Lockbox Capital 2020 Mid-Year Review

Posted on July 22nd, 2020

The COVID-19 Market

The COVID-19 pandemic has marked the changing of an era, much as the 2008 financial crisis and the 9/11 terror attacks did in preceding decades. The pandemic has already impacted our lives in innumerable ways and will continue to reshape daily life for years to come. Financial markets too have been hit with violent changes and are still grappling with a new economic reality that will likely remain in flux for the foreseeable future.

The market reaction to the pandemic in the first half of 2020 can be separated into three phases. In the opening phase, markets regarded the outbreak with slight concern and considered it likely to be a passing risk. During the second phase, the investors realized the enormous economic damage the pandemic would bring, and markets crashed in panic. The third rebound phase has seen markets bounce back, driven by optimism for a massive recovery and fueled by trillions of dollars of government bailouts. Now at mid-year, markets have nearly erased their losses and are just short of their 2020 starting lines — with the exception of the Nasdaq having carved new all time highs — but momentum has slowed and the huge disconnect between the surging market and dismal economic reality is weighing on investors.


The first case of COVID-19 was identified in December last year, but we still saw a brief prelude in 2020 before the pandemic exploded onto the stage. The stock market seemed like it would continue its decade-plus bull run with solid economic data and the phase one trade deal in place. The COVID-19 outbreak in China was initially just background noise to investors who had seen SARS, MERS and other disease outbreaks in recent decades. However, as the outbreak grew extremely rapidly, China was forced to take drastic action, quarantining the city of Wuhan, the entire province of Hubei, and closing down factories critical to companies such as Apple and GM.

Markets finally reacted to the economic impact of these shutdowns, and we saw it take its first turn down at the end of January. Adding to the concern, evidence was mounting that COVID-19 was now spreading beyond China’s borders. Despite this, markets recovered from this first stumble and even achieved new highs in February as optimism reigned that the economic impact of the outbreak would be finite and ephemeral. However, the outbreak continued to worsen at an alarming rate in February, with surging cases and multiple deaths around the world. Faced with the reality of the epidemic with the potential to halt the global economy, financial markets plunged in late February, beginning the first leg of the crash.

End of the Bull Market

Stocks began plummeting February 24th, selling off rapidly as the scale of the outbreak continued to intensify at an alarming rate. Markets raced downward to price in the economic damage that they were now realizing would be severe, protracted and global in scale. In just the first week, the crash dropped markets more than 10% into correction territory.

Stocks saw a brief reflex bounce at the start of March, but this was a red herring; the plunge had outpaced investor understanding of the pandemic, and markets hung in limbo for a week as investors hoped the worst was over. However, the rapidly metastasizing epidemic began forcing lockdowns in the United States. The market’s fears were realized as commerce halted, hundreds of thousands of businesses closed down and millions became unemployed, freezing the economy and slamming it into the sharpest recession ever.

The crash resumed with redoubled intensity as investor sentiment devolved into panic. Noone could be sure how bad the pandemic would become, and how terrible the toll would be in mortal or economic figures. The market was chasing the possible worst case scenario of a protracted worldwide depression. The US government was forced into action, injecting trillions of dollars of bailout money into businesses, individuals and the stock market to avert a total economic collapse.

With no way to reliably gauge or predict the consequences of the pandemic, markets were trading blind. The pace of the crash was dizzying with indices moving nearly 5% a day on average and setting a record for the fastest decline into a bear market in the modern era. The crash hysteria peaked in late March, and the market reached its nadir almost exactly one month after it started, on March 23rd. The S&P had seen a 34% loss in just that one month period. Now that the selling frenzy had exhausted, the market was primed for a rebound.

Rebound & Rally

The chaos at the height of the crash made it difficult to recognize the bottom, and the early stages of the rebound were messy, with massive wild swings up and down. Nevertheless, with the peak of hysteria past, markets climbed at a furious rate, regaining 15% in the final week of the first quarter. Amidst the economic devastation, investors latched onto the idea of a resurgent economy roaring back once the pandemic had passed. Markets honed in on this story with laser focus, and turned the slingshot bounce into an improbable rally, delivering the best quarter for the stock market in decades and erasing almost all of 2020’s loss. The rally has left the stagnating real economy far behind, fueled by powerful trends that have kept momentum up.

Recent Developments

Now at mid year, the rally has not conclusively ended, but momentum has diminished notably since mid-June and markets are being buffeted by varying forces. The market’s tunnel vision on the recovery to the exclusion of other major market forces has made the current market levels unstable and susceptible to wide swings as optimism gives way to uncertainty. We began to see this in June when markets were yanked around by shifting sentiment amid a flurry of both positive and negative developments.

