I first presented ARKK as a short idea in the January 3, 2021 of my Short Seller’s Journal issue at $124.49. And of course like every other insanely overvalued stock or ETF, it continued to run higher, with a high-close of $156 on February 12th. As air seems to be leaking out the stock bubble, ARKK has taken a 25% beating since the high-close. At one point Friday it was down 32% from the high-close. ARKK is an ETF that has attracted a high degree of speculative interest because it has invested heavily in many of the high-beta, Silicon Valley “tech” and bio-tech stocks.

These are stocks that have captured the market’s imagination to such an extreme degree that once again, just like in 1999, earnings or even the potential to generate earnings are irrelevant. The ARKK Invest website describes its investment thesis as “disruptive innovation.” It harkens back to 1999 when earnings were dismissed as “old economy” and the value of dot.com’s was derived from “clicks and eyeballs.” At some point as the stock bubble is popping, ARKK will turn out to be “disruptive” to its investors net worth.

The flip-side to a market that will chase any stock to Pluto as long as it keeps moving higher is when the music stops and the next “greater fool” vanishes, leaving the longs looking for a seat. The only buyers are shorts, many of whom have been squeezed into covering on the way up. In ARKK’s case, compounding the liquidity problem just described is the fact that many of its holdings to begin with are not very liquid.

An important facet of successful money management is prudent position management. The riskiest stocks also tend to be the most illiquid, especially on the way down. Cathie Wood has ignored this aspect of running a high-risk, high-return stock portfolio. 18 of her positions representing 19% of ARKK’s NAV would take about 20 days on average to liquid in an orderly fashion based on the 30-day average volume of each holding (this table was put together by @Motorhead – he and I share a lot of trading idea and this analysis showing ARKK’s lack of liquidity is his):

Take MTLS – Materialise – which creates and sells manufacturing and medical software, a highly competitive business dominated by the biggest software companies. ARKK owns 16.4% of equity. Based on its 30-day average volume, it would take ARRK 30 days to sell its position. That’s the best-case scenario and assumes ARKK is the only holder looking looking to sell a lot of shares. In a rapidly falling market, if faced with large redemptions like this past week’s $718mm of outflows, ARKK would not have a prayer of unloading a pro rata amount of shares of MTLS without hammering the share price. As it turns out, MTLS lost 26.7% of its value last week. It’s down 58.8% since February 9th.

But this is just a portion of the problem faced by ARKK in a falling market. As @Motorhead discovered, Nikko Asset Management paid a fee to ARKK to enable Nikko to mimic ARKK’s portfolio and sell it in Japan. Often Sumitomo Mitsui (which owns Nikko) will hold positions of equal size in the ARKK portfolio mirrored by Nikko. As an example, ARKK holds 8.56mm shares of MTLS and Nikko and Sumitomo each hold 2.65 million shares representing a combined 10.1% of MTLS’s shares. Thus ARKK, Nikko and Sumitomo in aggregate own over 26% of MTLS’ outstanding shares, thereby compounding the liquidity problem faced by ARKK.

“She’s cornered. I worked at Amaranth. (No, not on the nat gas team). I know what this looks like.” – @eddiemac3356 – Amaranth was a leveraged hedge that blew itself up in 2006 speculating on natural gas futures. The natural gas market began tanking and the guy running the position continued buying while other parts of the fund were liquidated to fund the margin calls. Eventually the fund could not meet margin calls and Amaranth collapsed – at the time one of the largest hedge fund collapses in history. “What this looks like” references the doomed strategy of selling highly liquid positions in order to double-down on the illiquid ones that are quickly losing value.

I reference this because, based on the daily changes in ARKK’s positions this past week, ARKK was selling liquid holdings like AMZN and AAPL to buy positions which have been battered hard over the last few weeks, like WKHS (Workhorse Group) and VUZI (Vusix Corp). WKHS plunged nearly 50% on February 23rd when it lost its bid on contract with the U.S. Postal Service to help modernize its delivery vehicle fleet. WKHS was a $2 stock in June 2020 and it looks like it will be headed back to that price. VUZI produces consumer “augmented reality” consumer products. It generates about $9mm in revenues (TTM) and multiples of that in operating losses. Vuzi fell 32% this past week.

Here’s ARKK’s top-10 holding as of Friday:

The point here is that ARKK is taking “swing for the fence” positions in stocks that really should still be private companies funded by venture capital funds run by sophisticated investment professionals investing the play-money of the wealthy. But the biggest stock bubble in history has enabled the VC funds to cash out early-stage, high risk ventures and shifted the immense degree of operational and economic risk of these companies onto the unsuspecting public.

And then along comes Cathie Wood, raising billions from the public and throwing the money recklessly into the illiquid stocks of high risk companies, many of which will not be around in the next 5-10 years. But not only is Wood tone deaf to position risk management, she’s selling liquid stocks to double-down on stocks for which price discovery is being rediscovered. Again, many of these positions were inadvisable investments to begin with except maybe in very small quantities.

I have recommended several of these names as shorts well before I started focusing on ARKK a couple months ago. Many of these names ran up to levels I would have never thought possible – chased higher by a flood of momentum-chasing retail idiots and hedge fund algos – but they are now losing altitude quickly. Zillow has plunged 32.1% in the last three weeks; Zoom is down 40.7% since mid-October 2020; Spotify is down 24.7% in the last 2 1/2 weeks; Teledoc is down 35.7% in the last 2 1/2 weeks; and of course TSLA, which is 10% of ARKK, is down 32% since January 26th – at one point on Friday it was down 39%. The top-10 positions represent roughly 47% of the value of the fund.

Ultimately, Cathie Wood is playing with fire. It’s easy to make a lot of money on highly risky illiquid stocks and look like a genius during a stock bubble. It’s even easier to blow up a fund and inflict financial damage on the investors when a bubble pops (just ask Bill Miller who was the “rock star” manager of Legg Mason’s Value Trust until he blew it up in 2008). Wood was regarded as a money management “rock star” recently.  At the time, I wondered if that was one of the “white swan” bubble-top indicators.


The commentary above is an excerpt from the Short Seller’s Journal, a weekly newsletter that dissects the latest economic reports and presents ideas for short seller’s. You can learn about it here:  Short Seller’s Journal information.