The British EU Referendum has hardly been out of the news of late as markets across the globe appear to be taking stock of this major event affecting the European Union. It is a big question. Many people have asked me about the issue. Yet for lack of time recently I have stood back.
I'll be straight with you immediately. I am in favor of Britain remaining in the EU. I have spent a great deal of time reading both sides of the argument and was left, to my mind, with one conclusion: Remain. Nonetheless, what is clear is that momentum has grown for the Brexit campaigners.
Taking a look at a recent poll of polls and the figures do not look great for the "Remain" camp:
A 4% margin is pretty handsome at this stage considering the "Remain" lead they had to overhaul. Brexit - that is, Britain voting to exit the EU - has therefore become a very real possibility judging from these numbers.
Uncertainty as to the result means that volatility (already high) seems set to get higher. I am sure many readers from the UK, the US and further afield have at least some of their investments tied to UK investments either individually through the likes of Diageo (NYSE:DEO), GlaxoSmihKline (NYSE:GSK) or Burberry (OTCPK:BURBY) on which I have written previously or ETFs like iShares MSCI United Kingdom (NYSEARCA:EWU) or iShares MSCI United Kingdom Small Cap (BATS:EWUS).
With the UK market increasingly depressed on the back of the apparently growing threat of Brexit, many of you may be scenting an opportunity to pick up UK shares on the cheap. Yet, understandably, many of you may have been scared off by the prospect of Brexit becoming a reality.
Here I plan to explain that although Brexit is a serious possibility, we need to keep a perspective on what the polls are telling us. The headline figures often disguise what is a rather different underlying picture. This is what I plan to explain here.
The Power of Indecision
Chiefly my point revolves around a hidden cohort of voters in the above results. As you are no doubt aware, there is also a third option in such polls not reflected above: undecided voters. Indeed, this is not a small proportion of the sampled responses as can be seen from my summary of the recent polls since the start of June (data collated from the Financial Times):
(Note: One poll on 9th June has no undecided votes. This is simply because the option to not have decided was not given to those asked. You could either vote "Leave" or "Remain" and that was it.)
All told, if we average this data it suggests that the June polls believe this is the split:
If we shove the average to since 10 June (inclusive) the only figure to change of note is the undecided vote:
Why is this important? Well, historically the proportion of undecided voters tend to (in similar such referendums) generally support the status quo. If you can't decide either way, you tend to lean towards what is a "safer" and more familiar option.
Stripping out this undecided portion of the polls and forgetting the tangible trend towards the status quo when they actually come to the voting booth is a regular error. Here in the UK, both the Scottish Independence Referendum in September 2014 and the Alternative Vote Referendum in May 2011 showed a similar trend.
The Scottish Referendum Example
Take the Scottish Independence Referendum, for example. Looking at the polls in the month leading up to the vote itself and this is the average we came out with (incidentally, "Yes" was a vote for Scottish independence):
If we set aside the undecided voters this would have presented a familiar 48% to 52% split in favor of the "No" vote. Yet when the result finally came in, the undecided voters' preference for the status quo made its impression on the final result. A much more comfortable win for the "No" camp of over 55%:
So what does this mean? Well, it may suggest that despite the current impression of the polls being released by the papers that the "Remain" camp may well still be in a much healthier position than it seems. Certainly, it would be preferable to have a "hard" lead coming into the vote rather than relying on the reticence for change of the undecided voters.
How Likely Are the "Undecided" Closet "Remainers"?
Yet this is, in itself, not all. What may be useful here is to reflect on those undecided voters a little more. Are they more likely to really vote "Remain"? Well, one way to test this would be to compare results between those with lower than average respondents in the "undecided" bracket with those with higher levels if we take all those recent polls which had undecided voters at or below the average over the period (9%). In this case, I will not be counting the recent poll which did not offer undecided votes.
Setting aside the remaining undecided votes, it is clear that the split between "Leave" and "Remain" is much tighter in those polls where more people had made their decision:
What does this suggest? Well, it gives a little indication to the point made earlier. It seems likely that more of the undecided voters favor a "Remain" vote over a "Leave" once they have made their decision.
So what is the conclusion? Well, I am not sure there really is one. Predictions of this sort and polling generally is a notoriously inaccurate business. Yet I'd argue that the reaction to the polling results at present seems a little extreme. The UK stock market has been pummelled on the back of these recent polling releases.
Yet today's lift in the FTSE 100 is little surprise. The scale of the negative reaction recently seems to have been perhaps a little disproportionate. It is undoubtedly true that the "Leave" campaign has gained ground recently. Yet we forget the influence of the undecided voters at our peril in such predictions. Previous referendums in the UK (and, indeed, General Elections) have shown a similar trend: an undecided preference for the status quo. The bigger the question it seems, the bigger the tendency of the unsure towards keeping things as they are. And, for the UK, there are few bigger questions than our membership of the EU.
Brexit is certainly a far stronger possibility now than previously. Yet I can't help think that the reality of the vote itself will be more generous to the "Remain" than the "Leave" campaigns. What you make of my thoughts above and how you utilize them in your investment decisions is up to you. For me, it has steadied my nerves a little. It is still a tense vote which could go either way. Yet for those brave investing souls happy with such risk, the headline grabbing advance of the Brexit campaign and its effect on the UK market may well throw up some compelling buys.
Unless otherwise stated, all graphs and the calculations contained within were produced by the author. Creative Commons image reproduced from Flickr user mpd01605.
Disclosure: I am/we are long DEO, GSK, BURBY.
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.