Financial markets snapped higher in April in a strong rebound from the depths of the previous month’s crash, and delivered the best month the stock market has seen since the 1980s. This rally is at odds with the current data showing we are in the midst of one of the sharpest economic contractions in history with an uncertain road ahead of us. Nevertheless, market sentiment shifted from crash hysteria to optimism for a strong economic recovery as investors placed their bets that the worst was behind us. Investors did not seem to see any big warning signs to derail the rally as new information and developments came to light throughout the month.
Economic data throughout April was predictably terrible as it reflected the near shutdown of the economy in the face of the pandemic. More than 30 million people filed for unemployment in six weeks by the end of April, one of the worst rounds of layoffs in history. Consumer spending set its worst monthly reading, dropping by 7.5% in March. Oil prices were another shocker as oil futures temporarily plummeted below $0 due to collapsing demand and no storage availability.
The stock market’s record surge in April looks odd against this dismal economic picture, and one of the main reasons for this mismatch is that investors believe the stock market had already priced in all this negative news during its crash in March. During the height of the crash, investors were selling as they repositioned against the risk of an economic collapse. In April, that scenario seems much less likely as lockdowns began to control the pandemic and massive government bailouts supported the economy. Investors believe the worst economic pain is already past and the stage is set for a rebound once lockdowns are lifted.
The second main idea helping to propel the market rally has been the optimism the economy will be able to bounce back strong once the pandemic has run its course. The prospects for such a strong recovery hinge on two things: the timeline for lifting lockdowns and reopening the economy; as well the economic damage already suffered by families and businesses. In April, markets honed in on potential signs that the outbreak was beginning to slow, and hopeful talk of loosening of lockdown restrictions. Hopes for a COVID-19 treatment were also boosted with news of encouraging results from preliminary trials of antiviral drug remdesivir. These positive stories bolstered the idea that the economically draining lockdowns could be lifted in short order, limiting the economic damage and improving the odds of a strong recovery.
The potential for recovery will also depend strongly on how much economic damage people and businesses have suffered. Record unemployment and plunging corporate profits reported in April reflect an economy deeply damaged by the sharpest recession in history, but investors believe the massive bailout programs from Congress and the Federal Reserve will stave off financial ruin until the economy can be restarted.
Overall, investor optimism that the pandemic and lockdowns will begin to ease soon, and faith in an ensuing strong rebound in the economy were the main themes that contributed to the record rally in April. While news and data indicated a grave state of affairs for public health and the economy throughout the month, the market largely took this in stride as much of the bad news was already anticipated by investors. By the end of the month, the rally had slowed to a less frenetic pace as markets approached an equilibrium with investor expectations, and awaited more data and clarity about the virus and economy to inform its next moves.
The incredible volatility throughout April made the market very challenging to trade. Wide daily swings and chaotic moves on stock indices made it too risky to employ our main trading strategy for most of the month. We instead relied on small, simple and short term trades to capture movements we could predict with our modeling tools. As the market began to calm in the latter half of the month, we did find some opportunity to employ our main trading strategy in limited fashion as well. Overall, while our trading activity in April was quite atypical, we were still able to generate a strong performance for the month and increase our return for the year.
Our main trading strategy uses time and distance in the market as a risk mitigation buffer; but with the market as volatile and quick moving as we saw in April, these provide little protective power and leave our typical positions at too great a level of risk. Furthermore, volatile markets also make the complex trades our strategy often relies on more difficult to complete, slowing our ability to react to new risks or unexpected market movements. In this environment, we switched to one of the simplest and most straightforward trades, buying and selling at small sizes. These smaller and simpler trades are more nimble and quicker to complete, providing the flexibility we needed to keep up with the frenzied tempo of the market. We used our modeling tools to guide our trading activity and were successful in maintaining a high percentage of profitable trades despite the chaos.
Approaching the end of the month, we were able to decrease our reliance on these trades and shift some of our trading activity back to our main strategy, but a vast majority of our trading activity and the bulk of our April performance is attributed to our simplified trading methodology. Our ability to continue generating a positive performance through the COVID-19 crash is due to our flexibility in adapting to the market. There will undoubtedly be many more twists and turns in the COVID-19 saga through the rest of the year, and we anticipate being able to roll with the punches and continue making 2020 a strong year for Lockbox Capital.
*Incentive fee is calculated at twenty percent based on the difference of the high watermark and ending account balance for the Incentive Allocation period.