Dr. Newton: How I Learned To Stop Worrying And Love The Brexit

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Includes: GLD, SPY
by: Timothy Newton

Summary

Investors should stop worrying so much about a potential Brexit.

British polling is inaccurate, and shouldn't be driving the news cycle so heavily.

Turnout is key, and both major parties support staying in the EU.

Even the U.K. were to leave, it's not as big an issue as investors fear it is.

For the record: I'm not a doctor.

A new poll by The Guardian/ICM shows the Brexit "Leave" vote garnering 53% compared to 47% voting "Remain". Investors panicked, driving the S&P (SPX) (NYSEARCA:SPY), Dow (INDU), and Nasdaq (IXIC) lower, gold (NYSEARCA:GLD) higher, and pushing German 10-year bunds close to negative territory.

However, Brexit is given far more drama than it deserves. The quiet summer news cycle needs to be filled with something, and bears are looking for excuses to drive the market down from record highs. Smart investors should place their money on the "Remain" campaign.

British Polling: More Art Than Science

As nerve-racking as the poll numbers sound, there's a strong precedent for why they can't be trusted. Let's take a quick case study: The U.K.'s general election in May of 2015.

For those of you who don't follow British politics, I'll give a brief summary. David Cameron and his Conservative Party (center-right) had formed a ruling coalition with the Liberal Democrats (rough center) in the prior election. His opponents, Ed Miliband and the Labour Party (center-left), were poised for gains in Parliament, while his coalition partner, the Liberal Democrats, were likely to lose seats as voters were generally disenchanted with the coalition. Lastly, the U.K. Independence Party (far right), was gearing up for its best election ever, pushing its Euroskeptic and anti-immigration platform.

Polling supported the theory that Conservatives would not have a strong election, losing to Labour on its center-left and UKIP on its far right. As the election neared, it was widely believed no party would have enough seats to form a majority, and no clear coalitions existed.

Then came election day. After all the polling predicting their demise, the Conservatives won their biggest majority in years. Not only did they gain seats, they gained an outright majority.

The fact of the matter is that polling accurately is extraordinarily difficult. In the United States, likely the most poll-happy country on the planet, we ourselves have difficulty accurately forecasting winners and losers. Countless examples exist: Understatement of President Obama's lead in 2012, multiple blowouts in 2014 that were supposed to be toss-ups, and upsets in 2016 primaries on both the Democratic and Republican side. While polling is an important metric and can give us an idea of what people are thinking, the correct samples are often difficult to come by. It fails to account for trends like actual voting habits vs. what respondents say, and most importantly...

Turnout: The Real Key to Elections

It's not so much about getting people to believe you as it is about getting your believers to the polls. Even if the country is theoretically split 50-50 in Leave vs. Stay, voter turnout is going to favor the "Remain" campaign.

Reason 1: British Voters Aren't Crazy

If the 2015 election proved anything, it wasn't that polling was terrible. It was that British voters are actually quite pragmatic. Regardless of where you lie on the political spectrum, one has to admit David Cameron falls very close to the center. In giving a majority to the Conservatives, the British people gave a nod of confidence to a government that had done a decent job of recovering from a worldwide economic crisis. They calmly chose to stay the course, and most importantly, only handed 1 seat to the country's far right party, UKIP. This demonstrates a sense of pragmatism, as well as a group of voters that favors the center over the fringe.

In the 2014 European Parliament election, UKIP garnered the largest share of the vote, reaching almost 28%. While this sounds like an outstanding achievement, it demonstrates the weakness of the Euroskeptic movement. UKIP's primary platform in MEP elections is to send anti-EU representatives to the European Parliament and protect British interests. The fact that they could only get 28% of the vote in an election where they have the most compelling platform demonstrates the lack of voters who are really pushing for the U.K. to leave the EU.

Reason 2: Party Infrastructure is King

Political parties exist to provide fundraising and organizational structure to elections. In the U.K., Conservatives and Labour comprise the bulk of political muscle, comparable to Democrats and Republicans in the U.S.

While the fringe of each party is in favor of leaving the EU, the centers of both parties are in favor of staying. Additionally, the leadership of both parties have endorsed the "Remain" movement. With that, the political machinery of both parties is running full bore to mobilize and turn out vote "Remain." Given that the two most powerful political organizations in the U.K. are backing this movement, it's a safe bet that turnout will favor it.

What if the U.K. Votes to Leave?

Even if the U.K. votes to leave the EU, the repercussions are not as serious as the media would have you believe. The country would have two years to negotiate new trade terms and regulations with the EU before the current treaty would be rendered moot. That means the country has two years of uninterrupted economic flow from a regulatory perspective. The only potential economic interruptions to the U.K. or worldwide economy would be lower levels of economic activity from fears of different regulation. Once they've priced in two years of normal economic activity, investors must consider what a new trade agreement would look like.

The blocs at the negotiating table would be representatives from the EU and representatives from David Cameron's government. While both sides are likely to try to extract from concessions from the other, they are also both incentivized to keep trade rules as similar to current rules as possible to minimize economic fallout. Remember, both sides are hurt by diminished trade between the U.K. and Europe. A new trade treaty would likely mirror current trade regulations, just embodied in a NAFTA-like treaty instead of the current EU treaty.

Lastly, while the Brexit concerns many in the U.K., it is not a significant cause of concern for global growth. Calculations estimate that the U.K. only contributes under 4% of worldwide economic growth. Given that we are not likely to see a major economic contraction in the U.K. and that a Brexit seems unlikely in the first place, investors should cease their worries over the coming referendum.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.