Three Key Thoughts:

• Populism strikes markets

• Volatility almost everywhere

• Attractive returns hard to find

We have long been advocates of leaving politics aside when it comes to planning investments as changes tend to be evolutionary, not revolutionary, given the checks and balances built into the US system of government. However, in this uniquely wild presidential election year, there is a distinctive edge to the fervor on both sides and growing sentiment for “none of the above” as a write-in candidate. Beneath the surface of this fervor are some underlying trends which bear watching as they hold the potential for significant impact on the world economy and financial markets.

The (apparently) successful candidacy of Donald Trump, the huge support given to Bernie Sanders, and the surprising vote by the United Kingdom to exit the European Union all indicate that a large segment of citizens is not satisfied with a current system which they believe has treated them unfairly. Note I said system, not just policies. In each case, the proponents want to throw out the current system (immigration, banking and free trade, to name a few -- feel free to mix and match as you like) but don’t seem to have a compelling alternative to offer. Indeed, in the UK, it has been interesting to see the politicians who led the LEAVE movement stand aside saying their work is finished. Unfortunately, the real work has not even begun, leaving political and economic uncertainty for some time to come.

It doesn’t take a vivid imagination to see how these “throw out the system” sentiments could lead to harmful changes to the world economy, global financial markets and geopolitical relationships. That said, each of these movements is based on real concerns that have not been effectively addressed by current governments and their policies.

All of this background supports our investment view that heightened volatility in the financial markets is likely to continue and may well get worse before it gets better. For example, we saw a strong selloff after the Brexit surprise and then an equally strong rally back in short order. We don’t believe we are out of the woods by any means as the actual effects are only beginning to be identified, much less actually felt.

For now, politics seems to have shoved aside the more substantive economic issues we should still be quite concerned about: where are oil prices headed…will China be able to transition to a services economy without a crash landing…will the US dollar stay strong…and, of course, when will the Federal Reserve finally embark on a sustained increase in interest rates. An even more pressing and puzzling question is what will be the ultimate impact of negative interest rates on a large share of global sovereign debt?

While we don’t believe we know the answers to any of these questions in advance, there are a few clear implications in the questions themselves.

First, global growth will continue to be quite slow. The EU was already in slow growth mode and Brexit confirms that there will be no breakout to the upside anytime soon. China’s growth rate is coming down, probably faster than they care to admit, but the base is now large enough for it to still be a major contributor to global growth. We continue to believe that the US is stuck in a 1-2% real growth economy for some time to come. The first quarter’s number just confirmed that trend.

Second, interest rates will stay lower for longer. At this writing, US Treasury yields are at historic lows as investors seek safety over return. While this flight to safety may fade over the coming months, US rates are being pulled down by much lower interest rates on government debt across the globe.

Third, sources of positive investment returns will continue to be hard to find. We continue to be neutral on US large cap stocks while staying negative on US small caps. Outside the US, we favor a mix of carefully selected active stock fund managers, including those with dedicated emerging market and Asia exposures. The hedged strategy portion of most portfolios continues to grow as we maintain our underweights to bonds and US small cap. Despite these shadings in our investment allocations, we have a hard time getting excited about any asset class right now.

Fourth, in the short term, currency re-alignments may have an outsized impact on returns. Predictably, the British pound suffered a big decline after the surprise Brexit result. However, the Euro stayed relatively stable and the Japanese yen rallied strongly. The yen rally this year has been particularly surprising as Japanese economic results have been somewhat disappointing and the central bank shows no signs of slowing its easing program. Meanwhile, stability in oil prices around $50 per barrel has allowed some strength to return to the currencies of big oil producing countries. Finally, political change in Brazil gave rise to some optimism about Brazil’s future, affording a rally in its currency.

We will summarize by reiterating that we see lots of potential sources of volatility and not many sources of great prospective returns. This combination of low expected future returns and high risk is not a hospitable environment for investors. We continue to emphasize a broad diversity of strategies in client portfolios and expect to use volatility to clients’ advantage when we believe it is appropriate.