ARKK – Upgrading ARKK To Strong Buy

The stock market’s characteristics have changed dramatically in 2023. We’ve had more than a year of flat-to-down action, depending upon the index you’re looking at, but starting in January of this year, the behavior of US equity markets has been unbelievably bullish.

I see tailwinds for US equities all over the place – many of which I covered recently in my bullish TQQQ article, and can be read here – including sentiment, interest rate movement, and rotation of money from value-oriented corners of the market to growth-oriented ones.

Those looking for exposure to growth can select individual stocks, or find funds with exposure to growth. I’m not aware of any fund that has more exposure to outright growth potential than the now-infamous ARK Innovation ETF (NYSEARCA:ARKK).

We all know the story; ARKK exploded to the upside during the pandemic, but has now given back all of its gains. There were good reasons for that, as economic and interest rate headwinds caused investors to sell growth and buy value. However, those tailwinds have abated and it’s quite clear to me that Wall Street wants exposure to growth, and therefore, so do I.

The last time I covered ARKK was back in September of 2021, and the article was titled “Look Out Below”. The fund is down 67% since then, as many of the risks outlined in the article came to fruition. However, those risks are now priced in, according to what I’m seeing, and the risk has shifted firmly to the upside.

What is ARKK?

ARKK is an actively managed fund that seeks to give investors exposure to companies that are highly focused on innovation. The companies in the portfolio tend to have little in the way of profits, but a lot in the way of future growth potential.

There are very obvious risks to this kind of fund, and those risks have been on full display in the past year or two as the price of ARKK fell off a cliff. Stocks like the ones in the ARKK fund are heavily dependent upon investors paying a premium for future growth. When that premium goes away – as it did in the past couple of years – the prices of these stocks seemingly cannot find a bottom. That’s a risk you must be willing to take with ARKK. However, as we’ll see below, I believe this risk was fully priced in as of December of 2022, and that the risk is firmly to the upside now.

The decline of ARKK has been the stuff of legends. It outperformed everything by hundreds of percentage points into early-2021, and has now given all of that back. In fact, since inception, the fund is now worse off than a simple S&P 500 or Nasdaq fund. It’s been a wild ride.

The holdings of ARKK change everyday just as soon as we get a print of what the fund owns, it’s generally slightly out of date. Still, we can get an idea of the kinds of companies ARKK holds with the below. The overall composition doesn’t change much as ARKK finds a few companies it really likes, and trades its positions around those companies.

Obviously, Tesla (TSLA) remains number one as ARKK rode Tesla’s meteoric rise to massive gains, and has now ridden it down to losses. But these companies all have a few things in common. They are generally operating at a loss, or with narrow profit margins. They are generally early on in their projected growth cycle. They either offer some sort of competitive advantage, or are working on some sort of sustainable advantage. None of these are “sure bets” or safe places to park money. These are aggressive growth stocks with massive risks and massive rewards. That’s not for everyone, and ARKK is certainly not for everyone. However, if I’m right about where US equities are going this year and beyond, aggressive growth is exactly where you want to be.

Money is rotating bullishly

That’s the fundamental case for ARKK, but anyone that reads my work knows that I follow the money more than anything, and for that, I use charts. Let’s take a look at the bull case for ARKK, beginning with the growth to value ratio. This ratio shows us whether money is rotating into growth names, or rotating into value names. Bull markets see the former, while flat or bearish markets see the latter.

Growth underperformed value by 28% from late-2021 to late-2022, but has outperformed by almost 17% in the first quarter of this year. Wall Street has voted with their money and said growth is the place to be, not value. That argues for Nasdaq outperformance over the S&P 500, growth over dividend stocks, etc. I expect technology and growth stocks to blow past anything else this year, and ARKK is a great way to get exposure to both.

One factor I mentioned above was interest rates, and the reason is simple; Wall Street discounts future growth by risk-free rates, which are measured by US Treasury rates. The benchmark 10-year Treasury is the oft-quoted one, and I have a chart of it below. Essentially, when looking at growth names, lower rates are better, and higher rates create a headwind for growth stock valuations.

The 10-year yield is at critical price support right now, and I believe the path is lower. This chart has all the characteristics of an asset that has already topped, and as such, it is my view that whether it breaks down next week or next month, it’s very likely to break down. When it does, ARKK and other growth-oriented areas of the market will get additional leeway on their valuations, and that means higher prices.

Now that we have the backdrop, let’s look at ARKK itself. This is a two-year chart, which shows the almost unbelievable decline the fund’s price.

From spring of 2021 to the end of last year, ARKK underperformed the S&P 500 by more than 72%. That’s difficult to imagine, but that’s reality. However, as I mentioned above, the look and feel of this market is wholly different to what it was back in December, and ARKK should continue to be a massive beneficiary of that going forward.

The accumulation/distribution line is flying higher, indicating intraday buying. The A/D line measures whether the closing price is higher than the opening price, and in up trending assets, you tend to see the A/D line lead the way. It’s a way to measure whether Wall Street is buying dips or selling rips, and it’s firmly the former with ARKK.

The PPO is turning higher again at the centerline, which is very bullish. And the 14-day RSI is nowhere near oversold levels, which is bull market behavior. All of this lines up with ARKK going higher this year, and that’s why I’m long.

I’ve annotated a symmetrical triangle on the price chart, and that’s the obstacle the bulls need to break through. The triangle is almost closed so we’ll get resolution in the near future, but it’s something to watch in the coming days.

Finally, the bottom panel has the fund’s 250-day correlation to the 10-year yield, and at -0.76, they are quite inversely related. Should the 10-year break down, as I mentioned above, that’s yet another tailwind for ARKK.

Final thoughts

The stars have aligned for ARKK to have an epic year, and that’s a train I want to be on. I believe 2023 is going to produce a massive bull run in the US equities markets, and that it will be led by growth names. ARKK is a great way to get exposure to growth names, and I’m very bullish.

I mentioned some risks above and I want to reiterate this is not for everyone. If the bull case goes off the rails, ARKK could very easily make new lows, which would be a long way down from here. I don’t think that’s going to happen, as I believe the worst was priced in back in December, but this is a high risk, high reward setup.

Overall, however, I think we’ll look back at ARKK in the mid-30s and wonder why we didn’t buy more, and I’m therefore upgrading the fund to a strong buy.