June 2020 State of the Market

Posted on June 17th, 2020

June Market Performance

Stocks continued their upward trajectory through early June, enjoying a boost from strong economic data and relief over Trump’s timid response to China diminishing Hong Kong autonomy. The rally halted abruptly near the middle of the month as markets gave up their gains in their worst day since March. The trigger for the selloff is not entirely clear, but stretched valuations and a plethora of investor concerns likely contributed to the downturn. At mid-month stocks have rebounded in an attempt to rally back again, but continuing concerns mean the market remains fragile and reactive.

Stocks extended their May rally as the month started, trading higher largely on investor optimism. Potential trade issues with China seemed to have been avoided after the Trump administration avoided any punitive measures to hold China accountable for the pandemic as well as the Hong Kong security bill. China also continued to fulfill its side of the trade deal in ramping up soybean purchases, reassuring investors to the stability of trade relations. Unexpectedly strong jobs data showed a gain in hiring that wasn’t expected until next month, further feeding expectations of a V-shaped economic rebound and giving the market a shot of upward momentum. That surge took the Nasdaq to new all time highs, and the S&P 500 into positive territory for the year.

Investor focus has been heavily biased towards the recovery narrative, and the market has been ignoring significant issues that could hurt the recovery. COVID-19 case counts have been accelerating as the economy attempts to reopen. The tensions between the US and China are dormant but could become an issue if either side decides it is to their advantage to inflame them. Social uproar over police killings of black Americans have exploded into protests across the country and around the world. Add in deteriorating relations with North Korea and there is a laundry list of issues that should concern the market.

These concerns are undoubtedly part of the reason why stocks tumbled heading into the middle of the month. The market had just moved too high too fast, experiencing the strongest 50-day rally in modern history. Investors looking for a reason to take profit could take their pick from all of the ongoing issues. The downturn was the largest single day drop since March, and wiped out the market’s sizable June gain.

Now, the market has already started to turn higher again after just a few days, rebounding and attempting to rally back as investor optimism reasserts its dominance. The Fed has also stepped in once again to give the market a boost, announcing direct purchases of corporate bonds and strengthening government control over financial markets. A strong rebound in retail data and a breakthrough in development of a COVID-19 treatment have also fed the bounce as the market recommits to the economic recovery narrative.

Market Outlook

Looking ahead, market momentum appears to remain to the upside, even after the sharp mid-June selloff. Investors have a seemingly endless appetite for risk as they chase the narrative that the economy will experience a smashing recovery. This recovery narrative has continued gaining steam as obstacles keep falling away with better than expected data, vaccine & treatment research progress, and massive market support from the Federal Reserve. Nevertheless, there are significant risks that investors are watching even if the market has seemed to ignore them thus far.

At the moment, rising COVID-19 case counts are the most immediate worry; if the pandemic continues to worsen it may be necessary to halt or reverse the easing of lockdown restrictions, slamming the brakes on the recovery and likely the market. The COVID-19 resurgence in Beijing necessitating a new lockdown could be prophetic of what will happen here, especially since testing and treatment capability is so thin in the United States. Even now, the rising case counts should be casting some doubt on the recovery narrative.

Other prominent issues include the widespread Black Lives Matter movement and protests which could slow or interfere with efforts to restart the economy. The relationship between the US and China has seen fraying over responsibility for the pandemic as well as China’s new HK security law, increasing tensions between the world’s two largest economies at a time when cooperation is vital to the world economy. North Korea has also been increasing tensions on the international stage at this precarious time, breaking off relations with the US and literally blowing up the liaison office with South Korea.

With so many landmines to navigate, the market is treading uncertain territory with plenty of opportunity for another crash. We cannot discount the resilience of the rally which has surmounted so many technical and economic challenges, but eventually the market has to square up with economic reality. While it remains plausible that the economy can roar higher with a spectacular recovery, too little information is available to correctly gauge how likely it will be. This leaves the market being driven almost entirely by optimism and fueled by the easy money of the Federal Reserve. This state of affairs should keep the rally on course and the market trending higher in the near future, but the extreme uncertainty and present dismal state of the economy make it a big unknown how long this can continue.

Looking at the charts, the S&P 500 hangs between a recent peak at 3233 and trough near 3300 which will likely have some constraining effect, though the reactivity of the market means it can easily break out of this range. The market will likely attempt to head higher towards the top of the range, but will be unlikely to make headway beyond the recent high. More likely, we see a medium term pullback with the market revisiting territory below 3000 and more firmly establish support for the market based on economic data. Some technical support levels that appeared during the rally are at 2800 and 2500 and should help prevent the market from crashing back down to the March lows.

Lockbox Strategy Update

We continued to trade consistently during the start of the month as June looked to continue the market’s uncanny strength. When the market fell over 5% in one day, our trades suffered significant losses as the sudden volatility spiked our risk and we cut our losing positions to reassess the market, putting us at a large negative return for the month so far.

With the market in such a state of flux swinging between periods of relative calm and huge gyrations week to week, we have needed to continually adjust our risk tolerance to fit the market’s mood. In this case, our risk thresholds and trade size were ill suited to the market plunge. More specifically, our trade sizes ran up risk much faster than our risk tolerance could contain during the downturn. So even though we were able to predict a rebound from the downturn, our risk overruns forced us out of the market with significant losses and we were unable to properly trade the market patterns we saw.

In the current market climate, the risks and opportunities are both greatly amplified, increasing the potential pain of setbacks such as this. Nevertheless, maintaining discipline and a strong trading strategy will make the best of the available opportunities. We will continue to review our trading losses this month to determine how to avoid future occurrences. The lessons we learn will help us improve our strategy, particularly as the post-pandemic market shows no indication of calming, and we should still expect plenty of volatility for the foreseeable future. The turbulent outlook continues to be a net benefit to our strategy; while our June losses have set us back significantly, the continuing volatility will enable our trading strategy to generate strong and consistent performance in the months to come and deliver a strong year for Lockbox Capital.