Is Europe losing London and the rest of Britain? Photo by Getty Images.
Are the UK and Europe breaking up? You might think so, [i] especially with all the chatter about a British referendum on whether to stay in or exit the European Union—“Brexit” for short. One poll says 71% of Conservatives support leaving, and headlines blared that in the 35% chance Britain leaves the EU, economic calamity would ensue. But in our view, this is mostly noise and speculation. Brits don’t even know what they’re voting on yet, so we suggest taking a wait-and-see approach rather than drawing any concrete conclusions about how Brexit could impact the UK economy or stocks.
Here is the Reader’s Digest version of the Brexit saga. In 2013, Prime Minister David Cameron promised to hold a referendum on Britain’s EU membership by the end of 2017, largely to quell euroskeptic rebels within his party. Cameron pledged to renegotiate Britain’s relationship with the EU and then present those revised terms for Brits to vote on. This was one of Cameron’s major campaign planks in May’s election, and after the Conservatives won a surprise majority, Brexit chatter and speculation intensified. Cameron is meeting with various EU leaders to begin the negotiation process, and Chancellor George Osborne recently went to Germany to unveil the UK’s demands.
Those demands fall into several broad areas, which Cameron will officially lay out in a letter to EU officials later this month.[ii] A major one: securing an opt-out to the EU principle of an “ever-closer union,” which many interpret as more political union and loss of sovereignty. Other demands include increasing Europe’s economic competitiveness, protecting the rights of non-eurozone members and regaining powers for national parliaments, and overhauling welfare rules related to migration. Provided Cameron sends his letter in time, EU leaders will debate his renegotiation plans at a summit[iii] in December.
But for as much attention as Brexit is getting today—and the noise is only likely get louder—it is far too early to start handicapping whether the UK leaves. Some recent polls have stoked this fire, like one that says more than two-thirds of Conservatives support a UK departure.[iv] Now, besides polling’s well-known struggles with accuracy recently, a deeper dive into a poll’s methodology reveals its limitations. Unless a poll gets a representative sample of the broad electorate, it won’t tell you much about the populace’s opinion. YouGov’s Anthony Wells went deeper into this issue in January. We recommend reading the whole piece, but here is a snippet:
Polls are meaningful only to the extent that they are representative of the wider public—if they contain the correct proportions of people of different ages, of men and women, of different social classes and incomes and from different parts of the country as the population as a whole then we hope they should also hold the same views of the population as a whole. Just getting a lot of people to take part does not in any way guarantee that the balance of people who end up taking the poll will be representative.
An even more important consideration: Voters don’t even know what they’re voting on yet—negotiations for revised terms have only just started. Voters’ sentiment is primarily influenced by current events, like the refugee crisis, not the actual long-term implications of remaining in the EU. Suffice to say, we think it’s a tad premature to guess how folks will vote on something that isn’t even defined.
Plus, both Cameron and EU officials have incentive to make a deal. Compromises could appease many of the euroskeptics’ qualms and win their support, flipping them to the “stay” column.[v] After all, many Brits recognize the broad benefits of EU membership. Despite its clunky nature, the EU is a free-trade marvel, and the participation of an economic powerhouse like the UK benefits both sides. EU leaders are open to clarifying the EU’s “ever-closer union” principle—noting that the principle’s intent isn’t to force Britain to integrate politically with other European countries—which signals a willingness to work with the UK’s demands. German Chancellor Angela Merkel has also offered support of Britain’s desire for EU reform.
If it is too early to start gaming how folks will vote on currently non-existent terms about a potential British exit from the EU, it is even more of a stretch to project the possible economic fallout of that event. Some analysts put the odds of a Brexit at 35% and warn the fallout would roil both the UK economy and markets. Now, we aren’t exactly sure how those odds[vi] were calculated, but projecting hypothetical economic impact is a mostly academic endeavor. For example, some worry about the potential trade ramifications for the UK, especially after a senior US trade official warned America doesn’t do bilateral trade deals anymore, leaving Britain out in the cold. Yet this is just wrong, considering the US concluded bilateral trade deals with both Panama and South Korea in 2012. But also, the referendum vote must happen before 2017 ends. Unless Cameron and the EU come to terms rapidly—not typical of EU politics[vii]—there will likely be a new US president with his or her own trade policy before the referendum takes place.
Plus, whatever ends up happening probably won’t be a big, sudden surprise to markets. Some of Cameron’s EU counterparts complain he isn’t being upfront about what he wants—a typical political move (i.e., bicker loudly and publicly). However, the Brexit discussion is developing out in the open and gradually, giving markets plenty of time and information to digest what is happening. Cameron will send a letter to EU leaders, and that letter will be published from here to kingdom come. Summits will happen, and with summits come statements, Tweets and leaks. Leaders will hold press conferences, provide updates on talks and publicize their opinions. All this allows markets to price in possible scenarios and outcomes—so whatever scenario becomes reality, it is highly unlikely to blindside folks, decreasing the “wallop” potential of a UK exit.
While plenty will theorize about Brexit’s implications, we recommend investors tune out the speculation. Politicians’ threats and promises change constantly, and with nothing close to finalized yet, it is futile to try and game anything right now. While this makes all for fine pub discussion, we suggest avoiding making any investment decisions on a potential Brexit today.
[i] Or, at the very least, it seems like they’re in need of some counseling.
[ii] Letters are one way politicians update each other. “Strongly worded” letters are equivalent to sending emails with the “High Importance” notice, we think.
[iii] Summits are where bureaucrats congregate for big important meetings and photo-ops. And catered lunches.
[iv] That 71% figure is based on the responses of 761 Conservative Party member responses via website. We couldn’t find more details about those 761 responders, but a website poll already carries some notable biases (e.g., Folks who respond to online polls tend to be younger).
[v] This could naturally go the other way, if talks stall and the euroskeptics harden their stances. But we find it misleading that only the worst-case scenario is presented. However, we’re also optimists.
[vi] According to the report, there is a 50% chance of a close vote but voters decide to stay in the EU and a 15% chance of a resounding rejection of a Brexit. Or, you can interpret this all to mean that the analysts think it’s most likely the UK remains in the EU.
[vii] Or any politics, really. Unless you’re a dictator.