October 2020 State of the Fund Report

Posted on October 15th, 2020

September Pullback Suggests Market Top

Financial markets saw their first negative month in September since the crash as stock indices dropped from their all-time highs after the furious August rally. A pullback in red hot tech stocks combined with a plethora of growing economic and political concerns sent markets plunging at the start of the month and dragged them lower through most of September.

The unstoppable market meltup in August finally popped in the first week of September as tech stocks plunged back towards reality and dragged the rest of the stock market down with it. The drop was particularly severe in the tech heavy Nasdaq which saw its worst pullback since the March crash and put it briefly back into correction territory. The drop seemed to wake investors up to the myriad issues that threaten to derail the economic recovery as the rebound from this drop failed to rally back to its highs.

Most concerning for markets has been the missing-in-action economic stimulus from a deadlocked congress. Investors had been expecting another bill from Congress to bolster the economic recovery as far back as July, but have been disappointed as differences between political factions and the administration have entrenched deeper over time. Differences between the GOP and Trump created further difficulty in negotiations, and there was no sign of a stimulus bill by the end of the month.

By contrast, the urgency of getting such a bill passed has only grown as data has shown a deceleration in the economic recovery. Federal Reserve Chairman Jerome Powell promised zero interest rates through 2023 to support the economy, but pleaded with Congress that they needed to pass vital stimulus to nurture the nascent recovery. Even more worrying, COVID-19 infections continue to increase, threatening to strangle the economy again as experts fear even further worsening in the coming winter months.

Various other events also contributed to the gloomier sentiment. The death of Supreme Court Justice Ruth Bader Ginsburg threw the political world into further turmoil, making it all but certain no stimulus deal would be reached soon. China outlined sanctions it will soon impose on selected US companies, reminding investors that trade relations between the two largest economies remains rancorous. President Trump falling ill to COVID-19 created a great momentary uncertainty before his recovery.

The perilous economic outlook kept investors on edge through the entire month, injecting volatility and dragging markets off their all time highs in a much needed correction. This reality check now also begs the question whether we have seen the top of the market for the coming months. Huge uncertainties around the economy, politics and the pandemic create great risks for the market; however the resilience of market sentiment through the pandemic turmoil make it a strong possibility that the September slump may have just been a consolidation.

October Rebound Reaching Back Towards Highs

The first half of October has seen no great change of fortune either politically or economically, yet the stock market has seen a strong rebound, retaking the majority of its September loss within the first two weeks. The one notable positive that investors are looking to in current events is a clear polling lead for former Vice President Joe Biden in the upcoming election. Investors had been worried about the prospects of a contested election generating massive political and social uncertainty. A clear win would clear this potential volatility, and markets are hopeful that Biden will be a more steady leader that will be more effective in the fight against the pandemic.

News from other quarters has remained less positive. Congress seems less likely than ever to pass an economic stimulus bill as the three factions of the Democrats, Republicans and Trump have been unable to compromise on their differences. Trump himself has been a source of significant chaos, tweeting support for a deal, then no deal, then smaller deals, and then another big deal all within the span of a single week. Nevertheless, stocks have rebounded back near their all time highs in the past two weeks, a clear sign the market is not very concerned about the precarious state of the economy.

The prevailing sentiment among investors seems to be a buy-the-dip attitude, and expectations seem to be that the rally should resume now that the September correction is out of the way. Given the market’s momentum, this may very well be the case, but significant bumps in the weeks ahead may hold the market back, most prominent being the election. It is difficult to say exactly what the market is looking for in the election, but it is likely that a contested election would be the most negative short term outcome. The 3rd quarter earnings season has also begun, and investors are hoping to see an improvement over the 2nd quarter’s disastrous showing. Further ahead, an stimulus bill from Congress is needed to maintain momentum in the economic recovery and perpetual delays are likely to wear down the market’s patience.

Looking at the charts, the S&P 500 is near the psychological level of 3500 which may act as a gravity point for the market to pivot on as we approach the election and earnings season, with a lower bound at 3430 and upper bound at its all time high at 3588. Given the reactive nature of the market, however, a news event or simple momentum could easily send it to new all time highs and fuel further speculative trading. On the other hand, if sentiment deflates for whatever reason, we could easily see the market fall to lower levels and retest support from back in July at 3200. Further down at the 3000 psychological threshold there are very likely to be a strong cache of buyers acting as a strong level of support. Below these levels negative momentum would begin to pick up and carry the market lower and it would be difficult to pin an exact bottom, but it grows increasingly unlikely that the index would retread below the 2500 from the crash nadir.

Lockbox Fund Performance and Strategy

The pandemic and resulting market turmoil have created massive challenges for our fund this year. As we enter the final quarter of 2020, market volatility has shown no signs of slowing and seems to be getting even more explosively unpredictable. Our attempts to trade in these wild market conditions have backfired, delivering painful losses to the fund over the past several months through September. These losses have made clear we need to reevaluate our strategy in the context of the 2020 market, and we have decided to step back from trading ahead of the election until the market stabilizes.

What has become clear during the record setting rally over the past half year is that the market is being driven by speculation fueled by an unprecedented supply of money from the Federal Reserve. The disparity between a sky high stock market while unemployment remains near historical records is a clear sign of severe imbalances in the market. Market overreactions trigger wide swings and generate movements over several months that ordinarily take years. Many market surges have been concurrent with rising volatility, highlighting growing uncertainty among investors even as their fortunes rise. Simply put, speculation has grown to be one of the dominant trades driving the current market, creating investing conditions unlike any in the modern financial era.

We initially believed we could harness this kind of market volatility as our trading strategy can benefit from volatile conditions and we have extensive experience trading through market turmoil. Unfortunately, the market’s sheer unpredictability and speed of movement proved more than we were prepared for, and we have been humbled by the market over the past several months. We have taken lessons from these losses, gradually cutting back our risk and moving back to our statistical models. With the continued bleeding, however, we have come to the decision that we need to halt our trading while the market instability threatens to deepen our losses.

We have already closed our trading positions and intend to make only very small trades when the market presents opportunities with minimal risk, just enough to cover fund operations. In the leadup to what promises to be the most polarizing and significant election in modern memory, we believe it best to sit on the sidelines and minimize risk. In the meantime we are reevaluating our trading process; our recent string of losses have revealed significant shortcomings in our assumptions about the market and the frequency of extreme volatility events. Time and distance away from the market will help us make more objective assessments in our review and give the market time to settle.

We plan to resume trading with fresh eyes in November after the election frenzy has crested, though that will largely depend on the market. Initially we will be trading at small sizes with very strict risk controls as we rebuild our portfolio and ensure we are trading appropriate to market conditions for a sustainable recovery. Our 2020 losses have been a major setback, but Lockbox Capital has recovered from similar losses in the past. We intend to make the best use of this situation and apply the lessons learned from our mistakes to improve Lockbox Capital’s investment strategy moving forward.

September Lockbox Monthly Return After Fees*: Please Contact Us
2020 Lockbox YTD Return After Fees*: Please Contact Us
September S&P 500 Monthly Return: -3.92%
2020 S&P 500 YTD Return: 4.09%

*Incentive fee is calculated at twenty percent based on the difference of the high watermark and ending account balance for the Incentive Allocation period