Early Q4 earnings disclosures from the big investment banks show big cracks re-emerging in their capital markets businesses, which underline the urgent need for more fundamental changes to operating practises and systems. Returns from FICC and other trading activities at Citi, Goldman, BofA and JPM have all fallen noticeably short of market expectations.
There are many ways of restoring profit margins but at their core, there will have to be a dramatic shift to a much lower and viable operating cost base. This reflects increased competition, permanently lower returns on equity and consequently wafer-thin margins. At the heart of any shift will be smarter use of technology, more collaboration and shared resources, and greater use of cloud capabilities, utilities and other external resources.
So is it possible that 2019 will finally see this sort of shift take hold in investment banks and the wider capital markets where the rewards of using cloud are finally seen to outweigh the risks? It appears so, but it’s unlikely to be straightforward. Now, we’re not claiming to offer better advice than the “Sage of Omaha,” but we can look for some context.
Any port in a storm?
Volatility has returned to Wall Street in a major way, with the Dow either up or down by 1 percent or more just eight times; in 2018 this occurred 64 times. Most market analysts are pessimistic in the face of rising US rates, potential trade dislocation through tariff barriers, real economies sliding back into recession and the impact of Brexit on both the UK and the EU. Momentum is also on the side of the naysayers given the downwards trajectory with which the markets left 2018.
So where are the experts looking for value and risk mitigation and what are the implications for capital markets in general and IT in particular?
Respected investor and hedge fund legend Stanley Druckenmiller said in a rare recent interview with Bloomberg: “The inside of the stock market, which is the best economist I know and which I’ve used every cycle when I’ve invested, is saying there’s something not right there.”
So, for safety sake, Druckenmiller is overweight in bonds versus equities, because of the likely volatility in the latter and the propensity for short squeezes and other unpredictable moves. But in the broader context, and with those treasury investments in mind, he is viewing a longer-term horizon where rates plateau and begin to fall. As a result, he is already positioning himself short of financial stocks, which tend to benefit amid rising rates and suffer as they fall. And while he steers clear of advocating any of the well-known tech stocks, or FAANGS, he does single out what he calls the secular growth stocks in the IT sector, such as Microsoft, Salesforce and others that will benefit from an accelerated conversion to cloud computing.
Druckenmiller is not alone in expecting 2019 to be the year when adoption of cloud resources becomes the norm. “Everything has to convert to the cloud,” he concludes, “Even if we only get a mild recession, demand goes up because it is the way to cut costs.” There are already signs that momentum is building, not least from Amazon’s 2017 results which revealed that although less than 10% of its near $180 billion revenues came from its AWS division, that provider of outsourced web and data centre hosting services delivered more than 100% of its just over $4 billion in operating profit.
This tallies with observations from Risk in its outlook for 2019 where it highlights the opportunities for providers of modular technologies or services, offered on a “pick ‘n mix” formula which allows customers to integrate new offerings with existing infrastructure. “This is creating openings and opportunities for narrowly focused financial technology – known as fintech – firms, for example, in the fields of collateral management and buy-side risk management,” it maintains.
But these niche players are also evolving and maturing from an initial ability to solely service the needs of small specialist industry players, to providing the scalability to cope with the huge data management requirements of Tier 1 financial institutions. It is the combination of smart, fast, efficient and agile new technologies from the leveraged resources that cloud capabilities offer that are together now able to meet the needs of the capital markets’ principal players.
Even so, the brief window for investment banks that boosted profitability over the past 18 months looks like slowly shutting, as the benefits of tax reductions and some regulatory relaxation diminish. This will hasten demand for more widespread technology solutions that tackle rising costs and regulatory constraints, with cloud at the forefront.
So banks should be optimistic in both considering new business models and the new technologies that will deliver them, while the providers and creators of those technologies should be optimistic that interest in and support for their capabilities is finally materialising. And if that happens, with cloud strategies at the heart of business transformation, it will be win-win for both sides, leaving the pessimists trying to run old banks on old technologies on the premise that change would have been more difficult and dangerous than the status quo.