Preparing for Certain Recovery in the Financial Markets

As COVID-19 morphed from a regional pandemic in China’s Hubei province to a global epidemiological disaster, equities fell sharply and market volatility rose sharply all over the world. In the US, financial market volatility levels are higher than those last seen in October 1987/December 2008; they also surpass the fluctuations of the late 1929s/early 1930s (Figure 1).

These financial market volatilities are not limited to the US economy, across the major financial markets of the world, there have been significant slumps in market valuations (Figure 2). Researchers believe that this sharp and unprecedented slump during the COVID-19 pandemic is driven by three factors: a more interconnected global economy, faster velocity of information flow in society, and the drastic impact of the social-distancing policy enforced in many countries.  

Figure 1: U.S. Stock Market Volatility (Source: Kellogg Insights)

Figure 2: Three Month Changes in Stock-Market Valuation (Source: Statistica)

The financial markets are a reflection of what investors speculate will occur in the future. So, rather than accounting for current realities alone, the financial markets update rapidly into a future dimension of time. Even though investors (naïve and sophisticated) expect a future slump, there is evidence that a strong recovery is on its way in the medium term.

After the dot-com bubble burst in 2001 and the recession induced by 9/11, the financial markets recovered much faster than actual economic activity – this recovery began in October 2002. Similarly during the 2008 great recession, markets began to recover in 2009, many quarters before actual economic activity ramped up.

There is the strong possibility of a quick recovery (barring any second wave of COVID-19 infections). First, compared to the great recession of 2008, larger government policies have been put in place at a much quicker pace to minimize the blows (See Figure 3). In the UK Chancellor of the Exchequer Rishi Sunak has announced 65.5 billion pounds worth of emergency packages. This is significantly more than the 42 billion pounds (in current money) that the UK deployed during the 2008 recession.

Figure 3: Summary of Fiscal and Monetary Policy Interventions in Select Countries.

Earlier this month, during a Berkshire Hathaway Annual Shareholder meeting, Warren Buffet, also made a case for a certain and quicker recovery. The Wizard of Omaha said “”This country, in 231 years, has exceeded anybody’s dreams. We’ve faced tougher problems, and the American miracle, the American magic, has always prevailed.”

Zooming into firm level activities, financial service firms all over the world are taking steps to minimize COVID-19’s effects on daily operations. Firms are executing on business continuity plans – such as remote work, and rotating shifts for all employees, including traders. Under these new work conditions, firms will need to design innovative cyber-risk controls to manage work-from-home risks and malicious third-party attacks. In the US, the Financial Industry Regulatory Authority (FINRA) has waived, temporarily, trade-from-home restrictions on traders). In the UK, these restrictions on trading-from-home remain. In addition, firms need to more closely manage liquidity and capital using AI backed technology to track trade and liquidity flows.

In the final analysis, there are two approaches that firms can take. Firms can either build out bare-minimum lean technology ecosystems optimizing for low-cost or build in redundancy and resilience into their technology ecosystem. However, research suggests that the present value of future losses that occur when lean technology tools fail in periods of crisis is significantly more than the cost of building out more robust technology systems upfront. Moreover, when the financial sector begins to recover, only firms who have a robust technology stack (hardware and software) will be able to manage the growth in transactions and operations that will result.

Poatek is uniquely positioned to work with leading firms who are intent on building out a robust tech ecosystem. We employ only the top 1% of developers and technical staff from top universities all over the world, and we have built unique expertise in servicing leading clients in the financial services sector.

Featured Image by Stephen Dawson on Unsplash