Update: 31-March-2020 – Anson Funds

Planet Earth Under Attack

During the first quarter of 2020 the entire world (and almost all markets) experienced a massive and unprecedented crisis, the likes of which has not been seen in modern times–the global pandemic known as COVID-19. As of the end of the first quarter, there is still no end in sight to this pandemic. This post looks at the expected effects of the pandemic across the following dimensions:

Health of populations – hundreds of thousands of deaths
Economies of all countries – grinding to a halt
Financial systems – including banks, payment systems, non-bank lenders, investment banks, broker-dealers, etc.)
Social systems – people’s day-to-day lives
Politics – not yet affected, but likely to happen once crisis stage passes

The COVID-19 pandemic arrived at a terrible time for global securities markets, given the instability and fragility of most markets

Markets spent the first seven weeks of the quarter continuing their multi-year climbs. Suddenly, right after making all-time highs in late February, markets began dropping on fears of the pandemic
- In the space of just four weeks, major equity markets tumbled from all-time highs on February 19th to multi-year lows on March 23rd.
By March 23rd, the benchmark S&P 500 index had fallen to levels last seen in December 2016, over three years ago
- The S&P 500 index fell over 34% from its all-time-high on February 19th to its low on March 23rd. It then rallied hard in the final week of March to end the first quarter down just under 20%
Commodities, especially bellwethers like oil and gold made huge moves during 1Q20, pointing to the massive stresses in global markets
Oil prices began dropping after the start of a price war between Russia and Saudi Arabia
- As Russia and the Saudis failed to agree on production cuts, oil tumbled almost 70% from its recent high during the third week of January through the end of the first quarter
Gold reached new multi-year highs in early March before selling off (like all assets) in mid-March.
- Gold also experienced unprecedented short-term swings during the quarter, including a huge sell-off in mid March
US dollar funding stresses also rose dramatically as borrowers and traders worldwide all scrambled to access the currency

As explained in a recent report by the Bank of International Settlements (BIS) titled “Dollar funding costs during the Covid-19 crisis through the lens of the FX swap market“:
- Indicators of US dollar funding costs in FX markets have risen sharply, approaching levels last seen during the Great Financial Crisis (2008-2009).
- One such measure is the so called FX swap basis, or the difference between the dollar interest rate in the money market and the implied dollar interest rate from the FX swap market
- In recent weeks, the FX swap basis widened sharply, with the large negative basis reflecting a scarcity of dollar funding.

Initial Responses to Pandemic

As we are facing numerous unknowns, no one can honestly claim to have answers. Everyone is in a brand new world. Still, as of the end of the first quarter, here is how things stood:
- Virus/health
  - As of mid-April, the USA already had the highest number of infected cases and the highest number of death from COVID-19
  - The good news is that the numbers for China, Italy, and Spain (the worst affected countries previously) all appear to have peaked and started to turn down. If the USA follows a similar path, hopefully the peak for the USA is only a few weeks away
  - However, no one knows for certain whether or not there will be new waves of infection cases once strict lock down rules are relaxed
- Economies
  - The coronavirus crisis will exact the biggest toll on the global economy since the 1930s Great Depression, according to warnings from the IMF. In a report dated April 14th, 2020, the IMF predicted that its forecast for 2020 global GDP will fall 6%, from +3% to -3%.
    - The IMF’s sobering estimates expect the pandemic to leave lasting economic scars, with the economies of most countries emerging 5 per cent smaller than planned, even after a sharp recovery in 2021.
    - The IMF said the output loss would “dwarf” the global financial crisis 12 years ago. The global contraction this year will be so bad that only a handful of people in the world will have experienced a similar event in their adult lifetimes. The IMF had to look back 90 years to the 1930s Great Depression to find a deeper recession.
    - While avoiding some of the most pessimistic assumptions in the private sector, the IMF expects advanced economies to contract by 6.1 per cent and emerging economies to shrink by 1 per cent this year. Positive growth is still expected in India and China.
    - Even after the sharp rebound which the IMF forecasts for next year, output is still expected to be 5 per cent lower in 2021 than expected in the IMF’s forecasts from October last year for advanced economies.
    - “This is a deep recession. It is a recession that involves solvency issues and unemployment going up substantially and these leave scars,” said Gita Gopinath, the IMF’s chief economist.
    - Emerging economies are forecast to perform better as a whole, but that is boosted significantly by China which is expected to see output in 2021 just 1.4 per cent lower than the IMF forecast six months ago.
    - If extensive lock downs continue into the second quarter of the year and COVID-19 returns in a milder outbreak in 2021, the overall economic hit would be twice as large, the IMF estimated.
    - Still, the IMF’s economic forecasts for 2020 are not even as dire as many private sector forecasts.
- Financial system
  - The US central bank, the Federal Reserve, has acted faster and more aggressively than any other time in its almost 107 year history to address the crisis
    - It has re-launched every tool that it used during the GFC in 2008, but it has started faster and the facilities are much larger in 2020
    - It has also launched new tools and facilities, never used before
  - The US Treasury and Congress are also launching new fiscal actions, with the Treasury planning to work together with the Fed in setting up Special Purpose Vehicles (SPVs) to facilitate and accelerate spending
- Social systems
  - A recent Bloomberg story summarized the situation well:

