The carnage underneath the surface of the market

While the S&P 500 recently made all-time highs before pulling back, underneath the surface there is rotational carnage unfolding. Once loved darlings of the tech and growth world, many of which came through most of 2021 relatively unscathed, are seeing significant multiple compression as the market discounts their valuations in a world of rising rates.


In just the last week the ARK Innovation ETF lost 10.75% of its value, taking out previous lows made in 2021, and leaving it at levels not seen since 2020.

The chart pattern looks rather ominous, both as it is making lower highs and lower lows, but also because it is accelerating to the downside. Throughout 2021 ARKK consolidated after the initially parabolic blow off top and correction, but the recent moves are painting a more stark picture where the ETF begins to look more top heavy.


The role that rates play

Both real and nominal rates are a big part of the downside pressure playing out. The velocity of rising rates has much to do with the Federal Reserve's apparent more hawkish pivot toward the triple threat of accelerated tapering, rate hikes and balance sheet runoff (aka QT).

There is a strong positive correlation with the 10-year bond price and ARKK, meaning that as the 10-year yield rises the ARK Innovation ETF comes under additional pressure. A correlation we see in other parts of tech and growth as well.



With real yields more than doubling in the first week of January, the pain experienced in much of negatively rate sensitive longer duration assets has been rather profound, with no exception seen in high beta growth.


In fact, bearish yield curve steepening, combined with rapidly rising both real and nominal rates on the longer end have been a key source of pressure as investors are beginning to reassess the risk of holding companies that have higher multiples and don't make bottom line profits, or in some cases even produce free cash flow. There's also revaluation happening within companies that have higher levels of debt and a more difficult time funding it within rising interest rate environment with tightening liquidity.

A red week for many S&P 500 components, but strength in energy and financials

Even the megacap tightens of tech have not come away unscathed as hawkish Fed minutes. The first week of January brought about a number of large flows out of technology, healthcare, real estate and in to financials and energy. The first week's heat map (courtesy of FinViz) shows some of the rotational flows within the S&P 500.

We also witnessed the S&P 500 equal weight index begin to outperform the market cap weighted peer, demonstrating the amount of lower weight components demonstrating impressive relative strength. The majority of which were more in the late cycle categories like energy, financials, aerospace and defense, industrials, and telecom.


2022 may be the year of the trader

I expect that this year may continue to be a more volatile market. One with less directional certainty and as a result full of shorter time horizon opportunities to potentially generate profits from the carnage happening underneath the surface. Like 2021, 2022 may see rotations back and forth, as well as ever increasing levels of volatility erupting in individual issues and up to the surface level.


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