Economic indicators such as retail data and employment numbers displayed hard evidence of the promised economic rebound. On the other hand, increasing COVID-19 case counts in the US are threatening a resurgent pandemic and have forced some states to halt or even roll back their reopening plans. Tensions with China are increasing, which would be a major focus in different times, but is now just one of many factors pulling the market in different directions. These competing influences are coming to bear now when the stock market has reached levels indicating that everything will be getting back to normal, and some investors are wondering if the market is justified. We will only know when the rebound phase ends in hindsight, but the evidence is mounting that we will see a change in market behavior and enter a new phase.

2020 Outlook

2020 has been a crazy year by any perspective, and with the COVID-19 pandemic still ongoing, it is anyone’s guess where the market will go from here on. The pandemic could subside and allow the economic recovery to accelerate, boosting the market to new all time highs. On the other hand, the pandemic could continue festering, slowly bleeding the economy until we see a market crash. Or good and bad news will continue to jerk sentiment around and we enter a kangaroo market going nowhere. Future market moves will be heavily reliant on a multitude of issues still up in the air, with these being among the most important.

Pandemic Progress

How the pandemic changes moving forward is the threshold issue that could send the market up or down. In its present course, the market is pricing in a strong recovery which is entirely dependent on the pandemic quickly coming under control and economically ruinous lockdowns being lifted in short order. Worryingly, the rate and scope of infections has actually continued to increase in the United States, suggesting we never got the first wave of infections under control and raising the risks of a second surge of the pandemic. Data in the coming months will be critical for markets, whether they show improvement in infection and death rates and justify the market trajectory, or if rising cases force further lockdowns and cause a market retreat.

Economic Numbers

The second gauge of the expected recovery are hard data points to gauge the level of economic activity. Over the past couple months, weekly and monthly employment numbers have been the frontline indicators of economic health, and notable improvements have kept the market’s spirits up. In coming weeks, the corporate earnings season will deliver a snapshot of how badly the economic lockdowns have hit the companies that make up the stock market. Also at the end of July, the Q2 GDP estimate will provide a wider view of how much economic activity has fallen. These data points are all expected to show recession level numbers due to the pandemic, so the bigger test will be whether they point to the promised economic recovery the market is banking on in the 3rd quarter.

Government Support

As covered above, unprecedented government support from the Federal Reserve and Congress has been one of the strongest pillars of the rally. With significant parts of the stimulus set to expire including individual payments, unemployment benefits and small business loans, the most vulnerable parts of the economy are staring at a potential financial cliff. With significant disagreements between Democratic and Republic caucuses in Congress as well as the Trump administration, the risk that further government support may be too little or late is a major concern for investors. Congress is expected to debate and craft the next round of legislation in the coming weeks, and markets will be highly sensitive to new out of Washington.

Vaccine & Treatment Research

Hundreds of governments, research institutions and private companies have been furiously working on developing a treatment or vaccine for COVID-19 that will be critical in ensuring a timely return to economic normalcy. Promising results from early clinical testing have been key to maintaining hope for an aggressive recovery and by extension the continuing rally, but the bulk of the challenges still lie ahead. It is an unlikely bet for smooth sailing to a safe and effective vaccine, and chances are that we will see one or more major setbacks on the way. Depending on how much of a setback occurs, we could see the market’s upward momentum stunted or even trigger a pullback as investors reassess their recovery expectations.

Presidential Election

Amidst the pandemic, it can be easy to forget that we have a highly consequential presidential election in several months. Trump’s explicitly stock market friendly administration has lost significant ground in polls to Democratic nominee Biden; and yet the effect of the election on markets has become muddled as investors are unsure who will be able to better manage the post pandemic economic recovery. Trump’s handling of the pandemic overall is widely viewed negatively, and confidence is low that he will be able to steer the nation properly as the pandemic continues to rage. For now, the consensus remains that a Democratic takeover in Washington would be a net negative for stocks, and Biden’s polling lead over Trump in the leadup to the election may keep a lid on market gains in the coming months.

China Tensions

Prior to the pandemic, tensions with China had already been increasing despite the detente in the trade war. With the pandemic now gripping the world, it seems China has taken the opportunity to act on its ambitions, increasing its grip over Hong Kong, waging an ethnic cleansing campaign against its Uyghur citizens and aggressively pushing its claims in the South China Sea. Trump’s rhetoric blaming China for the pandemic notwithstanding, there is little political will to keep China in check. China has cemented its position as a critical link in the global economic chain, the traditional western alliances are preoccupied with their own coronavirus responses, and Trump’s weakening of ties with US allies has further diminished the restraints on China’s ambitions. The risk for markets is how much China is willing to destabilize the global geopolitical and economic stage in pursuit of its ambitions.

