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Cathie Wood’s ARK Innovation ETF: What A Bubble Looks Like

Not unlike the Japanese market in the 1990s and internet stocks in the early 2000s, ARK Innovation may become another classic case of bubble bursting.

Many investors have not been around long enough to remember what a market bubble looks like. In the 1980s, the Japanese stock market ballooned out of proportion, only to crash hard in the 1990s. Internet stocks followed suit a decade later.

With the S&P 500  (SPY) - Get SPDR S&P 500 ETF Trust Report managing to stay within 5% of all-time highs throughout 2021, talking about bubbles now may seem odd to most equity investors. But look under the hood and notice how many stocks have been undergoing deep, bubble-like corrections lately. Many of them can be found in Cathie Wood’s ARK Innovation ETF  (ARKK) - Get ARK Innovation ETF Report.

Figure 1: Cathie Wood, CEO of Ark Invest.

Figure 1: Cathie Wood, CEO of Ark Invest.

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The Japan and dot-com cases

The year 1989 was not merely the end of any decade: it also marked the peak in Japan’s Nikkei index.

After rising about 480% in market value in the prior ten years, Japanese stocks began to unwind. The 37% decline of 1990 was only the beginning. The Nikkei bubble continued to pop through March 2009, by which point stocks had dropped 82% from their all-time highs of 20 years earlier.

High-growth tech investors have experienced similar pain. Before peaking in March 2000, the Nasdaq climbed a whopping 1,000% over the previous decade!

But with the snap of a finger, the fairytale ended. It took less than three years for the index to melt down by 78% from the all-time high, in what has become known in the history books as the “dot-com bubble burst”.

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S&P 500 climbs, ARKK crumbles

While the broad stock market (in this case, the S&P 500) rang in the new year at its high, Cathie Wood and team did not have much to celebrate. Their ARK Innovation ETF ended 2021 in a 40% drawdown that only worsened to nearly 50% in the first few days of January.

The ETF’s rut can probably be blamed on pandemic-era investor exuberance. Strong momentum pushed the fund higher by a whopping 300% between the bottom of the COVID-19 bear and the peak reached only about 11 months later. The pattern of intense rally followed by a painful correction is the telltale sign of a bubble forming and then popping.

At first glance, there isn’t anything particularly wrong with the companies whose stocks ARKK invests in. Consider some of the fund’s top holdings.

Roku  (ROKU) - Get Roku, Inc. Class A Report is still projected to grow revenues by at least 25% per year through 2024. Coinbase  (COIN)  is at the center of the hyped crypto revolution. Tesla  (TSLA) - Get Tesla Inc Report, the largest holding, is considered the “king of the jungle” in the electric and autonomous vehicle spaces.

The problem is that now does not seem to be the right time to bet on high-growth stocks with stratospheric valuations. This is the case primarily because:

  1. the unwinding of fiscal and monetary stimuli should cap liquidity injections in the system (think the end of “free money” from the Fed and the government)
  2. rising inflation bodes ill for stocks of companies that can only promise to generate earnings and cash flow in the long term.

Where is the bottom?

I believe that, in hindsight, ARKK and the stocks that it holds will become known as another classic case of market bubble. The harder question to answer is whether the bursting of this particular one has run its course.

I don’t have a firm opinion on this last topic. But I would caution investors about betting too much on an imminent recovery in ARKK, given the very high levels of volatility that this ETF has produced. High expected returns from buying the dip are likely to come hand-in-hand with elevated risks as well.

Twitter speaks

Cathie Wood’s ARK Innovation is down nearly 50% from the February 2021 peak. Is this the time to buy the ETF?

(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)