The ARK Innovation Bubble Finally Popped. Is the Stock Market Bubble Next?

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Despite Tesla’s banner year, ARK Innovation is set to end the year down more than 20%, its largest holding.

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dream time

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Another year, another bubble bites the dust.

We’re talking, of course, about a bubble in hypergrowth stocks owned by the ARK Innovation Exchange-Traded Fund (ticker: ARKK). A year ago in this space, I highlighted the fund and the stocks in it as a potential bubble, and it seems to have popped. Big holdings such as Roku (ROKU), Teladoc Health (TDOC), and Zoom Video Communications (ZM) have fallen more than 30% in the past year, and ARK Innovation is down more than 20% despite a banner to end the year. ready for year from Tesla (TSLA), its largest holding.

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Worse, despite the fund’s spectacular gains since its launch in 2014 — it’s returned more than 340% — its investors have been terrible market timers. He invested billions in the fund during 2020 and early 2021, driving its flow-weighted price to about $109, according to StoneX strategist Vincent Delouard, or 16% of Wednesday’s close of $93.83.

Big drops often look like big opportunities, but there are likely more downsides ahead for ARK Innovation. 22V Research’s John Roke notes that the ETF’s large decline has left it looking oversold, but it still hasn’t been able to rally meaningfully. It continues to trade below its 40-week moving average, while its chart relative to the S&P 500 also looks indifferent. Roque expects the ETF to continue its downside downside at $60, or 36%, from Wednesday’s closing price. ,[The] The inability to bounce back after recording an oversold reading strongly suggests that the item in question is going down.

The bubble was not the only one in the fast-moving disruptions that popped in 2021. Solar and clean-energy stocks, which rose in 2020, slipped this year along with both the iShares Global Clean Energy ETF (ICLN) and Invesco. The Solar ETF (TAN) is down about 40% from its 52-week high. Special purpose acquisition companies, which were so hot during the last few months of 2020 and into ’21, ultimately failed, with the Defense Next Gen SPAC Derivative ETF (SPAK) also falling nearly 40% from its February highs.

As in previous years, the overall market weathered the storm. Bubble stocks either weren’t big enough to dent the S&P 500’s returns or weren’t in the index. With two days left to go into 2021, the S&P 500 was up 28%, on pace for its best year since 2019. But with the index trading 21.9 times forward earnings, the question remains whether the entire market is a bubble in itself.

The fact that the index’s profit is roughly equal to its rate of earnings growth suggests that this is not the case. The high valuations and heavy concentration in a small number of stocks, combined with the speculative behavior of retail investors, suggests that it is — and bubble spotters are quite confident in their own right. “Yes, we are in a huge—perhaps unprecedented—equity market bubble and it keeps getting bigger and bigger,” writes David Rosenberg, founder of Rosenberg Research.

No matter what you want to call the current run-up, large-cap valuations are high enough that investors shouldn’t expect much over the next decade, according to BofA Securities strategist Jill Carey Hall. Based on the historical correlation between valuation and earnings, at less than 21 times earnings, the large-cap Russell 1000 is set to deliver just 1.7% returns over the next 10 years. However, small-caps are set to outperform. Small-Stock Russell 2000,
At 15.5 times forward earnings, there would be an 8.8% annualized return.

Trying to convince people about the merits of small-caps may not be easy. The Russell 2000, though up 14% in 2021, is still nearly 12 percentage points behind the Russell 1000 and looks set to underperform for the fifth year in a row. Still, it’s only a certain type of low-quality small-cap that had a tough time in 2021, and those companies make up about a quarter of the index. This helps explain why the S&P Small Cap 600 . Why,
Which has just one-tenth of its portfolio among non-earners, up 26% this year, only a touch behind the S&P 500.

The 11 percentage-point difference between the Russell 2000 and the S&P Small Cap 600 is the largest since 2000. Certainly, this was the peak of the dot-com bubble, which marked the beginning of a period of strength for small-caps. stock. And while the S&P 600 continued to outperform the Russell 2000 over the next two years, both outperformed the S&P 500. Hall expects something similar to happen in the years to come.

“And if today’s market environment shares some similarities with ’99/’00 … it could prove to be a strong decade for small caps,” writes Kerry Hall.

We can always hope.

Write Ben Levishon at [email protected]

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