ARKK - SARK: Early Buy Rating As ARKK Is Leaking

2024-01-16 09:15:51 ET

Summary

• The article discusses the concept of shorting ARKK by investing in SARK, which mirrors the performance of ARKK inversely.
• SARK allows investors to benefit from the weakening performance and enthusiasm of ARKK.
• I highlight the potential advantages of shorting ARKK through SARK.

With all of the amazing press and hype directed at ARK Innovation ETF ( ARKK ) and its media favorite, Cathie Wood, you would think that ETF would have a better total return over the past 5 years and 5 months than... wait for it... zero! But that's the difference between modern markets and the markets of my youth. "Innovation" and "speculation" are now too closely related. And thus, while there have certainly been some big, highly-publicized "wins" from Wood and her research-driven firm, I wonder how many "Wood stock" fans (the cute nickname for passionate ARKK holders... or should I say "hodlrs") are really in this for the long haul.

That's why I have used, and am again using, the AXS Short Innovation Daily ETF ( SARK ) in my portfolio. This is an "early buy" if you will. That means I see the potential for a big move up in SARK, which equals a big drop in the price of ARKK.

But since risk management, not "picks" and "ratings" is what real investing is about, I'm starting with a low single-digit position. That's actually taking a page from the book of iconic 1980s mutual fund manager Peter Lynch, who explained that he would often take very small positions in his giant Fidelity Magellan Fund, just so he could track its progress without having to look away from his holdings list.

SARK: The opposite of ARKK, essentially

SARK is simply designed to perform the opposite of ARKK on a daily basis. And while there is always potential slippage in that relationship when SARK is held for longer periods of time, in my own experience I have been able to hold it for weeks or months without feeling it was punishing me for owning it beyond a swing trader's time frame. That said, if ARKK goes up 30% instead of down 30% to its November 2023 low of $34, which is my best-case scenario on this tactical move, a holding of SARK will... you guessed it, declined by 30%.

As an aside, some investors would say that holding something down 30% is a bad decision, and that the buyer (me, in this case) was "wrong" to buy it, or but a "buy rating" on SARK. But think of it this way: if a position is taken at 3% of a portfolio, and it goes up or down by 33%, that's a 1% total impact (100 basis points) on the total portfolio. That's the same thing as losing 10% on a 10% position or 5% on a 20% position, which can easily be accomplished by holding SPY or QQQ for a couple of weeks in a market downdraft.

My point on risk management, and particularly in my current use of SARK and other volatile inverse ETFs, is that if the math is discarded, and the only thing an investor looks at is "what was your rating?" and not "how much did you risk?" then they have lost a golden opportunity to learn something that will save their portfolio when many around them are losing theirs.

What's the point of no return? Since that's what ARKK has given investors for 65 months

As for SARK and ARKK, here's a look at what I mentioned above. 5 years, 5 months, no return. Oh, I see that 200% "rip" coming out of the pandemic. But I ask myself, how often will we see conditions like that? Not the health and tragedy aspect, but an environment where "innovation" stocks can rally like that again. I suspect we won't see one until a true washout of high P/E business that may or may not be around in 5 years occurs. Oh, and ARKK is also flat since late 2019. And since the first few months of 2022.

That's why I track ARKK closely: because it is cult ETFs like this one that often provide the very best tactical opportunities in both directions. I have owned ARKK. Actually, more correctly, I have "rented" it, for weeks at a time when its chart and the market's surrounding narrative put the wind at its back. But I also have owned call and put options on it, since it is a tactical investor's wish come true. It is concentrated in "story" stocks, including its top holding Coinbase ( COIN ) which is suddenly being recognized for what it likely is: a major loser in the spot Bitcoin ETF parade that debuted last week.

COIN is in part a crypto custodian, and with spot ETFs, their territory was just invaded by dozens of custodians who will allow investors to buy spot Bitcoin ETFs and hold them there. Many of those custodians would not partake in the custody of crypto directly, but with a tangible product now available in 11 different "flavors" of ETF, that could be a game-changer.

