Stable laws and competitive markets throughout much of the world go a long way toward providing investors confidence in their ability to size-up potential returns and risks, at least over a longer-term horizon.
The biggest threats to this investment framework are political instability (with global war the most extreme example), a pandemic (think The Black Death that plagued Europe in the 14th century) and famine. All three can be devastating and an economy may be hit by more than one simultaneously. Unfortunately, it is nearly impossible to quantify the risk of these threats.
The best we can do is react to such threats when they present themselves. Presently, political instability is front and center. Nearly every developed economy is dealing with an aging population, slow growth, stagnant wages for lesser-skilled jobs, and mounting levels of fiscal debt. These challenges have led to an increasingly polarized environment in which policies in place may be upended every few years by another election.
The world’s largest market, the United States, has become exhibit A for policy volatility. Take, for example, the country’s health insurance program for low-income households. It was massively expanded by one partisan effort following the 2008 election cycle, and is now under constant threat of being slashed by another partisan push post the 2016 election cycle. These are efforts that have multi-trillion dollar consequences, and it is difficult for anybody to say with confidence what policy will be in place in ten year’s time.
The potential for a trade war between the U.S. and China is simply the latest manifestation of policy uncertainty. We encourage investors to respond to political instability by ensuring their equity holdings are diversified across geographies and free of “home bias”. Our model portfolios are designed with the latitude to allow for higher allocations to foreign developed and emerging markets when appropriate.