Stocks continued their rally through July, claiming new post-pandemic highs for the major indices, and inching ever closer to all time highs for the benchmark S&P 500 index. A great deal of news and developments throughout the month painted a mixed picture for the economy, but investors focused on the positives. The pied-piper narrative of a strong economic recovery fueled by trillions of Fed dollars kept the market in its hypnotic grasp, leading the rally ever higher.
The many news stories and developments that played out in July had significant repercussions for the economy going forward, both positive and negative. The economic recovery took several steps forward and several steps back, leaving the path ahead still very uncertain at the close of the month. Nevertheless, the market took much of the news largely in stride, displaying remarkably little volatility despite the deluge of developments.
This torrent of news in a single month would have driven a great deal of volatility and whipsawed the market around in normal circumstances; but clearly these are not normal times. The impossibly strong rally fueled by a tsunami of government money has tempted many new investors to ride the wave, driving them especially into giant tech stocks that now make up more than a third of the supposedly diverse S&P 500 index. Four months after the March crash, the stock market has forged an almost complete comeback, reaching near its all time highs by the end of July.
Pullbacks have been common throughout the stock market recovery, and rightly so given the great uncertainty in our economic future. By July, the dislocation between the stock market and the real economy had become incredibly stretched, with the S&P 500 flirting with its all time high only several months since the pandemic crash. With a strong setup for another pullback and plenty of news to generate volatility, we spent the majority of July attempting to short the market. Unfortunately for our fund, bullish sentiment dominated despite a plethora of economic and geopolitical problems, and our fund suffered losses as the market moved against our trades.
The slowdown in the stock market rally in June seemed to indicate the market was ready to begin consolidating and waiting for the economy to begin to catch up. With many news events scheduled throughout the month and inflated upside options values from the strong rally, there was a very strong opportunity to take advantage of a likely pullback. In general we do not attempt to predict market movement, but the market has become so overstretched during the rally that we felt it was prudent to take a short position. However, despite some heavily negative news around the worsening pandemic, poor economic numbers and international tensions the market kept charging higher with only a handful of negative days that bounced back almost immediately. Despite the market’s irrepressible strength pushing our positions to a loss, we kept our risk on a leash, remaining disciplined and keeping the losses relatively minor.
While we continue to believe the market is due for at least a small correction, we are careful to respect the old trader adage that “The market can remain irrational longer than you can remain solvent,” especially during these most interesting and irrational times. The unprecedented flood of government from the Fed in the US and other central banks worldwide seems to have created a monster in the market that we can only guess when it will end. Like the tech bubble in the 2000s and the real estate bubble before 2008, this Fed bubble has an expiration date, but bubbles can last for many years, and we cannot fight the unlimited monetary resources of the central bank.
This is a lesson reinforced by our losses in the past few months, trying to capitalize on irrational market distortions and effectively fighting against the Fed. This has been a rough time for investors, and we want to thank our clients for bearing with us during these uniquely challenging times. Moving ahead, we are going back to our main market-neutral strategy that has been proven over many years. Rather than attempting to predict the market, our strategy is strong at taking advantage of volatility as it appears in this incredibly uncertain economic environment. With this back to regular business approach, we project we will be able to recover this year’s losses in the second half of 2020.
*Incentive fee is calculated at twenty percent based on the difference of the high watermark and ending account balance for the Incentive Allocation period.