Back in mid-February, speculative small caps topped, and a vicious rotation out of growth and into value names began. For the next three months, we saw constant pressure on the names that had been favored, and many fell deep into bear markets.
A good illustration of what occurred in many sectors of the market is the action in ARK Innovation exchange-traded fund (ARKK) , which holds high-beta growth names primarily. ARKK topped on Feb. 16 at almost $160 and then finally bottomed on May 13 at around $100, which is a drop of 37%.
While this drop was occurring in many sectors of the market, the Dow Jones was trending steadily higher. Value names were driving the indexes and hiding the misery underneath.
Now we see a repeat of some of this action. ARKK is dropping 2.5%, and my list of small speculative caps is deep red. On the other hand, the S&P 500 is doing nothing with a loss of just 0.25%.
The likely catalyst for this action is that the Fed is going to be less dovish when it announces its policy Wednesday. Will it start liquidating bonds more quickly? Will it move up the timing of potential rate hikes? We will hear more about the transitory nature of inflation, but the big issue is whether the Fed is going to start acting sooner rather than later.
The poor action now reflects concerns that growth and speculative names will underperform in a higher interest rate environment. This may just be a temporary bout of nervousness, but the similarities to the top in February are hard to ignore. The risk to the downside is not nearly as great at this time, but the correlated nature of the selling means that stock picking is futile and that we have to worry more about correlated selling and rotations.
The Fed meeting will be one of the more consequential ones in a while, and the market is nervous about it right now.