Why trouble may loom for stock market if Cathie Wood’s ARK Innovation ETF fails to bounce

An attempted bounce on Wednesday fizzled, with the ETF ARKK, -1.54% ending the day down 1.5% at $111.55. Adams sees support in the $105 to $110 region. But if that fails to hold there isn’t much in the way of further support until closer to $90, making it very important that the fund and other high-growth areas of the market find a bottom soon, he said.

ARKK and other funds focused on previously highflying growth stocks are sitting on huge gains since the pandemic-inspired bear market lows of last March, turning Wood, founder, chief executive and chief investment officer of ARK Investment Management LLC into one of Wall Street’s star stock pickers.

See: The Tom Brady of asset management? People love to hate Cathie Wood, but her funds get results

But more recently, they have come under heavy pressure as investors, betting on a broad U.S. economic reopening and the release of pent-up consumer demand this summer, have favored more cyclically sensitive sectors and value stocks.

A sharp selloff in high-profile tech shares sent the Nasdaq Composite COMP, -0.37% and the more tech-concentrated Nasdaq-100 NDX, -0.30% down nearly 2% on Tuesday, while ARKK fell 3.1%. The damage elsewhere was more contained, with the S&P 500 index SPX, +0.07% falling just 0.7% on Tuesday, while the Dow Jones Industrial Average DJIA, +0.29% eked out a gain.

Read: Who sparked the tech-stock selloff? Blame the boomers

ARKK remains up nearly 103% over the last 12 months but is down 7.6% this week and more than 10% for the year to date, leaving it more than 30% below its 52-week high shy of $160 in February. Major indexes were mixed Wednesday, with the Nasdaq erasing a modest rise to end with a loss of 0.4% while the Dow rose 0.3% to finish at a record.

Adams was cautiously optimistic about prospects for a bounce.

“Many of the ARK and similar funds that hold high growth stocks are now trading between one and two standard deviations below their 50[-day moving averages] where buyers usually enter,” said technical analyst Andrew Adams in a Wednesday note for Saut Strategy. “I don’t think the market needs to go down any more, so a bounce attempt should occur given all the nearby support levels.”

But if a bounce doesn’t occur, “I think we’ll then have to be a little bit more concerned,” Adams wrote.

ARKK came close to hitting a band two standard deviations below the 50-day moving average on Tuesday, which means it is already oversold and hitting downside extremes, he wrote.

What are the implications for the broader market?

“If the high-growth areas start breaking support and taking the rest of the market down with them, then maybe the 3,980-4,000 zone in the S&P 500 will be retested after all,” Adams wrote. The S&P 500 finished at 4,167.59 on Wednesday, 1% off a record close of 4,211.47 set on April 29.

A test of support in the 3,980-4,000 area would mark a pullback of only 5% to 6%, but given the damage seen in other parts of the market could lead to “some huge losses” elsewhere, he said. “I’d rather avoid that, so for now I think we can use yesterday’s lows as a test to see if that represented a selling climax in much of the market.”