Marco Bello
ARK Innovation ETF (NYSEARCA:ARKK) has continued to consolidate remarkably well along its COVID lows, as the market forced a false downside break during the recent selloff, ensnaring late short-sellers who went aggressively into the recent October CPI release.
We updated in our previous article, arguing that ARKK has likely staged its long-term bottom predicated against May lows. Therefore, the strength of buyers to deny further downside momentum by bearish investors increasingly suggests an accumulation phase at the current levels.
ARKK’s resilience at its long-term bottom was also picked up by S3 Partners (a technology and data analytics firm), as it highlighted: “This implies bears have been taking profits [as] opposed to reloading on the winning trade. A potential sign of falling conviction.”
Our price action analysis suggests that ARKK bears have failed to gain further decisive momentum against its long-term bottom. Hence, ARKK bears are urged to consider cutting significant exposure at the current levels, particularly if they are sitting on massive profits.
Also, we believe that speculative investors willing to bet on maximum Fed’s hawkishness can consider adding exposure at the current levels. The subsequent return of risk-on sentiments could benefit ARKK’s consolidation zone, eventually helping Cathie Wood’s flagship fund turn around its bearish bias.
Maintain Speculative Buy with a medium-term price target (PT) of $45.
We urged investors in our previous article to consider using pullbacks to add more exposure. Notwithstanding, ARKK’s pullback to force a re-test of its May lows was not anticipated.
However, we urge investors not to be fearful of re-tests because they allow investors to assess the validity of their thesis. Therefore, we have been watching how ARKK has been consolidating and believe bears have been unable to sustain their momentum.
Furthermore, with the Fed’s rate hikes possibly reaching a peak by early 2023, it forebodes well for ARKK’s accumulation as it attempts to reverse its nearly 80% decline to its recent November lows.
US10Y yields price chart (TradingView)
Still, bond sellers retain the bullish initiative, as seen in the 10Y yields price chart above. However, it’s possible that they could be losing momentum from their October highs if the 10Y yield pulls back further.
Our analysis indicates that it’s too early to call the endgame for bond sellers, as we have yet to glean any potential bull trap. Notwithstanding, ARKK’s price action suggests that the market has progressively moved away from battering speculative stocks much further, despite near-term volatility. Hence, the reward/risk for the 10Y yield is likely pointing to the downside if inflation expectations can moderate further.
5Y Breakeven inflation rate (TradingView)
The 5Y breakeven inflation rate has recently continued to moderate from its March highs, pulling back to 2.47%. Notwithstanding, it remains well above the previous average over the past ten years. Hence, the Fed’s job is far from done, as it needs to moderate medium-term inflation expectations further.
ARKK Top ten holdings
We believe that the price action in the macro indicators is positive to help spur a further re-rating in ARKK moving ahead. ARKK’s top ten holdings accounted for nearly 60% of its portfolio. In addition, healthcare and technology stocks form almost 75% of its portfolio.
Therefore, we believe it’s essential for investors to consider whether the sectors’ valuation makes sense to consider a re-rating since a rising tide lifts all boats (including speculative stocks).
Also, we need to consider whether earnings estimates have been revised adequately for the market to consider a re-rating if it anticipates peak Fed hawkishness by early 2023.
S&P 500 Healthcare sector net earnings revisions % (Yardeni Research, Refinitiv)
As seen above, analysts’ estimates on the healthcare sector have already been revised markedly downward, indicating a high level of pessimism about the sector’s performance through the coming recession.
S&P 500 Tech sector net earnings revisions % (Yardeni Research, Refinitiv)
Likewise, analysts have also downgraded the tech sector’s earnings projections through October, even though it remains well above lows seen in severe recessions.
Consequently, we cannot rule out further value compression hitting ARKK’s portfolio holdings further if the market anticipates a severe recession that could impact the tech and healthcare sectors’ earnings significantly.
ARKK price chart (monthly) (TradingView)
As highlighted earlier, ARKK has been consolidating remarkably well along its long-term support since May. Several attempts to force further selling to break that level have been rejected resolutely by the buyers. Hence, sellers appeared to lack the conviction and momentum to force another capitulation from the current levels.
ARKK price chart (weekly) (TradingView)
Therefore, we are confident that our thesis of a consolidation zone along the current levels for ARKK remains intact. Bearish investors sitting on significant gains are urged to consider cutting exposure as ARKK could be re-rated moving ahead when the accumulation phase is completed.
Notwithstanding, we view its near-term resistance or August highs as a significant resistance zone that should attract considerable profit-taking.
Maintain Speculative Buy with a PT of $45.
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Disclosure: I/we have a beneficial long position in the shares of ROKU, SQ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
