WEBVTT - Axioma's Morokoff: Test Shows Brexit Could Trigger Crash(Audio)

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<v Speaker 1>I'm Charlie Howlett's Stocks Laura across the board. We are

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<v Speaker 1>down three tenths of one percent, down six points to

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<v Speaker 1>two thousand, seventy one. Nastack down thirty eight, a drop

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<v Speaker 1>of eight tenths of one percent down, Industrials down fifty one,

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<v Speaker 1>a drop of three tenths of one percent, The tenure

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<v Speaker 1>down ten thirty seconds. Looking at the yield of one

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<v Speaker 1>point six one percent, Gold down a dollar sixty twelve

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<v Speaker 1>ninety six, the ounce dropped there of point one percent.

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<v Speaker 1>Crude Oil West Texas Intermediate rebounding today a three point

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<v Speaker 1>rallying a dollar fifty two right now to seventy three.

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<v Speaker 1>I'm Charlie Pellock. That's a Bloomberg business flash the Brexit

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<v Speaker 1>vote on Bloomberg Radio. Brexit. It will be the vote

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<v Speaker 1>heard around the world and could certainly rattle financial markets,

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<v Speaker 1>even though day by day stocks, bonds, currencies have been

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<v Speaker 1>adjusting their values as the risk of the Brexit rises

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<v Speaker 1>and as the chance of the remain sometimes falls. Bill

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<v Speaker 1>Morokoff joins this now. He's head of research at Axioma. Actually,

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<v Speaker 1>it provides factor based risk models and profoil portfolio construction

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<v Speaker 1>tools for equity investors. So of course they've applied these

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<v Speaker 1>tools to the Brexit and what it could do to

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<v Speaker 1>markets around the world. Bill, welcome to the show, and

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<v Speaker 1>thank you for sharing a research. Thank you very much

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<v Speaker 1>for having me. It's a pleasure to be here. So

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<v Speaker 1>first of all, tell us what you use. How do

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<v Speaker 1>you look at this question for example of how Brexit

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<v Speaker 1>could affect stocks. You say that your opinion, equities could

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<v Speaker 1>lose nearly of their value in the aftermath of a

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<v Speaker 1>Brexit vote. That's correct. My research looked into politically driven

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<v Speaker 1>events with significant market impact, and we found cases of

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<v Speaker 1>equity and currency markets dropping twenty over a two to

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<v Speaker 1>three months horizon. So this formed the basis of our

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<v Speaker 1>stress test analysis. Now let me be clear that's not

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<v Speaker 1>a prediction or a forecast. We don't have a crystal

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<v Speaker 1>ball is so this will happen. But prudent risk management

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<v Speaker 1>requires considering severe but plausible stresses and examining the impact

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<v Speaker 1>on a portfolio. What are some of the tactics that

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<v Speaker 1>you would employ in order to measure this risk and

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<v Speaker 1>also mitigate the risk. Sure So in measuring it, besides

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<v Speaker 1>the correlations the volatilities we put in, we look to

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<v Speaker 1>the historical experience of the European Greek debt crisis, specifically

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<v Speaker 1>the summer of two thousand and eleven, and also periods

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<v Speaker 1>like Black Wednesday from September when the pound left the

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<v Speaker 1>exchange rate mechanism. We also took a look at the

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<v Speaker 1>Scottish referendum, and we're doing that in order to get

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<v Speaker 1>a sense for what could be the magnitude of shocks

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<v Speaker 1>and how the markets moved together. We then take our

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<v Speaker 1>enterprise risk platform and put those in the shocks and

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<v Speaker 1>random against a portfolio of European bonds and equities to

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<v Speaker 1>see what the impact could be. And clearly, a huge

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<v Speaker 1>shock to the foot see shock to the decks leads

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<v Speaker 1>to significant losses in the in these portfolios. But it

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<v Speaker 1>is very consistent. What's what we have observed in the

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<v Speaker 1>past when there have been political crises and markets have responded.

