ARKK: The Growth Bubble Has Burst, Now What?

May 23, 2022 1:11 PM ETARK Innovation ETF (ARKK)13 Comments7 Likes
Andrew McElroy profile picture
Andrew McElroy
10.23K Followers

Summary

  • Growth stocks and the ARK Innovation Fund are nearing the final stage of a bubble.
  • A comparison to similar bubbles suggests ARKK can recover and form a second bubble.
  • However, this could take many years. Cathie Wood's fund is not dead, but it is likely deadwood for some time.

Bubble Shot

Adrian Los/iStock via Getty Images

The Bubble

Growth stocks came crashing down to earth this year. A variety of drivers are behind the falls, with the Fed's pivot from massive stimulus to aggressive hikes the main culprit. Growth stocks typically aren't very profitable, require cash and are long-duration investments so rising yields are a serious headwind. They are also a victim of their own success - during the 2020 recovery and early 2021 bubble many of them doubled, and then doubled again, stretching valuations. Cathie Wood's ARK Innovation Fund (NYSEARCA:ARKK) soared into bubble territory as it gained 387% from the 2020 low to the 2021 high and made a parabolic move on the chart. Each trend was steeper than the last... until the trend broke.

ARKK Parabolic Trend

ARKK Parabolic Trend (TradingView)

The Pop

When the parabolic trend breaks, the bubble pops. This is what happened to the majority of growth stocks in 2021 and this year. ARKK has created a near-perfect bell curve, or Rodrigue Bubble:

Rodrigue Bubble

Rodrigue Bubble (Wikipedia)

ARKK has returned to the mean and entered the despair phase. The comparisons to the Nasdaq 2000 bubble are compelling.

ARKK v Nasdaq bubble

ARKK v NDX (TradingView)

The analogy suggests there could be a bounce developing, but that the low is not in for ARKK.

After the Pop

Many stocks do not recover from bubbles. Occasionally they go bust or go sideways for years and decades (think Intel (INTC)). However, some do recover and many of the high-flying Tech stocks from the 2000 top went on to develop new uptrends. Indices and ETFs such as ARKK have a better chance to rally again as they are diversified.

As we know, the Nasdaq crash of 2000-2002 recovered and went on to form another significant uptrend. In fact, the behavior after a popped bubble can follow a set path, just like the behavior during and immediately following the bubble as described by Rodrigue. Comparing well-known bubbles like the Nasdaq, gold and Bitcoin side by side is quite revealing. The moves may happen at different speeds, but the trajectories of each period are almost identical.

Bitcoin, gold and Nasdaq bubbles

Bubble Trajectories (TradingVIew)

The above chart raises some big questions. Will gold follow Bitcoin lower? Will the Nasdaq follow gold and Bitcoin? And finally, to circle back on to our initial point, will ARKK form a second bubble and follow all 3 examples above?

ARKK compared to bubbles in Bitcoin, gold and Nasdaq

ARKK compared to other bubbles (TradingView)

Considerations

The above chart suggests growth, and ARKK is not dead. The Fed moves in cycles and there should again be a time when the environment supports a growth stock rally. Indeed, now that the old-growth stocks such as Amazon (AMZN) and Apple (AAPL) have matured, new stocks will take their position and ARKK will likely own many of them. However, the path higher will likely be slow. The above chart suggests the bottoming process could take up to four years and even when the next trend is underway, it could be very slow to begin with. How you approach this information depends on your trading style. The best prices for growth stocks are likely struck in the next year, but they could trade sideways in the doldrums for years; costly in this high inflation environment. There are likely much better sectors and even holding slow-moving dividend stocks could be more profitable.

Conclusions

ARKK is following a classic Rodrigue bubble template. It is still in a dangerous phase but I propose it has every chance of bottoming and forming a second, even larger bubble over the next decade.

This article was written by

Andrew McElroy profile picture
10.23K Followers
Independent investor and stock analyst at Matrixtrade.com. Trend follower and market timer. Correlations and analogues. All time frames, all instruments.....wherever I see an edge I trade it.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

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