Wall Street is scrambling for a narrative to explain why Britain decided to leave the European Union.
One narrative in particular is getting a lot of attention: whether this referendum decision marks a tipping point toward populism that will define politics in the Western world — and set up a new political backdrop for investors.
The argument that's captured their imagination at the moment is that the seemingly sudden appeal of populist movements across Western nations is a response to the decades-long trend of globalization, which failed to adequately reward the middle classes in advanced economies and decreased the ability of these groups to raise their standard of living via housing wealth and cheap credit.
"The Brexit vote was a shock to Wall Street because an electorate in a country with no economic or financial crisis voted to dramatically change its political status quo," wrote
Bank of America Merrill Lynch Chief Investment Strategist Michael Hartnett. "This partly reflects the fact that economic recovery in recent years has been a. deflationary and b. unequal. Wall Street has prospered; Main Street has not."
Here are the three ways investors should brace themselves for a new populist era in politics, according to Mr. Hartnett.
1. Buy gold. And volatility.
2. Long "Main Street" plays (such as regional banks and mass retailers); short Wall Street plays (such as broker-dealers and luxury retailers).
3. Play the tails of deflation and attempted-reflation trades.
"Investors should be long an 'uber-barbell' of high-growth/high-quality stocks (FANG stocks, global Best-of-Breed stocks, and "yield plays") and underowned inflation assets (commodities, TIPS, EM and the UK)," he wrote.
The strategist believes that the "war on deflation" waged by monetary policymakers will give way to a "war on inequality" in the fiscal arena. Potential policy prescriptions include protectionism, increased redistribution via the tax system, higher minimum wages, more regulation of banks and, if a
recession strikes, a more expansionary stance of fiscal policy—perhaps even the deployment of so-called "helicopter money."
"Brexit has already been a big risk-off event. The combo of falling EPS and falling rates is not a good one for stocks or credit," concluded Mr. Hartnett. "But we think a barbell of gold and yield plays (staples, utilities, dividends, REITs) will outperform until investors see redemption pressures stabilize and contagion risks contagion risks contained."
