Cathie Wood’s ARK Stumbles as Tech Trade Unwinds – The Wall Street Journal

Her flagship innovation fund has fallen 15% in the first eight trading sessions of May. That is more than what the ETF shed in February and March when worries about a sharp rise in bond yields began to dent the allure of growth stocks. Shares of the fund are now down more than a third from their mid-February high after more than doubling last year.

The Nasdaq Composite, in comparison, has stumbled 6.7% in May and set a record as recently as April 26, while the S&P 500 is off 2.8% and hovers closer to its record highs.

Many of the stocks that sit in ARK’s funds are unprofitable tech and biotech companies whose lofty valuations are tied to bets that they will one day dominate their industries. Those stocks have stumbled lately on worries about rising inflation and an eventual tightening of monetary policy. The latest sign of inflation came Wednesday when the Labor Department said its consumer-price index jumped 4.2% in April from a year earlier, the highest 12-month level since the summer of 2008.

Analysts and money managers also say there are rampant concerns over the rich valuations of companies that boomed during the pandemic but whose growth now appears unsustainable as the economy moves closer to a full reopening.

“You have a pretty clear trend of the frothiest and costliest corners of the market needing to be repriced,” said David Bahnsen, chief investment officer of the Bahnsen Group, a $2.8 billion money-management firm. “And the darlings of 2020 have a ways to go.”

Several of those darlings litter ARK’s funds and have given up a chunk of the large gains they racked up last year. Tesla Inc., TSLA -4.42% the biggest holding in several of ARK’s funds, has tumbled 17% in May after surging 700% in 2020 and is on track for its first annual decline in five years. Teladoc Health Inc., TDOC -3.92% Fastly Inc., FSLY -10.57% Twilio Inc. TWLO -3.19% and Crispr Therapeutics AG CRSP -2.61% —other pandemic winners that generate little to no profits—are down even more.

Few tech stocks have been left untouched by the selloff. Even the FAANG stocks— Facebook Inc., FB -1.30% Amazon.com Inc., AMZN -2.23% Apple Inc., AAPL -2.49% Netflix Inc. NFLX -2.04% and Google parent Alphabet Inc. GOOG -3.02% —have suffered declines of about 5.5% to 9.1% this month.

The tech behemoths reported blowout earnings for the latest quarter, but many investors say the economic winds have shifted away from the group. For starters, the economy is getting back on firmer footing as more Americans get vaccinated and businesses fully reopen, creating a more conducive environment for a wider variety of stocks to run.

“The quick money is gone,” said Max Gokhman, head of asset allocation at Pacific Life Fund Advisors, which manages $32 billion in assets, of the tech trade. “When growth is abundant in an economy, that’s when lower growth stocks, such as value, do better because you don’t need to pay a premium for growth.”

Mr. Gokhman said Pacific Life’s funds remain tilted toward value stocks, such as regional banks, energy firms and consumer staples that trade at low multiples of their book value, or net worth.

Inflation also appears to be simmering, with analysts and investors pointing to shortages in the labor market, rising commodity costs and a pickup in consumer prices. The Fed’s primary tool for combating inflation is raising interest rates, something the central bank says it has no intention of doing this year or next. Yet, the influx of fiscal stimulus along with near-zero rates has spurred speculation that the Fed might have to act sooner to rein in an overheated economy.

Investors said any chatter about a potential rate increase puts tech stocks on unstable footing, especially after last year’s gangbusters performance. That is because interest rates are a significant variable in often-used valuation models that discount cash flow. Higher rates, under those models, diminish the value of future cash flows, lowering the ceiling on valuation projections.

“The outperformance in megacap tech stocks has likely run its course,” said Andrea Bevis, a senior vice president at UBS Private Wealth Management. “We believe the next leg of the equity rally will be driven by value stocks, and small and midcap segments of the market.”

The latest downdraft has cut valuation multiples in half for some of the pandemic’s biggest winners. Tesla shares now trade at 116 times future earnings, down from nearly 220 earlier this year, according to FactSet. Online marketplace Etsy Inc., ETSY -6.18% whose shares quadrupled last year, trades at 49 times earnings versus more than 100 times in January. Its shares have fallen 20% this month.

Both stocks remain relatively pricey. The S&P 500’s consumer discretionary sector, where the stocks reside, trades at 35 times earnings, while tech is at 25. The S&P 500 stands at 21 times earnings, above its five-year average of 18.

The tech sector’s repricing has shaken billions of dollars out of growth and tech funds, including those run by Ms. Wood. Investors have pulled $1.6 billion from the ARK’s ETFs over the past month, with nearly $600 million coming out of the innovation fund, according to FactSet. That’s on top of about $7 billion investors have pulled from other U.S. growth and tech funds so far this year. Over the same period, more than $30 billion has flowed into U.S. value funds.

Ms. Wood has repeatedly brushed off worries about the losses and outflows, saying the firm invests in stocks for at least five years, and nothing has changed other than their cheaper price tags. In fact, ARK has taken advantage of the selloff to add to its positions in some beaten-down stocks such as Twitter Inc., Peloton Interactive Inc. PTON -1.82% and Roku Inc. ROKU -1.94% in recent sessions.

“Many consider what has happened in the last three months to be the beginning of another, or the equivalent of the tech and telecom bust,” Ms. Wood said in a Tuesday webinar. “We do not believe that’s the case in the least. The kinds of growth that we’re going to see coming out of these technologies, we believe, the kind of growth is going to be astonishing.”

Other investors have followed Ms. Wood’s lead—they stepped in to buy the dip in tech stocks Tuesday, helping the Nasdaq erase nearly all of a 2.2% intraday decline by the end of the session. ARK, in this case, tracked the market, with its innovation ETF closing up 2.1%.

But the tug of war in the stock market will likely continue, with several money managers saying they have no intention of leaning back into the tech trade soon. Tuesday’s reprieve for tech stocks has already proved short lived after another tumble Wednesday, sending ARK’s innovation fund down 3.7%.

“I don’t think there’s any place in the tech space where there will be easy growth or cheap growth,” said Mr. Bahnsen. “I believe we’re living in an era that favors cash-flow generating companies.”

Write to Michael Wursthorn at [email protected]