Here to stay: How markets will change after the pandemic
By Chris Jenkins, Managing Director at Tora
As we pass 40 trading days since the beginning of the global phase of the coronavirus crisis, patterns are emerging. For the trader, much like all of us, this presents both opportunities and challenges as we head towards the emergence of a ‘new normal’.
We have identified four areas where the impact of Covid-19 may continue long after the number of infected cases trails off.
Trading has been increasingly crowded around market open and close. While there have always been some traders that need to execute at the very beginning of the market, the share of trading around the open and close has spiked. While before the crisis the ‘busy’ period around market open lasted around half an hour, during this period of increased volatility we are seeing some cases running for 90 minutes.
A similar period of higher trading occurs at the end of the market day, driven primarily by index funds. Reduced top of book liquidity means that spreads can be double or more during other times in the trading day.
A clear symptom of the aggregative nature of the market over the past few weeks has been higher spreads. Goldman Sachs research found the average spread in the S&P 500 moved from 4 basis points to 14 basis points by the end of the first quarter.
As volatility has surged, first in the stock market and now in the credit market, there have been patches of illiquidity. However, since the nature of this crisis is a macro shock, there is a high correlation between individual stocks, and sectors, and the overall market. This wasn’t the case in recent previous shocks. Which means index funds have not really been an issue, if anything index funds are helping liquidity in the market. This could be the beginning of a rehabilitation of the image of index funds in the eyes of the market participants as tools that help rather than hinder overall liquidity.
Closed trading floors and lost flexibility
While this is not the first time trading floors have closed due to emergencies, the coronavirus-related shutdown is already the longest. Since the last major trading pause – the NYSE & NASDAQ shutdown after the September 11 attacks – the markets have become significantly more electronified. With the relatively smooth transition away from physical trading spaces (for the parts of the market that still used them) an evaluation is beginning to question how much reversion actually needs to occur.
As NYSE and CME (some of the only major exchanges across the globe with people still on the floor) eye reopening the trading floor, questions are surfacing on what this is going to look like in the next few months. The traditional exchange floor is open, crowded and quite narrow – all unacceptable in the era of social distancing. Although physical trading floors are unlikely to disappear completely, it can be expected these will be thinned out, with only a select few specialists on-site joined by primary staff based remotely.
Post-pandemic plans worryingly might include periods of return and retreat from physical spaces. The new market will be more increasingly reliant on digital technologies than ever before. Instant connectivity and the ability to perform at the same level as on the trading floor or in the office will be imperative. Cloud-based technologies will most likely be the key factor in ensuring a smooth transition out of the pandemic and into the new normal.
Is the future outsourcing?
What may be the most lasting change for traders is the need for an unprecedented amount of flexibility. Trading will be more concentrated, with high spreads and shifting rules on where execution can occur. All of these will mean trade execution is increasingly a specialised activity performed by experts.
Outsourced trading was already a growing trend as notable benefits have come to the fore in an environment that has seen a shift from active to passive management, increased regulations and squeezed margins for asset managers facing pressure over their fees and costs. For outsourced traders, the way they conduct their business hasn’t changed much. In what is unquestionably a market that rewards speed, fundamental traders are able to find divergences between underlying value and current trade price and make investments. Meanwhile, technical traders can take advantage of the increasing velocity to arbitrage price movements.
Outsourced traders sometimes refer to themselves as the eyes and ears of the market for clients. Increasingly this round the clock operation is able to complete more activity outside of ‘traditional’ market opening hours. There now is the opportunity for all types of trading styles to make money in one of the choppiest markets in years; by extending their trading day, via an outsourced desk, managers can really capitalise on this. Outsourcing can also extend a firm’s presence internationally. Taking a company to a new jurisdiction, at a lower cost without the need to rent new offices, hire new employees or the general costs of ‘setting up shop’.
One of the most significant lessons from the Coronavirus pandemic is the importance of business continuity. What firms crucially need are BCP plans that not just allow for the safety of employees, but the flexibility to continue operation no matter the external shock. For the vanguard who have already embraced outsourced trading, they are currently reaping the rewards that come with stability. Others will certainly follow.