Will ARK ETF ever recover?

The flagship ARK Innovation Fund (NYSEARCA : ARKK) by ARK Invest has been severely punished by the bear market this year. This once highly sought-after ETF now trades at just a quarter of their all-time high.

Whatever gains were made during Covid is now all but history as the fund now floats in the $30s range. Such levels were only seen back during the initial days of covid as well as during the 2018 economic crisis. While prices at such levels may be attractive from a risk-to-reward point of view, the road ahead for ARKK is still highly uncertain given how market sentiment has shifted drastically over the past year.

In this article, I’ll be looking into why the market is punishing ARKK and what changes need to happen in the macroenvironment for this ETF to even have a fighting chance at a reversal.

What is ARK Invest and what is their investment philosophy?

For those new to this topic, you can refer to Zhi Rong’s article here which should bring you up to speed regarding ARK and the type of companies that they like to invest in.

In a nutshell, ARK invests in disruptive technology.

And this year has been particularly tough for these companies:

What happened this year?

Companies that fall in this category usually possess one or more of the following,

1. They are not profitable/cash flow positive.
2. They are burning cash to fund operations/growth.
3. They rely on loans to fund their cash flow.

The above 3 points may not necessarily be seen as a good or bad trait of a company’s health but in an inflationary/high-interest rate environment, the drawbacks of such traits are amplified:

1. They are not profitable/cash flow positive + INFLATION = Losses are further amplified.
2. They are burning cash to fund operations/growth + INFLATION = Will burn even more as the cost of production goes up.
3. They rely on loans to fund their cash flow + HIGHER INTEREST RATES = Cost more to borrow money.

Hence with current market conditions, there is simply no way out for ARKK due to the nature of the holdings within the ARKK fund. One would think that as an “Actively Managed Fund”, that their fund manager(s) would actually dial back on their investment thesis however in the past month alone, they have added over $18 million into one of their highest conviction stocks – UI Path.

What is Cathie Wood doing?

Cathie Wood is the founder and CEO of ARK Invest. It’s safe to say that ultimately, she is the one in charge of what’s happening to ARKK. At present, she believes that instead of inflation, there are signs that deflation may actually happen. Her thesis is that depending on circumstances, advancements in technology can eventually lead to higher productivity for companies which can eventually lead to prices going down.

“They’re probably overdoing it here,” said Wood, ARK’s founder, chief executive and chief investment officer, during the firm’s monthly market webcast on Tuesday afternoon. “They’ll let something crack first,” including employment, she said, adding that by the time the Fed relents, inflation is going to “unravel to something well below” its 2% target.”

“We’re seeing a lot of deflation in the pipeline,” she said, pointing to prices of commodities such as oil, lumber and copper falling steeply from their peaks, along with the Baltic freight index. 

Marketwatch

Over the years, Cathie has indeed gathered quite a following and while things look bleak now, I’m certain that she is far from “insane” as she does have a worthy track record to boast.

Are investors still holding onto ARKK? – Funds Flow Chart

While its difficult to tell exactly how many investors are left holding the bag for ARKK, the chart above shows that investor loyalty is being tested now more than ever as prospects dim and investor outflows continue.

The bulls would say that capitulation is right round the corner while the bears would say that there may be still more outflows to come.

While the future remains uncertain, what is certain is that this ETF is not performing in the short-term which will surely dampen any sort of momentum in this ETF.

What needs to change for sentiment to reverse?

Well a myriad of factors come into play here, I’ll place my bets on how a more dovish Fed will leave a largest impact in the short term. This can happen should we see the economy start to slow down (caused by interest rate increase, slowing business activity, unemployment rising etc.)

Either that or we see a decrease in the next CPI report which may be an indication that inflation is at its tipping point. There is much speculation at this point but what I’m looking out for would be indicators in both the housing market (property, rent prices etc) as well as unemployment rates.

Is there further downside for ARKK?

The charts are a little tricky here but what’s certain is that we are most certainly in oversold territory.

At present, we are seeing a divergence in the RSI where momentum is increasing yet price is holding which can be an indication that more buyers are entering the market.

At the same time, volatility is expected in the range of $30-$33 based on historical trading patterns. It should be watched closely.

Will ARKK recover?

The current inflationary climate has been tough for growth and disruptive tech stocks, which are key components of the ARK ETF. In the short term, inflation will continue to subdue the performance of ARKK.

While oversold levels make for good entry points, I do not have a position in any ARK fund at the moment. I don’t rule out entering as these levels are indeed attractive. However an “all-growth” ETF does seem to be a little too adventurous for me at present. That said, a buy order at exactly $30 does seem to be quite a steal.

But, we should not rule out having some faith in Cathie Wood given that her funds would surely shine should a sector rotation take place in 2023.