Earlier this week, I wrote a mystery that probably was easier to solve than an Encyclopedia Brown book. This week, I’m not even going to pretend there’s a mystery. I’m just going to cut to the chase and tell you what the crime is and who dun it.
What’s the crime? The tech market is about to die. No, it’s not interest rates again (though they’re clearly an accessory). It’s something else.
How do I know this? Wasn’t there that movie Minority Report where the bots knew Tom Cruise was going to kill someone before he did it? Yeah, I’m like that bot!
The poster child of this bull market has been Cathie Wood, the famed investor who runs Ark Investment Management. She’s going to kill tech stocks.
How do I know this? I don’t actually have some clairvoyance or artificial intelligence. But this is so blindingly obvious I don’t think it takes Nancy Drew to figure it out.
ARK Innovation
First, a little background. Who is Cathie Wood? She’s a now famous growth investor who has ridden all of the big tech giants of this bull market. She is most commonly associated with Tesla.
Her firm’s AUM went up ten fold last year to over $30B. The Reddit crowd loves her and follows her every move (note: consider that a clue, Blue).
Her most well known product is the ARK Innovation ETF (ARKK). This is an actively traded ETF. That is important because actively traded ETFs are required to disclose their holdings daily (note: that’s another clue).
Originally, this was considered a disadvantage because other investors could look at what you’re buying, surmise you would buy more, and try to front run you and drive the price up. However, that’s boomer thinking.
Bubble thinking is, if you want a stock to go to the moon, you let everyone see how much you’re buying. This lets the quants (and the Reddit crowd, but more importantly the quants) buy more and create momentum.
You don’t care that you have to buy higher the next day because you know the quants will drive it up ever further because the momentum is strong. Traders love momentum!
So, instead of being shy about what you are buying, you advertise it to kick off a momentum spiral. Or what some might call a flywheel…your buying begets others buying begets you buying more begets them buying more.
And since we’re in a market where valuation is irrelevant, nobody ever gets off the ride (yes, that’s your third clue. Now let’s put them in our notebook).
The Precog’s Vision
OK, I looked it up. Those bots in Minority Report were called precogs. So what do they see Cathie Wood doing? Well, it’s actually more what’s going to be done to her.
As I discussed last time, higher interest rates are bad for tech stocks. ARK holds all the high flying tech stocks. As tech goes down, ARKK goes down. NASDAQ is down about 10% from the peak. ARKK is down 25%.
So far, ARKK has not seen redemptions. What happens when it does? ARKK needs to start selling all those tech stocks it loves. What does that mean? Game over.
Let’s play out the precog’s vision. First, ARKK starts selling. That alone will put some pressure on tech stocks, but hey, she’s one fund. How bad can it be?
If ARKK were a traditional mutual fund, then not bad at all. But remember our second clue! It’s an actively managed ETF that needs to disclose its trades daily.
Just like the momentum has helped it on the way up, once the quant funds smell blood in the water, they will attack and try to force tech stocks down to create more selling pressure.
This will get ugly quickly as other firms will try to corner her the way the Reddit crowd attacked Melvin. Wait, the Reddit crowd? Weren’t they one of our clues?
Reddit Rebellion
Indeed! Why do they matter? Well, they do love Cathie and one might suspect WSB will defend her and try to fight the quants that try to take her down.
But this isn’t GameStop. The market cap of her holdings is much higher than GME. Retail isn’t big enough to fight a hedge fund tidal wave. In fact, they are more likely to read the tea leaves and flip on her.
Just as the WSB crowd figured out they could squeeze stocks with heavy short interest, why won’t they figure out they can squeeze concentrated tech funds that are facing redemptions and have to sell…especially when those tech funds have to disclose their positions daily!
WSB will realize the easy money is on the short side (well, technically, they’ll likely do it through puts since short sellers are evil and puts have more leverage) and get big time short tech.
While they won’t have as much financial power as the institutional funds, the pile on impact plus the negative publicity will cause even more panic that the bubble has popped.
How It Ends
With tech stocks a lot lower. In fact, a lot lower than they would be without Reddit and active ETFs. Just as their buying power was self fulfilling on the way up, it will be self fulfilling on the way down.
One way to assess potential stock volatility is to figure out at what stock price a new group of shareholders will be willing to step in and buy. For example, the reason energy stocks got so low was once the value buyers gave up on them, there was no one left to buy so they went far below a normal bottom.
Financials have faced this problem since the crisis. The people who used to own financials have underpeformed for so long and there are no natural buyers to take over, so the stocks sink to unnaturally low valuations.
When the WSB crowd finally abandons GME, who is left to buy it? That is why it will likely go back to $5.
But the worst case of this is fallen growth. When a growth stock loses its supporters, the only people left to buy are value investors and they’re not going to start sniffing until it’s down at least 50%. At least. Realistically, more like 80%.
If growth and momentum buyers abandon the Teslas of the world, the only buyers left are those who will value it on free cash flow (if it has any) or maybe 12X earnings. That is a long way down! If you’re trying to figure out when it will end, I’d guess probably when ARK’s AUM is down to about $5B.