Should I Invest in ARKK?

There is no Loyalty

I will get right to it- now is a great time to invest in ARKK.

There is no loyalty today. Take it from a long-time Knicks fan. None. Fans are fickle. They love you when you are up. They criticize you when you are down. Investors, too, are fickle and fund managers, like my beloved Knicks, are especially vulnerable when times get tough.

Analysts went from singing Cathy Wood’s praises to exiting her ARKK Innovation ETF in droves. Market pundits cry doom and gloom and question whether it’s over for Wood’s darling fund.

And the numbers prove it – the stock is down nearly 32% year-to-date.

But you know what? At these levels, I am Buying.

And, yes, I just wrote an article on the benefits of purchasing Value ETFs.

I know it appears counterintuitive. But before you call me a hypocrite, hear me out.

Here is the difference – I am buying Value for the short-run but investing in ARKK for the long-run. What does the short-run look like? The next 12 to 24 months. What does the long-run look like? Three or more years. I believe there is more upside this year in Value, and I am confident that Value outperforms Growth this year. But you still must be selective; in this environment I choose to diversify and spread the risk and go with ETFs that I trust. See my article HERE on ETFs I invest in. So, I choose Value as a hedge to stem the bleeding of individual growth stocks as valuations come back to reality.

Here is the difference – I am buying Value for the short-run but investing in ARKK for the long-run. What does the short-run look like? The next 12 to 24 months. What does the long-run look like? Three or more years.

The volatility that we are seeing in the market – things are overblown relative to what is happening.  We had tech stocks that were lifting aggregate valuations for years. And this buoy was disproportionate. It makes sense that many of our Tech names must cool off.

The selloff is NOT a long-term problem, however, for the sector. And that’s why ARKK is a great opportunity currently. I like 50% and 60% sales on Tech names that will continue to innovate and grow for many years into the future. Do you believe that technology will be any less important in 5 years? In ten years? Technology, in my view, is a long-term secular story. I am not denying that we are facing higher interest rates or higher cost inputs or slowing GDP on a year-over-year basis. This will put downward pressure on profitability, especially for “Tech as a service,” as opposed to “Tech as a product” names. I am not denying poor short-term prospects.

ARKK was the top performing equity fund tracked by Morningstar in 2020. ARKK is nearly 60% off its high from 19 months ago. The stock traded to an intraday high of $158.82 on February 16, 2021, but just closed at $64.80 on February 18, 2022. Cathy Woods’ flagship fund suffered a $352 million withdrawal back in January. This was the company’s largest one-day drop since March of last year, according to Bloomberg.

ARKK and the 10-Year Treasury

So, what is going on? It appears that the broader tech route is largely being caused by the more hawkish tone set by the Federal Reserve. ARKK funds continue to tumble as yields rise on expectations of the Fed beginning rate hikes next month. There have been several interesting articles pointing out that ARKK’s ETF price % change is nearly inversely proportional to the 10-year Treasury Rate. For example, the graphic below comes from a recent article by Robert Castellano on February 03, 2022, “Can ARKK Rebound, or Will it Continue Dropping?”

At the beginning of February 2022, U.S. Treasuries broke through the 2% level, driven higher by key inflation data. The CPI rose 7.5% compared to a year ago. This was the first time since 2019 that benchmark yields topped 2%.

The 10-year yield has spiked in 2022, rising almost 50 basis points from 1.50% at the end of 2021.

When I last checked, the markets were anticipating greater than a 60% chance that the Fed would raise rates seven times this year. SEVEN times this year. That’s essentially a move at every meeting for the rest of 2022. However, I do not believe the Fed raises rates this many times. The Fed will hit the brakes four times or less. Any more than this and Powell doesn’t want to get re-elected.

In summary, inflation is not backing off and neither will the Fed. And, as you know, there is an inverse relationship: the higher yields go, the lower equities go.

So where does this leave us? It appears that our big tech names are in for a rocky near-term. There will likely be continued selling. About 40% of Nasdaq stocks have lost half their value since November 2021.

I do not, however, believe that we are in a bubble. The selling is very different than in bubbles past, as stocks shed single digit percentages on a daily to weekly basis.

Remember that the value of these tech stocks is based upon their future earnings potential. When the Fed cut rates to near zero during the Pandemic, tech stocks innately became more attractive. And that’s what we saw between 2020 and 2021.

Invest in ARKK – Where do we Agree with Cathie Wood?

ARKK’s run was driven by Tech holdings that experienced rapid growth during Covid’s alpha variant year. But ARKK is more than a one-trick pony. I do not belief that Wood’s investments are solely “beneficiaries of the work from home economy.” Wood calls these stocks “connected stocks,” and we, too, believe that these stocks will have incredible growth rates beyond the Pandemic.

Wood predicts that these technology stocks can continue to push down the prices of goods and services. They are not solely to be viewed as Covid stocks.

Invest in ARKK – Where do we Disagree with Cathie Wood?

Wood is betting that deflation, rather than inflation, is the name of the game this year. Sorry – I don’t buy that line of thinking.  Further, Wood believes that supply chain bottlenecks will ease this year. If you are anything like me, you see no abatement in sight.

Inflation is quite real. And real yields, are deeply negative; maybe the lowest they have been in decades. And, therefore, when I put money to work, I put cash into higher risk – higher reward assets. I believe that Tech names will come back into rotation in 2023 and beyond. The sector was a haven during the pandemic. Consider this a shakeout in the post-pandemic world.

We believe that 2022 will be a continuation of the logjam of various goods and services. Why? Challenges facing cargo ships, severe labor shortages and supply and demand imbalances have not been adequately addressed.

