How best to handle volatility - with a capital ‘V’

There can be little doubt about the tense period in which we are living - a land war in Europe and all the shock waves that come with that, rising inflation, increasing interest rates, global supply chain issues, the Covid-19 pandemic and China's zero-Covid policy. Any one of these could create additional variability in the market. Combined, they make planning and investing especially tricky for businesses. 

There is some concern that ‘recency bias’ - where something that happened more recently has the appearance of being worse than something that occurred in the past - is simply making us think today’s scenario is worse than before. However, looking at the data suggests that at least some of the levels of volatility have been higher than we've ever experienced in underlying asset classes.

One reason for this relates to the forward-looking nature of markets. Therefore, they price in the expectations of what the future is going to look like. Except that when there are shocks to these expectations, especially shocks of the magnitude of Russia’s invasion of Ukraine or a once in a century pandemic, then you will inevitably witness spikes in volatility. 

Having said that, volatility is something that's been around forever – it’s just that the current situation makes everything seems that much more volatile.

Navigating this situation can be difficult. Businesses are tough institutions to operate optimally, even in normal circumstances, because there are simply so many aspects to consider. When you then add market instability into the mix, especially severe amounts of instability like we are currently experiencing, the challenge multiplies exponentially. 

The key to not merely surviving but thriving in such a market lies in having a clear understanding of the business risks over a long-term period. This means understanding how market shocks will affect the business and entails undertaking proper forecasting and analysis of multiple scenarios in order to be assess the true risk.

The businesses that cope best during spikes in volatility are those that plan properly, adopt the right hedging policies and ultimately look to the future with proper foresight.

For those businesses that are alert, market moves also create opportunities. For example, if you are an importer or an exporter, you would want either a stronger or a weaker currency, as this would provide the opportunity - with a bit of patience and the right hedging policies - to leverage market instability to the benefit of your business. It’s also worth noting that when there's a strain in the markets, asset prices tend to be subdued. As such, volatility might also open up opportunities for businesses to create a more balanced equity portfolio. 

Naturally, the current market conditions have left investors and businesses cautious. Many appear to be ‘keeping their powder dry’ by sitting on cash and waiting for more certainty in the market before actually investing. The main concern with keeping assets in cash for a long period of time is, of course, inflation, which can deplete these. Nonetheless, the current state of the market has led to many adopting a ‘wait and see’ policy.

Businesses, by the very nature of just being in business, are exposed to underlying asset loss through changes to interest rates, currency and commodity prices at the very least. In notably mercurial times like now, it is especially difficult to know how these underlying asset classes will behave going forward. 

The financial sector faces the same challenges, so we do a lot of scenario analysis, including projections of cash flows and how shocks to the underlying asset classes might affect those cash flows. We work together with our clients to assist with scenario planning and helping them to determine policies to mitigate these challenges.

In the end, it must be understood that volatility is neither new nor unexpected and is something that will always be a part of the economy, which means that the only way to succeed in such an environment is to plan carefully.