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Cathie Wood’s ARK Innovation Can't Find A Bottom, What To Do Next

ARK Innovation ETF is in trouble, and now trades at less than $80 per share for the first time since July 2020. Here is how to tell when to buy this dip.

Investors in Cathie Wood’s ARK Innovation ETF  (ARKK) - Get ARK Innovation ETF Report can’t catch a break in 2022. The fund is now down 49% from the all-time high reached in February 2021. Any attempt to buy the dip over the past year has, so far, proven to be a failure, as the ETF made fresh 52-week lows on January 13.

Now trading at less than $80 per share for the first time since July 2020 (yes, levels reached only a few months after the start of the pandemic), can ARKK rebound from here? Or will the share price dig deeper before, hopefully, finding its way north once again?

Figure 1: Cathie Wood, CEO of Ark Invest.

Figure 1: Cathie Wood, CEO of Ark Invest.

(Read more from Wall Street Memes: CEO Adam Aron Sells AMC Stock. Should Shareholders Care?)

ARKK: to the moon and back

Remember when rockstar investor Cathie Wood and her ARK Innovation fund were all the rage?

By the time ARKK peaked in price, in the second week of February 2021, the ETF had risen roughly 170% since the start of the pandemic. That’s right: nearly triple the price during a short period of 12 months that even included a “flash recession”.

Fast forward to the start of 2022, and there is mounting evidence that all of ARKK’s 2020 and early 2021 returns have been nothing but the result of a bubble that has been popping.

Not convinced? The chart below shows that ARKK has performed no better than the S&P 500 since the start of the COVID-19 crisis. The arch represents the bubble forming and bursting.

Figure 2: ARKK vs. S&P 500 performance.

Figure 2: ARKK vs. S&P 500 performance.

The main reason for ARK Innovation’s trip to the moon and back is macroeconomic in nature. The companies whose stocks the ETF owns continue to do just fine, by and large.

The top holding, Tesla  (TSLA) - Get Tesla Inc Report, is still the dominant player in the white-hot electric and autonomous vehicle space. Zoom  (ZM) - Get Zoom Video Communications, Inc. Class A Report is no longer the pandemic darling that it once was, but it is still projected to grow revenues by 15% to 20% per year for several years.

Teladoc  (TDOC) - Get Teladoc Health, Inc. Report, ARKK’s third largest holding, is another interesting case. Over the past 90 days, analysts have become slightly more confident about smaller net losses in 2021. Still, over the same period, the stock has fallen apart: down nearly 40% since mid-October.

The problem is that low interest rates and fiscal stimulus led to a sharp increase in liquidity and risk appetite in the past two years. Now that the Federal Reserve and the government have started to pull the fruit punch bowl away, valuations have started to come back down to Earth.

Is this the bottom for ARKK?

One would hope that, following the carnage seen so far, ARK Innovation would be close to finding a bottom. But it is hard to tell if this is really the case.

The Fed has yet to finish its tapering process, let alone announce the first interest rate hike of the year. With the 10-year yield still well below 2%, what could still happen to mega-growth and high-valuation stocks in 2022, should the rate climb much higher from here?

Then, there’s Tesla. The stock accounts for nearly one-tenth of ARKK. The bad news is that, unlike the ETF, TSLA is only 16% off the peak reached as recently as November 2021.

Could shares of the EV maker finally “feel the pinch” and correct from here? And if so, how much further could ARKK decline as a result?

It is best to watch price action

I believe that ARKK remains under pressure that transcends business and even macro fundamentals. Investor sentiment, whether justified or not, is about as bad as it gets today.

Then, there are the dangers of buying into a bubble. Think of the Nasdaq 100 during the dot-com burst.

After shedding 50% of its value between the March 2000 peak and the end of that same year, the tech-rich index dipped yet another 28% in 2001 and then 38% more in 2002. In ARKK’s case, the fund is only now about to drop its first 50%.

Because of the potential risks ahead, I would suggest that investors thinking of buying the dip in ARKK pay close attention to price action. It is better, in my view, to wait until the ETF shows a bit of support than to try to catch the falling knife.

What to do about ARKK

One possible approach is to use moving averages, since ARKK is a fund that usually trends — both to the upside and the downside. For example: since the start of the pandemic, a buy-and-hold approach in ARKK would have produced cumulative returns of 36%.

However, if an investor had held ARKK only above the 50-day moving average and sold it below the line, he or she would have participated almost exclusively in the upside swing (see chart below) and raked in a much better 78% in cumulative returns since the start of the pandemic.

Figure 3: ARKK share price and 50-day moving average.

Figure 3: ARKK share price and 50-day moving average.

Should the strategy above be deployed today, it would mean that ARKK would only be a buy at $102 per share. While it may be counterintuitive to want to jump in at a higher price, doing so would help to ensure that the ETF has ended its painful correction cycle.

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Pop quiz: since the start of the pandemic (February 2020) through now, how do you think Cathie Wood’s ARK Innovation ETF has performed relative to the S&P 500? Try to answer without looking at a chart!

(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting the Wall Street Memes)