Supply chain resiliency will require rebalancing of “on-shore, near-shore, and off-shore strategies.” Manufacturers and producers have become all too dependent on single source, low-cost suppliers. And this will need to change. Fortunately, COVID-19 has provided the necessary wakeup call. Corporate strategy now recognizes that supply chains are necessary for success and growth.

What About the Valuation of Tech Stocks?

As it stands today, net allocation to the tech sector is at its lowest levels since 2008. This is according to a Bank of America survey of global fund managers.

Over the last week, the Tech industry has dropped 2.5%. Most of this drop came from a large pullback from Microsoft.

Let’s look at the graphics below provided by Simply Wall Street. Over the past three months Tech names have lost more than 13%, with software names and semiconductors being particularly hard hit. P/E multiples have compress from 33X to 25X.

Technology – The birth of Industry 4.0 includes predictive analytics, 5G and enhanced AI

Tech will continue to ramp up. We are seeing machine learning and AI use IoT-based data to further automate decisions and processes. Automation equates to efficiencies and breakthroughs that push the pace of change.

Social media is pulling unprecedented amounts of data from people, devices and products to further inform this decision-making process.

All this data means that predictive analytics will enable companies to make better-informed decisions. And the strategists have taken notice. Smart factories will prominently feature 5G and AI solutions. Supply chains will benefit from investments in new technologies.

ARKK’s Holdings – Validating the Model

Critics may argue that investors are better off holding individual names, and avoiding management fees, as opposed to investing in ARKK. Critics say Wood has little concern for valuation and profitability. I disagree. The fund is well managed and positioned for outperformance.

ARK Invest has published their main investment themes for more than five years now. And Wood put numerical projections on how these themes would perform. The themes revolve around areas where Wood and her Team believe analysts’ estimates were overly conservative at the time of issuance. Themes where the fund has been spot-on include the following: Deep Learning, CRISPR, Mobile Payments, and Cryptoassets.

On the deep learning front, Tesla’s autopilot and Google’s AlphaGo, Photos and Smart Replay products have all benefited from the technology.

The three CRISPR stocks that were public at the time of this prediction in 2017, CRISPR, Editas and Intellia have had an average return of more than 300% over the past five years.

PayPal and Square have had excellent returns in the mobile transaction space. In fact, Paypal remains the leading mobile transaction platform and its returns have more than doubled the overall market over the past 5 years, even after the recent selloff.

Cathie Wood proclaimed, amongst others, that crypto and NFTs would find a space as its own asset class. At the time of her prediction, most analysts predicted that crypto would only grow to roughly $15 billion. Despite being incredibly volatile, cryptos market cap now fluctuates between $1 trillion and $3 trillion.

The number of big ideas that ARK publishes has since doubled to fourteen in 2022. New ideas include digital consumers, multi-omics, autonomous logistics, and orbital aerospace. Here is a link to their Big Idea Report 2022. Wood estimates that the market for all 14 themes will grow by more than 15x between 2020 and 2030, which represents a 31% CAGR. I remain a loyal fan of Cathy Wood and will remain invested in the long run. If you want to pick individual winners than more power to you. But ARKK is where I want to be. And who knows, maybe the Knicks make another run for the playoffs in 2023.

Wood is Not Afraid of Buying the Dip

Wood began gaining notoriety for buying the dip when her fund purchased the electric vehicle company, Workhorse Group (WKHS), in February 2021.

Recently, Cathie Wood just purchased $24 million worth of RBLX on February 16^th 2022, after the online gaming platform dropped 27%. That same week, Wood also snapped up 146k shares of Sea Limited after shares fell.

Wood has called a five-year price target on Tesla of $3,000 and bought an additional 33,482 shares in January, when the stock tumbled 11% on news of supply chain disruptions. Cathy Wood did the same thing in December 2021, when she bought more shares of Robinhood Markets Inc. and Block Inc.

Wood has a deep conviction in her buying.  Her buying is smart and opportunistic. I do not believe the rumors of her fund buying up stocks solely to prop up the names and the fund. She sells when the time is right. For example, Wood closed a large piece of her position in Skillz Inc., selling 7.5 million shares at the beginning of February 2022.

Alternatives

If you don’t buy into Cathy Wood, but still believe in technology and want potentially more diversification and lower fees, look at the S&P Technology Select Sector fund (“IXT”). The three-year return is roughly 30%.

Other alternatives that I would look at include VanEck Vectors Semiconductor ETF SMH (“SMH”), which is up more than 21% for the year and Invesco QQQ ETF (“QQQ”), which is up more than 15% for the year.

References
Bloomberg
https://www.bloomberg.com/news/articles/2022-01-14/cathie-wood-outflows-grow-as-diehard-fans-face-biggest-ever-test?

Forbes
https://www.forbes.com/sites/sap/2022/01/19/2022-global-supply-chains-four-trends-that-will-shape-the-future/?sh=172da6343ef4

Fortune
https://fortune.com/company/bank-of-america-corp/

Reuters
https://www.reuters.com/business/arks-wood-turns-focus-deflation-stay-connected-stocks-2022-01-11/

Seeking Alpha
https://seekingalpha.com/article/4483928-arkk-rebound-or-continue-dropping

Simply Wall Street
https://simplywall.st/markets/us/tech

The Street.com
https://www.thestreet.com/investing/tech-sell-off-continues-signs-point-to-a-bubble-burst#are-tech-companies-overvalued

Disclosure
We are long ARKK 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 and have no business relationship with any company whose stock is mentioned in this article.

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Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication and are subject to change without notice.