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

se i C dot com slash imagine. Stocks have resumed a drop that has sent them law in six of the last seven days. Right now, the SMP five index down three tenths of one percent, down six points to two thousand, seventy one. Nastack down thirty eight, a drop of eight tenths of one percent down, Industrials down fifty one, a drop of three tenths of one percent, The tenure

down ten thirty seconds. Looking at the yield of one point six one percent, Gold down a dollar sixty twelve ninety six, the ounce dropped there of point one percent. Crude Oil West Texas Intermediate rebounding today a three point rallying a dollar fifty two right now to seventy three. I'm Charlie Pellock. That's a Bloomberg business flash the Brexit

vote on Bloomberg Radio. Brexit. It will be the vote heard around the world and could certainly rattle financial markets, even though day by day stocks, bonds, currencies have been adjusting their values as the risk of the Brexit rises and as the chance of the remain sometimes falls. Bill Morokoff joins this now. He's head of research at Axioma. Actually, it provides factor based risk models and profoil portfolio construction

tools for equity investors. So of course they've applied these tools to the Brexit and what it could do to markets around the world. Bill, welcome to the show, and thank you for sharing a research. Thank you very much for having me. It's a pleasure to be here. So first of all, tell us what you use. How do you look at this question for example of how Brexit could affect stocks. You say that your opinion, equities could lose nearly of their value in the aftermath of a

Brexit vote. That's correct. My research looked into politically driven events with significant market impact, and we found cases of equity and currency markets dropping twenty over a two to three months horizon. So this formed the basis of our stress test analysis. Now let me be clear that's not a prediction or a forecast. We don't have a crystal ball is so this will happen. But prudent risk management requires considering severe but plausible stresses and examining the impact

on a portfolio. What are some of the tactics that you would employ in order to measure this risk and also mitigate the risk. Sure So in measuring it, besides the correlations the volatilities we put in, we look to the historical experience of the European Greek debt crisis, specifically the summer of two thousand and eleven, and also periods like Black Wednesday from September when the pound left the

exchange rate mechanism. We also took a look at the Scottish referendum, and we're doing that in order to get a sense for what could be the magnitude of shocks and how the markets moved together. We then take our enterprise risk platform and put those in the shocks and random against a portfolio of European bonds and equities to see what the impact could be. And clearly, a huge shock to the foot see shock to the decks leads to significant losses in the in these portfolios. But it

is very consistent. What's what we have observed in the past when there have been political crises and markets have responded. What about US stocks? Sure? Well, of course what we've seen in the past is when there's been a major disruption, markets tend to become very correlated correlation and goes to almost one. So in our in our stress test, we actually did shot the S and P five plunder going down to capture that kind of effect. And of course if you put in a portfolio with US exposure, you're

going to see significant impact there. I wonder if you could describe what exactly you would buy and or sell in order to counteract this event that may happen. Sure, that's actually a question that's better asked to our clients, as we are essentially a framework provider and a tool provider allows people to do the analysis of their portfolios.

So our philosophy is we provide the tools and the clients who have the portfolios can analyze their portfolios themselves and decide what's the best approach to run with Our thinking here is that most likely it would be equity

related portfolios that would take the biggest hit. Currency exposure would be we put in say temper sent drop of the pound version dollars I would be more middle level, and we felt that a shock to the interest rates and the sovereign curves in Europe would be relatively muted under scenario. Again, it's just a scenario that we're considering. That was our order of magnitude. So obviously if you have this type of portfolio, as you'd look to reduce

your equity risk. That's interesting to me because we've had this screaming bond rally around the world. Not granted it's been going on for a while, but it really picked up steam. It has really felt the last week or so like a lot of people were trading off of Brexit headlines and the growing risk that the ukse citizenry will vote to leave the European Union. But you're saying your models suggests that the fixed income the bonds have the very least impact and very little at all potentially

from this particular scenario. Well, I should be clear hair that's our input as the stress test, So you could definitely do another stress test where you see much greater drop uh, in the bond prices or vice urs, you could see an actual tightening of the yields. So when we're doing this analysis, it's really stress test basis, and that's where the expertise of the risk manager is using this kind of tool needs to come in to express

their views and test out their ideas. Bill, I'm wondering if the UK decides to leave the European Union and the pound sterling falls in value, would that not help British manufacturing companies or companies in Britain be more competitive and therefore their stocks might actually do well. Definitely. In fact, we there's a historical precedent for that during Black Wednesday when over the full of the pounds fell by about but simultaneously there was an equity rally. So that's another

stress that's that you might run and it's quite plausible. Again, nobody knows what's really going to happen, so it's best to take your portfolio, express your views and have a tool that captures it across the multi astic class portfolio and is able to capture all those various correlations and let you express your ideas as you would like to. Bill Morocoffee is the head of research at Axioma. Thank

you very much for being with us right now. Taking a look at the dollar trading against the British pounds sterling, we're up one and a quarter percent, the pounds strengthening against the green back, up about one and a quarter percent at one point four three seven nine. And today the foot See index in London gains seventy points. It is down three and a half percent year to date.

You're listening to Taking Stock on Bloomberg Radio following birth rates of rise and globalization a client of work, explosion of debt around the world. This is why rich nations fail how to renew them? A new book, The Price of Prosperity by Todd Buckles coming up on Bloomberg Radio