Social unrest had already been increasing around the world before COVID-19 began its journey. According to one count, there have been about 100 large anti-government protests since 2017, from the gilets jaunes riots in a rich country like France to demonstrations against strongmen in poor countries such as Sudan and Bolivia. About 20 of these uprisings toppled leaders, while several were suppressed by brutal crackdowns and many others went back to simmering until the next outbreak.
The International Labor Organization has warned that COVID-19 will destroy 195 million jobs worldwide, and drastically cut the income of another 1.25 billion people. Most of them were already poor. As their suffering worsens, so do other scourges, from alcoholism and drug addiction to domestic violence and child abuse, leaving whole populations traumatized, perhaps permanently.
In this context, it would be naive to think that, once this medical emergency is over, either individual countries or the world can carry on as before. Anger and bitterness will find new outlets. Early harbingers include millions of Brazilians banging pots and pans from their windows to protest against their government, or Lebanese prisoners rioting in their overcrowded jails.
Bloomberg – This Pandemic Will Lead to Social Revolutions

Outlook for the rest of 2020 and beyond

After this first wave, it is very likely that there will be additional waves to this crisis.
- Also likely that we start seeing some of the political ramifications of what’s happening right now.
- Can’t have a dislocation of this size in financial markets and the real economy without having very material political repercussions both within countries and then between and among different countries.
- So the question is how will all this affect corporations and consumers?
How do markets respond? The truth is we don’t really know. There are a number of different directions that we could go in. Below we look at optimistic, muddle-through, and dangerous scenarios for the future:
- Optimistic scenario
  - All of this intervention really does fill the hole that was left by this massive decline in people’s incomes and corporations’ revenues
  - Somehow, we push through this psychological disruption and this current stay-at-home crisis and the economy can restore balance reasonably quickly. And we just kind of carry on.
  - There probably needs to be a treatment (or treatments) for COVID-19, hopefully followed by a vaccine. Markets are currently pricing in this type of scenario. Right now, in early 2Q20, equities are not down that much, considering the economic and financial chaos. The equity market appears to be trying to look through this crisis to the other side.
- Other scenarios – versions of ‘just trudge through this’
  - Consumers and corporate CEOs are so reluctant to spend money or make capital investments that we just get stuck in a bit of a depressionary-type bunker mentality by all the major economic actors
  - This existing depression that we’re in right now turns into something that’s just more chronic
  - While the policy makers feel that their tools are sufficient to get us out, it’s just much harder than expected to reverse that type of bunker mentality that people grind themselves into.
- More dangerous scenario
  - Could lead society to start looking for all kinds of scapegoats and could lead to just darker scenarios.
    - Economic disruptions
      - Higher taxes
      - Low interest rates for a long time
      - Reversal of off-shoring
    - Geopolitical disruptions
      - De-globalization
        Would destroy a lot of capacity, just in that if we make a decision as a society that we want to just essentially trash our international supply chains, that’s just a huge productive capacity that we’ve built up over the last 20 years.
        If we decide after this crisis that we need to build a lot more redundancy here in the US, then by definition we have destroyed a lot of capital and productive capacity and we will need to rebuild it here.
        And so the economy that starts to get its legs back with the decision to have to rebuild productive capacity domestically, that would be a very strong case for a really material inflation.
      - Less international cooperation
    - Political disruptions
      - Rise of leftist politics
      - Slowdown of immigration
  - Inflation becomes a consideration that we all need to think about.
    - An environment where the government throws a lot of money at the economy and people just save it, that’s not a particularly inflationary-type setup. And I think it’s probably where we are right now.
  - But in an environment where the central banks and governments throw a lot of money at the economy and things really start picking up quickly, then inflationary risks become a lot more likely
    - But the big inflations of the world are really caused by a major decline in supply combined with some type of monetary mischief by countries.
    - The question is what is the big disruption? It’s supply. Historically, wars destroy supply, the ability to produce things. When you combine that with monetary mischief or money printing, you get a lot of inflation.
It is very possible that this eleven-year period of rising equity prices is over now. Since the Fed launched QE and related programs in early 2009, markets have been on a slow-and-steady climb. But in many respects, the US has been the outlier already for the past few years.
- Japan is still essentially where it was in the late 1980s.
- European stocks are back to where they were twenty years ago.
- The US has really been the only major market that’s really moved.
  - There have been a couple of other markets, but in terms of the really big major markets, the US has been a huge outlier.
  - Very likely that this period is in the process of ending.
  - Possible that future policies will be much more friendly toward labor, much less friendly toward capital.
  - And all that will impact the financial markets in a really profound way.

And, as pointed out in a recent blog post by Boston University professor Perry Mehrling:

…[O]nce everyone finally moves to recovery mode, we will not be restarting the BC (before coronavirus) supply chains because we have learned from the crisis about their fragility. Supply chains of the future will be more resilient, with plenty of inventories and redundancies. And certain industries deemed vital for national security will be on-shored. The real challenge facing us is thus the challenge of reconstruction, which I take to be about resisting the drift to autarky and nationalism and embracing instead the challenge of re-globalization.
Imagining the AC Economy 3-April-2020

Here at Anson Funds, we remain committed to navigating the stormy seas that lie ahead. While we cannot discuss the specific performance of our various funds on this public blog, we can say that we are pleased with both the performance of our funds and with our overall risk management during the volatile first quarter of 2020.

Going forward, we intend to continue to invest carefully, given the uncertainties and disruptions we expect to face for the rest of 2020 and beyond.

Questions or comments? Email Bruce Winson.