ARK Innovation Outlook: The Stars Align for More Weakness in Early 2022
- ARKK jumps on Thursday, but it still misses out on Santa’s rally
- The ETF is down approximately 7% in December and 22% in 2021
- Cathie Wood’s flagship fund is likely to languish in early 2022 as traders prepare for the Fed’s liftoff and shun tech and growth-oriented stocks
ARK Innovation (ARKK) surged on Thursday, gaining approximately ~4%at the market close, but it has still missed out on the Santa Claus rally in a big way. For example, for the month of December, the S&P 500 has jumped more than 5%, but Cathie Wood’s flagship fund is down more than 7%. If trading ended today, ARKK would lose 22% in 2021, its biggest pullback since its inception in 2014.
Though financial assets tend to meanreverse after significant declines, ARKK could cement its underperformance in early 2022 before staging a comeback later in the year or in 2023. The main headwind for this growth-oriented ETF is the Fed’s transition to tighter monetary policy at a time when the economy is losing momentum.
At its December meeting, the FOMC accelerated the pace of its asset purchases and signaled that it will hike three times over the next 12 months. A higher rate regime is usually detrimental to technology and growth stocks for two reasons.
First, it raises financing costs for companies that rely heavily on cheap debt to develop their businesses. Second, it undermines valuations by increasing the rate at which future cash flows are discounted, a conventional technique to price equities.
As investors prepare for the Fed’s liftoff, we may start to see large pockets of weakness on Wall Street. While mega-cap tech complex may initially struggle, they are in good shape to “weather the storm” caused by the shift in monetary policy thanks to solid earnings and strong balance sheets. However, growth stocks, with unprofitable businesses and long-duration cash flows, are not well-positioned to withstand increasing borrowing costs, so they could bear the brunt of a market sell–off.
Most of ARKK’s holdings consist of fast-growing disruptive firms with little cash flows and no profits. As such, these companies are very sensitive to rising rates and may fall substantially once the Fed becomes more aggressive in its fight against inflation. For these reasons, investors should not be surprised if ARKK were to pull back significantly early in the new year.
ARKK TECHNICAL ANALYSIS
After Thursday’s rebound, ARKK is approaching key resistance near the 100 psychological level. If buyers manage to push the price above this level, the ETF could be on its way to retest the 104 area before aiming for 109.
On the flip side, if sellers resurface and ARKK pivots lower, support appears at 89.50. Traders should carefully monitor this area as a move below it could accelerate the downside pressure and trigger a drop towards 82.00, the September 2020 low.
ARKK TECHNICAL CHART
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—Written by Diego Colman, Contributor