The 'Canary in the Coal Mine' Is Down, but Not Out

In the past, miners used birds as an early warning system for carbon monoxide underground...

Canaries were the best candidates. Due to their extra-high efficiency lungs, they are able to fly great distances... but on the flip-side, they're ultra-susceptible to airborne toxins.

So if a miner's caged canary went limp, that meant the gas was coming... and it was time to get out.

Many investors are betting on a "canary" situation in one sector. But they may be rushing for the exits too soon. Let me explain...

Until early last year, telemedicine company Teladoc Health (TDOC) was riding high. The stock had a dizzying bull run that started in late August 2019. At its peak last February, it had notched gains of 433% – a handy 18-month winner.

By March, the stock had plummeted. Teladoc traded sideways for a time... Then, last November, it entered a tailspin from which it hasn't yet recovered. Shares have fallen more than 70% from their February peak.

What happened to Teladoc isn't the only such story in the technology sector today, though. A number of tech stocks have had similarly dismal results in recent months.

One great way to track the performance of high-growth tech stocks is through the Ark Innovation Fund (ARKK). This fund is known for its high volatility, its massive gains since the pandemic low in early 2020, and its highly visible CEO, Cathie Wood.

It's also notable that the fund's third-biggest holding is... Teladoc. So you can imagine the overall backdrop for this growth-stock "indicator" today.

Now, ARKK's recent performance has not been as harrowing as Teladoc's. Solid performers like electric carmaker Tesla (TSLA) and music-streaming giant Spotify (SPOT) have helped spare the fund from a rout on that level.

But the fund still lost 23% in 2021... And it has put up several straight days of losses recently.

Investors see ARKK as a "canary" for the tech sector, and for growth stocks in general...

Last week, short-sellers bet against ARKK at near-record levels. Short interest as a percentage of shares outstanding reached 6.86%, just barely below its previous all-time high of 6.89%.

We can also see this action through the Tuttle Capital Short Innovation Fund (SARK), which was created to return the inverse of ARKK's performance. Broadly speaking, when ARKK goes down, SARK goes up. And this fund is up more than 40% since its November debut.

There's no doubt that tech stocks are hated right now. But as contrarians, we read this as a sign of a coming reversal.

ARKK's basket of high-volatility and high-growth stocks is a risky short... Any number of changes could send its share price higher again.

Meanwhile, negative sentiment surrounding the fund is near all-time highs. And extremes like these tend to go in unpredictable directions.

It's true that the Federal Reserve's policy looks increasingly hawkish. That's one of the reasons investors are bearish right now. Many of the tech companies ARKK holds are still in their growth phase, which means they're still on the path to turning profitable.

Easy money may be drying up... And the clock could be running on growth companies' ability to operate at a loss. It's not hard to imagine an end to the growth-stock gravy train.

But as longtime readers know, whenever investors bet on an outcome in droves, the opposite tends to occur.

Although we won't know for sure until the trend changes, this negative sentiment is a strong sign that a reversal may be coming.

Right now, the canary might be looking weak... But I wouldn't bet against it just yet.

Good investing,

Sean Michael Cummings

Further Reading

When company executives start selling their shares, investors get jumpy. They think that insiders know something we don't and that we're nearing a market top. But this selling might not always mean what you expect... Get the full story here: Insider Selling Isn't Always a Sign of the Top.

With all the gains we've seen in stocks over the past few years, you might think we're headed for a crash. But don't be fooled into thinking that stocks are bound to suffer this year. This indicator tells us we could see even more gains ahead... Read more here.

Market Notes
HIGHS AND LOWS

NEW HIGHS OF NOTE LAST WEEK

Dell Technologies (DELL)… laptops and computers
GlaxoSmithKline (GSK)… pharmaceuticals
CVS Health (CVS)… drugstores and vaccines
W.R. Berkley (WRB)… insurance
First BanCorp (FBP)… regional bank
Archer-Daniels-Midland (ADM)… food-processing giant
General Mills (GIS)… food products
Flowers Foods (FLO)… bread maker
Coca-Cola (KO)… soft drinks
Keurig Dr Pepper (KDP)… soft drinks
PG&E (PCG)… natural gas
Cheniere Energy (LNG)… natural gas
Viper Energy Partners (VNOM)… oil and gas
Hess (HES)… oil and gas

NEW LOWS OF NOTE LAST WEEK

BlackLine (BL)… cloud-based accounting software
DocuSign (DOCU)… Software as a Service
CRISPR Therapeutics (CRSP)… gene editing
Kratos Defense & Security (KTOS)… “offense” contractor