ARKK in Peril as the Fed Pivots to a Higher Interest Rates Regime: Top Trade Q1 2022
The Federal Reserve made one thing abundantly clear at the end of its December meeting: the U.S. economy is moving toward tighter monetary policy amid upside inflation risks and improving labor market conditions. At this gathering, the FOMC doubled the pace of its taper to $30 billion per month, a move that will allow the asset purchases program to conclude in March, three months earlier than originally planned. At the event, policymakers also signaled that they could raise the federal funds rate three times in 2022 to counter elevated price pressures, a much more aggressive normalization schedule than envisioned in September, when the median dot-plot expectation only pointed to a half hike.
Although stocks initially gained despite the Fed's hawkish pivot, it is unlikely that broad-based bullish sentiment will prevail in the early stages of 2022, a situation that may pave the way for pockets of weakness in the equity market. This may be a good moment to entertain some trading strategies that capitalize on a potential pullback in risk assets.
First, I want to start by saying that I am not calling for a widespread sell-off. While the transition to a higher rates regime is clearly a headwind, stocks are not created equal. Based on this premise, it can be argued that some companies will feel the pinch of less accommodation more than others.
In my opinion, technology, but more importantly, growth stocks with exorbitant multiples and unprofitable businesses will stand to lose the most from the shift to an environment with less stimulus. Conversely, value-oriented companies with strong balance sheets and expanding margins may be the least affected.
With the speculative corner of the market in peril, I believe that the ARK Innovation ETF (ARKK) is in a very precarious place and, as a result, prone to a big drop in the coming months. ARKK is composed of long-dated innovative growth companies with little or no revenues, that happen to be very sensitive to rising rates expectations because their value rests predominantly on future earnings. As the Fed lift-off approaches and investors reassess valuations, ARKK’s holdings could take a hit, sending the ETF’s price tumbling.
For this reason, I am inclined to bet against ARKK in the first quarter of 2022. There are many ways to create a bearish position in an underlying, from an outright short to derivatives to limit the downside. Focusing on the options market, a bear put spread for a net debit is often used to play a bearish thesis as the strategy allows traders to define their risk from the outset while reducing the premium paid to set up the trade (buying a standalone put will be more expensive than a bear put spread, even more when volatility is high).
Zeroing in on technical analysis, I would not just enter the trade at any point, no! After all, I want the odds to be stacked in my favor. That said, I would personally wait for a bounce and only jump in if ARKK reaches some resistance level. Visual inspection of the daily chart shows that the first major resistance appears near the 104.00 psychological mark. Another key, and perhaps more significant, resistance can be seen in the 125.75 area, although price may not get there for a while if selling interest accelerates right off the bat in the new year.
In case of an outsize sell-off, the first support to consider can be found at the 90/89 band (at the time of writing). If this floor is breached decisively, the 61.8% Fibonacci of the 2020-2021 rally, near 81.26, could become the next downside focus before the 60-region comes into play.
ARKK TECHNICAL CHART (DAILY TIMEFRAME)
ARKK chart prepared in TradingView
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