario all the way down to the black swan. In the golden goose outcome, Tesla's got great margins, builds gigafactories quickly and efficiently and has largely solved the challenges associated with autonomous cars. It's worth noting that ARK Invest has four potential outcomes that include Tesla solving and launching their full self-driving network by 2024, giving that a total chance of about 30 percent of happening.

On the other end, we have the black swan cases, which include things like going completely bankrupt or being unable to raise any capital. Considering that Tesla just raised an additional five billion dollars in capital in September by selling shares at the peak of its massive rally, I'm going to say that these bottom two scenarios are a little less likely than ARK has in its table. The cases where Tesla doesn't solve autonomy by 2024 account for the other 70 percent of probabilities on this table.

Discounting the two black swan events, I'd say we can rightly make the statement that ARK Invest's twenty twenty four price targets for Tesla account for about a one in three chance of launching its autonomous network. One thing I don't see ARK Invest accounting for on here is if someone else solves the autonomy problem first, such as Intel's Mobileye, which partners with a lot of other auto companies, including everyone's favorite Tesla competitor, NIO. ARK Invest does a lot of research into the companies they hold, definitely including Tesla.

And part of that research includes predicting their future costs and demands using Wright's Law. Links to a few of the most relevant analyst articles can be found in the description below, along with a link to my video going over the basics of Wright's Law. I'll cover more laws like this in the future so you'll have every tool you need to follow along when I cover some of my personal stock picks and, of course, ARK publishes a lot of material about their expectations for Tesla over the next five years.

As a result of all that research, Tesla accounts for over seven percent of ARK Invest's total holdings across their five actively managed ETFs. They currently hold almost one point four billion dollars in Tesla split up across ARKK, ARKW and ARKQ. ARK Invest are not stock pickers; they're active fund managers. And if you're interested in following their biggest buys and sells each week and understanding the context behind their trades, I love creating cool visualizations like this one and showcasing exactly that on mARKet Mondays.

So hit that notification bell if you want to be warned when those come out, it's on Mondays. I hope you haven't forgotten about the elephant in the room, Wall Street's four point three dollars trillion dollar problem. Recently, ARK Invest released the third volume of BIS 2020 webinar series, and in it, Cathie Wood closes the webinar by talking about market dynamics. If you go to about the one hour and forty one minute mark in this video, Cathy says one of the most impactful things I've ever heard her say, the most massive misallocation in the history of the world took place in these later days of indexation.

Now that more than half of stocks are in index-based strategies, we believe the pendulum has pretty much swung as far as it's going to go. So let's unpack that. Almost one in two of all stocks are represented in some sort of index, which means that when passive investors buy these indices, that's how these companies are getting their stocks purchased. Many smaller companies rely on being included in an index to survive as passive investors keep allocating money to that index and they get a small piece of the pie. When the pendulum starts swinging the other way and money starts leaving these indexes, many of these companies will collapse as people are no longer passively buying their companies.

There's going to be a dramatic shift in which companies succeed based on who is represented in the index and what the indexes look like in the future. And now here's my crazy prediction on what's going to happen with these indexes. One thing you should know is the average amount of time that a company spends in the S&P 500 is going down drastically. In 1965, it was 33 years, and in 2027 it's expected to be just 12, that means in about the next ten years, 50 percent of the S&P 500 will be replaced.

Here is a rolling trend line of the life expectancy of a stock in the S&P 500. As you can see, over time, the S&P 500 is going to start looking more and more like an actively managed fund. Few companies are immune to the forces of creative destruction that is being disrupted as innovation continues to grow. And, as indexes try to better represent the current state of the art by picking the best companies in each sector, my crazy prediction is that index funds will start looking a lot more like ARKK does today, including being more actively traded.

And we can already see this starting to happen as Tesla, ARK Invest's biggest holding, has taken a top spot in two of them, the Nasdaq and now the S&P 500. If you've made it this far in the video, you're awesome. This is Ticker Symbol: You. My name is Alex, reminding you that the best investment you can make is in you.

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Alex Divinsky

💰 Investing in our future through disruptive innovation, ☕ lover of coffee, 📺 host of Ticker Symbol: YOU on YouTube

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