Latest / Bloomberg Intelligence / Axioma's Morokoff: Test Shows Brexit Could Trigger Crash(Audio)

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Axioma's Morokoff: Test Shows Brexit Could Trigger Crash(Audio) · Bloomberg Intelligence

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  Speaker 1: I'm Charlie Pellock. That's a Bloomberg business flash the Brexit
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  Speaker 1: vote on Bloomberg Radio. Brexit. It will be the vote
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  Speaker 1: heard around the world and could certainly rattle financial markets,
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  Speaker 1: even though day by day stocks, bonds, currencies have been
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  Speaker 1: adjusting their values as the risk of the Brexit rises
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  Speaker 1: and as the chance of the remain sometimes falls. Bill
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  Speaker 1: Morokoff joins this now. He's head of research at Axioma. Actually,
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  Speaker 1: it provides factor based risk models and profoil portfolio construction
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  Speaker 1: tools for equity investors. So of course they've applied these
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  Speaker 1: tools to the Brexit and what it could do to
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  Speaker 1: markets around the world. Bill, welcome to the show, and
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  Speaker 1: thank you for sharing a research. Thank you very much
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  Speaker 1: for having me. It's a pleasure to be here. So
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  Speaker 1: first of all, tell us what you use. How do
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  Speaker 1: you look at this question for example of how Brexit
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  Speaker 1: could affect stocks. You say that your opinion, equities could
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  Speaker 1: lose nearly of their value in the aftermath of a
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  Speaker 1: Brexit vote. That's correct. My research looked into politically driven
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  Speaker 1: events with significant market impact, and we found cases of
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  Speaker 1: equity and currency markets dropping twenty over a two to
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  Speaker 1: three months horizon. So this formed the basis of our
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  Speaker 1: stress test analysis. Now let me be clear that's not
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  Speaker 1: a prediction or a forecast. We don't have a crystal
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  Speaker 1: ball is so this will happen. But prudent risk management
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  Speaker 1: requires considering severe but plausible stresses and examining the impact
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  Speaker 1: on a portfolio. What are some of the tactics that
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  Speaker 1: you would employ in order to measure this risk and
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  Speaker 1: also mitigate the risk. Sure So in measuring it, besides
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  Speaker 1: the correlations the volatilities we put in, we look to
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  Speaker 1: the historical experience of the European Greek debt crisis, specifically
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  Speaker 1: the summer of two thousand and eleven, and also periods
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  Speaker 1: like Black Wednesday from September when the pound left the
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  Speaker 1: exchange rate mechanism. We also took a look at the
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  Speaker 1: Scottish referendum, and we're doing that in order to get
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  Speaker 1: a sense for what could be the magnitude of shocks
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  Speaker 1: and how the markets moved together. We then take our
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  Speaker 1: enterprise risk platform and put those in the shocks and
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  Speaker 1: random against a portfolio of European bonds and equities to
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  Speaker 1: see what the impact could be. And clearly, a huge
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  Speaker 1: shock to the foot see shock to the decks leads
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  Speaker 1: to significant losses in the in these portfolios. But it
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  Speaker 1: is very consistent. What's what we have observed in the
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  Speaker 1: past when there have been political crises and markets have responded.
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  Speaker 1: What about US stocks? Sure? Well, of course what we've
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  Speaker 1: seen in the past is when there's been a major disruption,
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  Speaker 1: markets tend to become very correlated correlation and goes to
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  Speaker 1: almost one. So in our in our stress test, we
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  Speaker 1: actually did shot the S and P five plunder going
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  Speaker 1: down to capture that kind of effect. And of course
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  Speaker 1: if you put in a portfolio with US exposure, you're
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  Speaker 1: going to see significant impact there. I wonder if you
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  Speaker 1: could describe what exactly you would buy and or sell
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  Speaker 1: in order to counteract this event that may happen. Sure,
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  Speaker 1: that's actually a question that's better asked to our clients,
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  Speaker 1: as we are essentially a framework provider and a tool
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  Speaker 1: provider allows people to do the analysis of their portfolios.
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  Speaker 1: So our philosophy is we provide the tools and the
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  Speaker 1: clients who have the portfolios can analyze their portfolios themselves
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  Speaker 1: and decide what's the best approach to run with Our
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  Speaker 1: thinking here is that most likely it would be equity
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  Speaker 1: related portfolios that would take the biggest hit. Currency exposure
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  Speaker 1: would be we put in say temper sent drop of
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  Speaker 1: the pound version dollars I would be more middle level,
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  Speaker 1: and we felt that a shock to the interest rates
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  Speaker 1: and the sovereign curves in Europe would be relatively muted
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  Speaker 1: under scenario. Again, it's just a scenario that we're considering.
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  Speaker 1: That was our order of magnitude. So obviously if you
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  Speaker 1: have this type of portfolio, as you'd look to reduce
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  Speaker 1: your equity risk. That's interesting to me because we've had
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  Speaker 1: this screaming bond rally around the world. Not granted it's
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  Speaker 1: been going on for a while, but it really picked
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  Speaker 1: up steam. It has really felt the last week or
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  Speaker 1: so like a lot of people were trading off of
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  Speaker 1: Brexit headlines and the growing risk that the ukse citizenry
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  Speaker 1: will vote to leave the European Union. But you're saying
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  Speaker 1: your models suggests that the fixed income the bonds have
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  Speaker 1: the very least impact and very little at all potentially
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  Speaker 1: from this particular scenario. Well, I should be clear hair
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  Speaker 1: that's our input as the stress test, So you could
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  Speaker 1: definitely do another stress test where you see much greater
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  Speaker 1: drop uh, in the bond prices or vice urs, you
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  Speaker 1: could see an actual tightening of the yields. So when
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  Speaker 1: we're doing this analysis, it's really stress test basis, and
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  Speaker 1: that's where the expertise of the risk manager is using
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  Speaker 1: this kind of tool needs to come in to express
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  Speaker 1: their views and test out their ideas. Bill, I'm wondering
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  Speaker 1: if the UK decides to leave the European Union and
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  Speaker 1: the pound sterling falls in value, would that not help
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  Speaker 1: British manufacturing companies or companies in Britain be more competitive
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  Speaker 1: and therefore their stocks might actually do well. Definitely. In fact,
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  Speaker 1: we there's a historical precedent for that during Black Wednesday
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  Speaker 1: when over the full of the pounds fell by about
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  Speaker 1: but simultaneously there was an equity rally. So that's another
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  Speaker 1: stress that's that you might run and it's quite plausible. Again,
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  Speaker 1: nobody knows what's really going to happen, so it's best
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  Speaker 1: to take your portfolio, express your views and have a
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  Speaker 1: tool that captures it across the multi astic class portfolio
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  Speaker 1: and is able to capture all those various correlations and
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  Speaker 1: let you express your ideas as you would like to.
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  Speaker 1: Bill Morocoffee is the head of research at Axioma. Thank
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  Speaker 1: you very much for being with us right now. Taking
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  Speaker 1: a look at the dollar trading against the British pounds sterling,
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  Speaker 1: we're up one and a quarter percent, the pounds strengthening
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  Speaker 1: against the green back, up about one and a quarter
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  Speaker 1: percent at one point four three seven nine. And today
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