Ark Invest CEO Cathie Wood first entered the media spotlight way back in 2018. She made a prediction, which was considered outrageous at the time, that Tesla (TSLA 2.97%) stock would hit $4,000 within the next five years. At the time, Tesla shares were trading for around $350, implying that Wood thought shares were going to rise by around 1,110%.
The Street was bullish on the stock at the time, but nobody was nearly that bullish except Wood. Yet she saw something at the time that no one else did. Her prediction that Tesla would hit $4,000 (split-adjusted) ultimately proved accurate. And it happened a full two years before she said it would.
While some calls have hit and some calls have missed since then, it would be unwise to ignore what she says. That's why her latest prediction got my attention. And it again has big implications for one asset class if it comes true.
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"Inflation ... could drop to zero"
In a recent market update, Wood stated her company's opinion on the direction of inflation. While tariffs continue to act as a pressure point, she sees other factors contributing to a pretty significant drop in prices: "But if we're right, growth will be much stronger and, importantly, inflation will be much, much lower than it has been with tariffs. And we think at some point it could drop to zero or below zero if we're right on oil continuing to fall and rents falling," she said.
Granted, there are a lot of "if's" here. If Oil falls. If shelter inflation falls. It probably would also have to involve food inflation falling and some mitigation in tariffs. But let's assume that her latest prediction does indeed come true. Much lower inflation should translate to much lower interest rates. If that happens, you get a new bull rally in long-term bonds.
The bull case for long-term Treasuries
If inflation does go to zero, a simple scenario analysis demonstrates the significant potential upside in long bonds.
According to the Fed, the current 10-year breakeven inflation rate is around 2.3%. If inflation were to go to zero and real yields were to hold steady, we can assume that long-term bond yields could fall by around 2.3% as well.
Let's also use the iShares 20+ Year Treasury Bond ETF (TLT 0.20%) as our proxy for long-term Treasuries. That portfolio currently has a duration, which is a measure of how sensitive a security is to changes in interest rates, of approximately 15.5 years. That means for every 1 percentage-point decrease in interest rates, the portfolio could expect to see its value rise by 15.5%.
NASDAQ: TLT
Key Data Points
Now it becomes a math problem. If long-term rates drop by 2.3 percentage points and the exchange-traded fund rises in value by 15.5% for every 1 percentage-point change, that implies 35% upside potential for long-term Treasuries if Wood's prediction comes true.
To be fair, there are a lot of assumptions and moving parts here. Real yields may move in lockstep with nominal yields ... or they may not. Any one of the primary components of inflation -- rent, energy, food -- could move differently than the overall trend. The Trump administration tariffs are a big wild card in this and could keep inflation rates persistently elevated for as long as they're in place.
But it's also realistic to come up with a scenario where this happens. The labor market is already cooling. The manufacturing sector has been shrinking for several months in a row. Overall demand in both goods and energy appears to be weakening. All of this is disinflationary. Whether it brings the overall inflation rate to zero or turns into outright deflation remains to be seen.
But given this backdrop and the potential for artificial intelligence to contribute to the disinflationary pulse, it's far from out of the question. And that could be the biggest positive catalyst the bond market has seen in years.
