Growth stocks have crashed this year. A variety of factors are behind these falls, with the main culprit being the Fed’s shift from massive stimulus to aggressive hikes. Growth stocks are generally not very profitable, require cash and are long-term investments, so rising yields are a serious headwind. They are also victims of their own success – during the 2020 recovery and early 2021 bubble, many of them doubled and then doubled again, stretching valuations. Cathie Wood’s ARK Innovation Fund (NYSEARCA:ARKK) soared into bubble territory gaining 387% from the 2020 low to the 2021 high and made a parabolic move on the chart. Each trend was steeper than the last…until the trend broke.
When the parabolic trend breaks, the bubble bursts. This is what happened to the majority of growth stocks in 2021 and this year. ARKK has created an almost perfect bell curve, or Rodrigue Bubble:
ARKK returned to the mean and entered the phase of despair. Comparisons with the Nasdaq 2000 bubble are compelling.
The analogy suggests that there might be a developing bounce, but the bottom is not for ARKK.
after the pop
Many stocks are not recovering from bubbles. Sometimes they go bankrupt or go sideways for years and decades (think Intel (INTC)). However, some are recovering and many of the high flying tech stocks from the 2000 peak have continued to develop new uptrends. Indices and ETFs such as ARKK have a better chance of rebounding because they are diversified.
As we know, the Nasdaq crash of 2000-2002 recovered and continued to form another significant uptrend. In fact, behavior after a burst bubble can follow a definite path, as can behavior during and immediately after the bubble as described by Rodrigue. Comparing well-known bubbles like Nasdaq, Gold, and Bitcoin side-by-side is quite revealing. The movements may occur at different speeds, but the trajectories of each period are almost identical.
The table above raises some big questions. Will Gold Follow Bitcoin Lower? Will Nasdaq Follow Gold and Bitcoin? And finally, going back to our original point, will ARKK form a second bubble and follow the 3 examples above?
The chart above suggests growth and ARKK is not dead. The Fed moves in cycles and there should still be a time when the environment will support a rally in growth stocks. Indeed, now that old stocks such as Amazon (AMZN) and Apple (AAPL) have matured, new stocks will take their place and ARKK will likely own many of them. However, the path to the top will likely be slow. The chart above suggests that the bottoming process could take up to four years and even when the next trend is underway, it could be very slow initially. How you approach this information depends on your trading style. The best prices for growth stocks are likely to be reached next year, but they could trade sideways in the doldrums for years; costly in this high inflation environment. There are probably much better sectors out there, and even holding stocks with slow-moving dividends could be more profitable.
ARKK follows a classic Rodrigue bubble pattern. It’s still in a dangerous phase, but I think it has every chance of hitting bottom and forming a second, even bigger bubble over the next decade.