Now, I'm no expert on crypto, as I've said before. I have done a decent amount of buying and selling of related ETFs and options.

What I care about it whether I can make money on it tactically from time to time, long or short. Most years, there's an opportunity to succeed both ways, via ARKK calls or owning the ETFs, and via SARK or ARKK puts. The options, like the underlying ETF, are so volatile, committing capital to puts or calls is only on the table for me when I think a huge move higher or lower is a very strong reward/risk tradeoff.

While I ultimately buy and sell based on technicals, that is the last step of a consistent process that starts with determining what I am willing to own at a price, and understanding what is inside, if it is an ETF. Here are the top 6 holdings of ARKK, and since I am a big fan of Seeking Alpha's Quant Factor Grades, those valuation grades, which look like a report card from one of the guys from the Delta House fraternity in the movie "Animal House."

These six stocks currently make up 44% of ARKK, and thus are 44% of what you are essentially shorting (though not shorting the stocks individually) through SARK. I am at the point where I am willing to put a little capital toward being short that group and the other 30 names that go with it in today's ARKK allocation.

I'll give ARKK credit for this: it has created a loyal fan base. How else do we explain that at a time when the price of the ETF fell 63% in 2 1/2 years, the assets under management only fell by slightly more. In other words, net-net there were few sellers. That's not part of my approach to investing, but apparently, it is for many others, since ARKK is still an $8 billion ETF.

ARKK also has an interesting relationship with the Nasdaq 100 Index, as implied by this chart below. For most of the past seven years, ARKK has been highly correlated to a 2x levered ETF that tracks that index. Translation: ARKK's price movement tends to be in sync with the Nasdaq, and risk-on investing in general. For all the chatter about this or that "innovative" business/stock it holds, it acts like the Nasdaq a lot of the time.

I read that chart above as follows: ARKK has not distinguished itself from a levered Nasdaq 100 "bet." It rises less but falls about the same. This is not an "all the time" situation, but it reminds us of how few ETFs really stand out based on what they own, versus what the broad market is doing. By "few" I mean a few hundred or so out of more than 3,000 ETFs. That's why I only track about 100 very closely, and those are most of the ETFs I write about on Seeking Alpha.

SARK to the rescue... but proceed carefully

If you are wondering why I'm talking so much about ARKK and its risks and rewards, and less so about SARK itself, that's because SARK and ARKK are mirror images of each other. They move in sync, just in opposite directions. However, at least recently, their rate of change on a 3-month basis has actually been a source of "alpha" in a sense for SARK.

As the chart above shows, there are times (like the past three months) where SARK goes down less than ARKK goes up. To long-short hedge fund managers, that's a source of alpha, since you didn't lose as much as the thing you shorted went up. A minor point, since losing 21% in three months is no one's idea of victory.

But to re-emphasize what I wrote above about SARK and about single inverse ETFs in general, the rationale for owning them is not always to "make a lot of money." It is to zero in on the potential to capitalize on the topping pattern in the price of an ETF or group of stocks, which in part acts as a hedge against my "long" positions. In an ideal case, ARKK underperforms the higher-quality part of the market (I believe the Dow will outperform the Nasdaq and ARKK this year). If so, just the difference in that "pairing" is a source of alpha, alongside my heavy slug of T-bills and other ETFs and equity holdings.

So, SARK gets a buy rating from me, with the important feature of that buy rating being that it is an "early" buy. That, to me, means I'm taking a "baby" position right now, but would seek to increase it if I start to see a more convincing price pattern develop. Its price just broke up through its 20-day moving average, which is one of several hurdles I want to see a stock or ETF cross, along with that 20-day average turning from down or flat to up trending. So it is early, but not too early to dip a few toes in the water. SARK gets a buy rating, and thus ARKK, which I am not formally rating here, has an implied sell rating over that same tactical time frame.

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