Stocktake: Complacent markets bruised by Brexit

A look around the world’s markets

Complacent markets bruised by Brexit

Markets have a reputation of pricing in risks long before they become reality, but they got it badly wrong on Brexit.

For the last six months, betting markets indicated there was little chance of Brexit, despite countless polls indicating otherwise. Before the results rolled in, bookies estimated the odds of a Remain vote to be about 90 per cent; the $5 trillion foreign exchange market was following the bookies’ lead, with sterling hitting new highs for 2016; UK and European stocks had soared while the S&P 500 was on the verge of all-time highs.

Unsurprisingly, all hell then broke loose.


Investors believed (as did StockTake) that status quo bias would kick in and that voters would play it safe. However, it’s clear too much faith was placed in the apparent wisdom of prediction markets and too little faith in what the polls were actually saying. Risk was not priced in and too many investors left themselves badly exposed.

Markets will surely start paying more attention to unlikely-but- possible events. A Donald Trump US presidential victory is one such possibility – prediction markets had indicated Brexit was less probable than a Trump victory, so investor nonchalance regarding his chances is not likely to persist.

Market uncertainty means further volatility lies ahead

It generally pays to buy when there’s blood in the streets, and Brexit has certainly caused market bleeding aplenty. Sterling’s decline was more than twice as severe as that seen on Black Wednesday in 1992, the currency plunging to a 31-year low; gold enjoyed its biggest one-day rise since Lehman Brothers’ collapse; and Europe’s banking sector suffered its biggest one-day fall in history.

To use another investing cliché, however, markets hate uncertainty, and uncertainty – particularly political uncertainty – will not go away any time soon. The Brexit campaign’s successful fusion of populism, jingoism and scaremongering will encourage demagogues across Europe; there have already been calls for referendums on European Union membership in France and the Netherlands, and the possibility of further referendums “may plague European equity markets for some time”, as investment consultants Mercer warned last Friday.

Investors might be more willing to accept political and financial uncertainty if stocks were dirt cheap. However, the S&P 500 has long looked pricey and was near all-time highs prior to the Brexit vote; British stocks, too, were near 2016 highs; European stocks have been under pressure for some time but they remain above their February lows.

Last Friday was a reminder of what real market volatility looks like. Market calm is unlikely to descend for some time to come.

Short sellers decry Tesla’s ‘shameful’ SolarCity move

"Brazen . . . a shameful example of corporate governance at its worst" – clearly, short seller Jim Chanos isn't keen on electric car maker Tesla's proposed $2.8 billion takeover of struggling solar outfit SolarCity.

Chanos could be accused of talking his book – he has bet against both stocks – but Wall Street analysts were not queuing up to defend Tesla chief executive Elon Musk (above) last week.

One can understand why: both companies are bleeding cash. Analysts were never likely to cheer a merger of two companies that burned almost $5 billion last year.

Then there are the corporate governance and ethical concerns.

Musk is the main shareholder in both companies; SolarCity is headed by his first cousin. He says the combined company can one day be worth $1 trillion (roughly 30 times their current value), but sceptics see the deal as a backdoor bailout.

SolarCity has seen a 13-fold rise in its debt over the last three years, to $3.25 billion; shares have more than halved over the last year; it is “one bad economic downturn away from going belly up”, as one analyst put it last week.

Little wonder markets don’t expect the deal to go through, with SolarCity share gains quickly dissipating.

Musk has built his $12 billion fortune by defying the doubters and conventional wisdom. But this time the conventional wisdom may be right.

Bankers’ risk-taking driven by personality, not pay

Curbing executive pay and bonus packages is unlikely to rein in excessive risk-taking by the “wolves of Wall Street”.

A new study, which analysed 1,578 bank managers who worked for 165 US banks over the 1992-2010 period, found the “style” or personality of individual executives was far more important than financial incentives when it came to explaining the varying behaviour of different banks: it explained up to 72 per cent of these differences, whereas compensation arrangements only accounted for 4 per cent. A manager’s style – that is, whether s/he was an “innovator”, a “traditionalist” or a “prudent” type – explained the majority of the variation in banks’ business policies in seven out of 10 different categories.

So-called innovators – the risk-takers – were more likely to be employed by “shareholder-friendly” banks; prudent managers were linked to banks with large numbers of female directors.

Regulatory moves designed to tackle compensation packages, the authors suggest, will likely only have a “small impact” on bank risk-taking.