Putting Brexit market moves into context
You may be surprised to hear that following the Brexit fallout global shares remain 10% above February lows.
UK equities are 14% above February lows. Note that UK equities represent 6% of total global equities including emerging markets (EM) and 7% excluding EM.
NZ shares, global property, global infrastructure and commodities are all +15% above Jan/Feb lows.
However, UK bank shares are close to February lows and Eurozone banks are at new lows.
UK and Eurozone bank share prices are down 33% and 50% in the last 12 months and this alone must be a concern for bank executives, lending managers and staff.
Following Brexit, analysts are subtracting around 1.5% from UK growth next year (raising the likelihood of a mild recession) and taking ~ 0.5% off Eurozone growth and ~ 0.2% off global growth.
Here are some shorter run (2-3yr) cumulative estimates of UK deviation from baseline growth (with no Brexit baseline circa 2% pa growth).
UK banking and systemic risks
The UK represents 2.5% of global GDP but we should not downplay the risks from a simple size perspective; too many people did that with US subprime mortgages at first.
Nominal UK house prices are 20% above pre-GFC levels according to BIS data but real house prices are a touch lower.
UK real house prices
Also, household debt and debt service ratios are notably lower than pre-GFC levels. Household debt is 87% of GDP versus 99% pre GFC. The household debt service ratio is 10% versus 14% pre GFC.
UK household debt/GDP
While a lower risk than during the GFC, a sharp fall in house prices would be a concern for UK banks. How much of a concern? In its bank stress tests earlier this year the Bank of England (BoE) stress scenario included a 31% decline in residential prices and a 41% decline in commercial prices. The results are due later this year but in his post-Brexit speech BoE Governor Mark Carney said the capital requirements of the largest UK banks are 10 times higher than before the financial crisis.
Looking at my Bloomberg screen, on a risk-blind basis (i.e. no risk weighting applied to assets), the UK has a 7% equity/assets ratio and Eurozone banks have a 6% ratio.
This has increased from ~4% pre GFC, which represents a sizeable improvement. Note that US banks have a 11.5% equity/assets ratio.
But there is more to banking risk than adequate capital levels. The level of complexity is also important because greater complexity makes it harder to discern where the true risks lie.
In terms of global financial linkages, UK banks are among the most important in the world. And the large UK banks (like their global counterparts) have not reduced complexity since the GFC on proxy measures such as size of balance sheet, notional value of derivatives and trading assets. See more in this speech: On microscopes and telescopes
UK banks are better capitalised than they were (regardless how you measure it) and they currently hold £600bn of high-quality liquid assets.
The BoE is supporting banks with $250bn of liquidity, plus foreign currency lines.
It's likely the BoE will cut interest rates and restarting quantitative easing (QE) is an option.
Household debt levels and service ratios are lower.
UK interbank (Ted) spread
Indicators of bank funding risk, such as overnight indexed swap (OIS) spreads, remain relatively benign compared to GFC and Euro crisis levels.
Equity risks premiums rise as they should
While US and global equities are above February levels, lower bond yields have pushed equity risk premiums back over 6%.
Source: AMP Capital
If 4% is the long-run average equity risk premium, you can argue that equity investors are being paid for heighted uncertainty.
One area of uncertainty I can see that may be diminishing is Clinton getting further ahead of Trump in the polls. But who can trust the polls?
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