Bubble Fears

The speed and ferocity of the rally amidst the economic turmoil has many wondering if the market has become an unsustainable bubble, with the potential to pop and crash back down again. The increasing concentration of indices into tech stocks even bears an eerie resemblance to the heady days of the dotcom boom. With so many investors having piled into tech stocks and specifically the mega cap FAANGM companies during the rally, they have become wildly expensive and enormously influential in the market. A pullback in one or more of these stocks is immediately felt in the broader market, and a concerted selloff can easily start a large correction. Even outside the tech sector, stock prices across the board are inflated by recovery expectations and not representative of current company values; so there is almost no data to determine how grounded these prices are. The gulf between stock prices and the economy all but confirm the market is too high for its own good, but the question is by how much, and whether it will end in a crash.

At present market levels, with the S&P 500 flat for the year, the rally faces strong technical hurdles, and we suspect it will be constrained in its current range between 3000 and 3230 in the short term. Strong positive developments in the issues covered above would be needed to sustain the rally to higher levels; and even then, strong pressure will likely push the market back towards current range. If catalysts are able to push the index to new all time highs above 3400 however, we predict a resurgence of momentum that would help the market carve significant new territory higher.

More likely, however, we view the market as ripe for a pullback in the coming months. The truth is that no one really knows what comes next in the pandemic or the economy, and the market rally has far outpaced the real economy on a surge of optimism and financial engineering. News up till now has shown that the impact of the pandemic was not as bad as the March crash had priced in; but future developments will likely show the pace of recovery cannot justify current levels, setting the stage for a correction that could erase a significant portion of the rally. There is little chance of revisiting the March lows, but the S&P 500 is likely to dip below the 3000 mark in a coming pullback, and could easily see a correction back down as far as 2600 on a sustained series of negative developments.

In the end, we expect the market to settle somewhere between the two extremes, and revert near current levels towards the end of the year, but it is truly a fool’s game to attempt firm predictions when so many unknown factors remain in flux.

2020 Lockbox Fund Performance and Strategy

The pandemic which upended the course of the market in 2020 also upended our portfolio. While our trading strategy was able to mitigate the worst effects of the initial crash in February and March, the chaotic aftermath proved very difficult to trade. We were still able to generate returns in those volatile months using our intraday predictive models as a guide; however, the market’s wide swings meant we were one news event away from our risk thresholds. We had made strong progress in the first half of the year, but our trading proved too aggressive. In June the market turned sharply; expanding volatility ballooned our losses and overran our risk thresholds. We were forced to close our positions at very large losses that put us into the negative for the year. In the past month, we have begun to make back these losses as we examine our missteps and adjust our trading to be more resilient in the current market.

In our analysis, we identified two main factors that inflated our losses and set us back for the year. First, we did not react quickly enough to match our trading strategy to the market’s behavior. As the market began to coalesce into the rally through April and May, we ramped up our position size and traded aggressively to take advantage of the volatility. When the market turned in June, we started to see an expansion in the daily range, one of the indicators of risk in our market modelling. We began to adjust the size of our trades down, but did not act fast enough, and so when one of our trades went bad, the losses were significantly multiplied.

Second, our trading strategy has shifted to using futures contracts over the past year, making our portfolio more nimble; a double edged sword which can help us avoid significant losses but can also put us back in the fire if we reenter the market too quickly. When we took significant losses due to the market turning in June, we were able to cut the losing positions quickly and stop the losses. Without the use of futures, we would not be able to get out of the market in a timely manner and losses would accelerate, significantly deepening the loss as much as a 20% hit to the portfolio before we were able to fully close. However, this characteristic also allowed us to reenter the market too quickly with the same large position size. When the market swung against our trade again, we suffered another significant hit due to our large trading size, eating the rest of our returns for the year and then some.

Despite the loss, we continue to have a strong outlook for 2020. The pandemic continues to heighten the risks of trading, but also creates strong opportunities. Understanding the mistakes we made, we have made changes to more aggressively control and limit the risk of significant losses. We are implementing new risk measures to cap daily losses to 5% and monthly losses at 10%. These thresholds will trigger trading stops for the day and for the month respectively. This will keep us from “double-dipping” in poor market conditions, and prevent losses from compounding. We can then gather more data to reassess and better match our trading strategy to the market so we are better equipped to take advantage of the opportunities when reentering the market.

Looking ahead, we see the pace of the rally diminishing as the market is constrained by technical and fundamental factors approaching it’s all time highs. Volatility will certainly remain high as the pandemic, presidential election, geopolitical tensions and other factors keep investors on their toes, creating significant opportunities for smart trading. With the lessons we have learned, a resilient trading strategy and our history of delivering strong returns through volatile markets, we aim to recover our loss and deliver strong returns through the end of the year.

June Lockbox Monthly Return After Fees*: Please Contact Us
2020 Lockbox Mid-Year Return After Fees*: Please Contact Us
June S&P 500 Monthly Return: 1.84%
2020 S&P 500 Mid-Year Return: -4.04%