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<v Speaker 1>What about US stocks? Sure? Well, of course what we've

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<v Speaker 1>seen in the past is when there's been a major disruption,

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<v Speaker 1>markets tend to become very correlated correlation and goes to

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<v Speaker 1>almost one. So in our in our stress test, we

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<v Speaker 1>actually did shot the S and P five plunder going

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<v Speaker 1>down to capture that kind of effect. And of course

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<v Speaker 1>if you put in a portfolio with US exposure, you're

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<v Speaker 1>going to see significant impact there. I wonder if you

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<v Speaker 1>could describe what exactly you would buy and or sell

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<v Speaker 1>in order to counteract this event that may happen. Sure,

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<v Speaker 1>that's actually a question that's better asked to our clients,

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<v Speaker 1>as we are essentially a framework provider and a tool

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<v Speaker 1>provider allows people to do the analysis of their portfolios.

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<v Speaker 1>So our philosophy is we provide the tools and the

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<v Speaker 1>clients who have the portfolios can analyze their portfolios themselves

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<v Speaker 1>and decide what's the best approach to run with Our

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<v Speaker 1>thinking here is that most likely it would be equity

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<v Speaker 1>related portfolios that would take the biggest hit. Currency exposure

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<v Speaker 1>would be we put in say temper sent drop of

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<v Speaker 1>the pound version dollars I would be more middle level,

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<v Speaker 1>and we felt that a shock to the interest rates

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<v Speaker 1>and the sovereign curves in Europe would be relatively muted

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<v Speaker 1>under scenario. Again, it's just a scenario that we're considering.

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<v Speaker 1>That was our order of magnitude. So obviously if you

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<v Speaker 1>have this type of portfolio, as you'd look to reduce

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<v Speaker 1>your equity risk. That's interesting to me because we've had

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<v Speaker 1>this screaming bond rally around the world. Not granted it's

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<v Speaker 1>been going on for a while, but it really picked

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<v Speaker 1>up steam. It has really felt the last week or

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<v Speaker 1>so like a lot of people were trading off of

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<v Speaker 1>Brexit headlines and the growing risk that the ukse citizenry

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<v Speaker 1>will vote to leave the European Union. But you're saying

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<v Speaker 1>your models suggests that the fixed income the bonds have

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<v Speaker 1>the very least impact and very little at all potentially

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<v Speaker 1>from this particular scenario. Well, I should be clear hair

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<v Speaker 1>that's our input as the stress test, So you could

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<v Speaker 1>definitely do another stress test where you see much greater

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<v Speaker 1>drop uh, in the bond prices or vice urs, you

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<v Speaker 1>could see an actual tightening of the yields. So when

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<v Speaker 1>we're doing this analysis, it's really stress test basis, and

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<v Speaker 1>that's where the expertise of the risk manager is using

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<v Speaker 1>this kind of tool needs to come in to express

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<v Speaker 1>their views and test out their ideas. Bill, I'm wondering

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<v Speaker 1>if the UK decides to leave the European Union and

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<v Speaker 1>the pound sterling falls in value, would that not help

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<v Speaker 1>British manufacturing companies or companies in Britain be more competitive

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<v Speaker 1>and therefore their stocks might actually do well. Definitely. In fact,

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<v Speaker 1>we there's a historical precedent for that during Black Wednesday

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<v Speaker 1>when over the full of the pounds fell by about

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<v Speaker 1>but simultaneously there was an equity rally. So that's another

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<v Speaker 1>stress that's that you might run and it's quite plausible. Again,

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<v Speaker 1>nobody knows what's really going to happen, so it's best

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<v Speaker 1>to take your portfolio, express your views and have a

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<v Speaker 1>tool that captures it across the multi astic class portfolio

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<v Speaker 1>and is able to capture all those various correlations and

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<v Speaker 1>let you express your ideas as you would like to.

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<v Speaker 1>Bill Morocoffee is the head of research at Axioma. Thank

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<v Speaker 1>you very much for being with us right now. Taking

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<v Speaker 1>a look at the dollar trading against the British pounds sterling,

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<v Speaker 1>we're up one and a quarter percent, the pounds strengthening

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<v Speaker 1>against the green back, up about one and a quarter

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<v Speaker 1>percent at one point four three seven nine. And today

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<v Speaker 1>the foot See index in London gains seventy points. It

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<v Speaker 1>is down three and a half percent year to date.

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<v Speaker 1>You're listening to Taking Stock on Bloomberg Radio following birth

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<v Speaker 1>rates of rise and globalization a client of work, explosion

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<v Speaker 1>of debt around the world. This is why rich nations

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<v Speaker 1>fail how to renew them? A new book, The Price

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<v Speaker 1>of Prosperity by Todd Buckles coming up on Bloomberg Radio