Back in March, I slapped a strong buy rating on the ARK Innovation ETF (NYSEARCA:ARKK) on the belief that we’d see a big rally in 2023. So far, since that article we’ve seen ARKK return 13% against about 12% for the S&P 500. Meh.
However, given the selling we’ve seen in the past two months in equities in general, I think the time is probably right for another go in ARKK. This one is obviously volatile as it’s intended to capitalize on long-term growth trends. Sometimes it works, and sometimes it doesn’t, so this certainly isn’t for everyone. However, if it’s capital appreciation you’re after, I still think ARKK is a better buy than a traditional index fund as I continue to believe we’re in a bull market that’s not done yet.
What is ARKK?
Let’s have a refresher on ARKK’s composition before we dig into the technicals. I covered the philosophy of ARKK in the linked article above, so I won’t go through all of that again as it hasn’t changed. However, what has changed is the execution of the philosophy, as holdings in ARKK change quite frequently, and in fact, generally change daily.
Here’s a look at the current holdings, and you can see ARKK is far from a diversified fund with hundreds of holdings. I prefer ETPs that are concentrated because all you get with massive diversification is that assurance that a bunch of the components will underperform. In other words, we know stock market cycles favor certain sectors during different conditions, so owning every sector all the time just ensures at least some of your money is in the wrong place. Focused funds help you beat the market with the enormous caveat that you have to be right with your timing and allocation.
With that out of the way, we can see that ARKK’s holdings are all tech-focused firms, even if their business is in autos, payments, etc. Given it’s focused on long-term growth potential, that’s unsurprising, but again, you have to be okay with the inherent volatility and risk of this.
Concentration risk is big with this one at 63% of the fund in just the top 10 holdings. In addition, turnover is 55%, so again, it’s very actively traded and pretty heavily concentrated. As I said, I prefer funds like this but I also know a lot of you don’t.
Tech makes up about a third of holdings, with healthcare at a quarter, and communications and consumer discretionary at one-sixth each. With those four sectors, we’re looking at 91% of the fund’s assets. That means we can focus on these sectors for things like seasonality, which we’ll get into in a bit.
Technical outlook
Let’s turn our attention to the chart, which is a bit mixed at the moment, to be honest. However, so long as trendline support holds, we should see a run at the highs for ARKK later this year and into next year.
That trendline is the blue I’ve drawn in, with support currently just over $41, but rising rapidly. If that line fails, I would not continue to hold ARKK as that indicates a shift in sentiment from investors. Apart from that, the accumulation/distribution line looks great, as it hasn’t wavered during this bout of selling. The momentum indicators are mixed as they’ve bounced out of oversold territory, but only to the centerline. I’d really like to see the RSI and PPO crest the centerlines but it may take a trendline test for the bulls to muster the strength to do that.
Generally I’d use seasonality to have a look at upcoming returns, but in ARKK’s case, the holdings change frequently enough that I don’t see a lot of value in comparing ARKK over time. In other words, the comparisons wouldn’t be apples to apples, so it’s not of value to me. However, what we can do is look at seasonality of the top sectors in the fund.
Here’s the technology ETF under ticker XLK for the last five years, which is the largest sector for ARKK.
September is weak, but we’re getting towards the home stretch on that. Looking forward, October is better, but November is very strong, averaging more than 5% gains.
Healthcare is next up, and it looks even better.
After a weak September, October through December accounts for +7.4% average returns, so again, quite good looking.
Finally we have communications, which admittedly looks quite a bit worse.
Returns for October to December are about flat, so that’s pretty uninspiring. But if we take these together, the outlook for the next three months certainly look like the odds are for higher prices. Seasonality is a secondary indicator, of course, but it’s still an indicator, and it is more supportive of bulls than bears right now.
Sentiment says we’re ready to rally
One final point here is on sentiment, which looks to me to be extremely pessimistic right now. As we know, sentiment is a fantastic contrarian indicator, so when investors get super pessimistic, it generally means a rally is incoming. My preferred sentiment gauge is the equity put/call ratio, which is under ticker $CPCE. The daily CPCE is quite volatile, so it helps a lot to smooth it with moving averages, and below, we have the 5-day moving average of the CPCE with some important notations.
This is a one-year chart, and it shows the 5-day moving average in blue, as well as the 0.80 level. That level tends to represent extremely pessimistic sentiment where many more puts are being bought than calls relative to conditions we normally see. This indicator works on the other side as well, when sentiment is far too bullish. But right now, the 5-day average is 0.85, which is an extremely high level of pessimism.
I’ve put vertical blue lines at other times we’ve seen values this high, and every single one of them resulted in rallies. The “worst” one of these was a 6% rally, and two of them produced rallies of more than 40%. I’m not suggesting we’re going to see 40% from current price, but I certainly think we could see another rally that’s well into the double-digits.
The point of sentiment analysis is that if we’re already at extremely pessimistic, how much worse could it realistically get? Don’t get me wrong, sentiment can just keep going, but the odds are that we’re at or near a peak in pessimism for this cycle, which would then mean we’d also be at or near the peak of selling in stocks.
In light of that, I think we’re on the cusp of another rally in equities, and that means a rally in ARKK. I’m reiterating my strong buy rating.
Read the full article here