Markets were driven down and then back up by responses to the U.K. referendum. Global Chief Investment Officer Colin Moore urges investors to balance return goals with caution for consistent performance ahead.

Q: The second quarter was marked by more volatility and mixed results around the world. But U.S. stocks and bonds both reached record or near-record levels. What was driving those markets?

A: There were two big effects during the quarter. When the U.K. referendum vote occurred, the first reaction was fear. It tends to happen very quickly and very violently because people are uncertain about the future. Then the next morning, or maybe it’s the next week, they realize that the world has not fallen apart, and the markets correct again in a positive way. The second effect occurs when people begin to think about the longer term implications of a change. But it’s not clear that people fully understand the long-term effect of the U.K. referendum. So I'm a bit nervous that the markets have come back so far so fast. The markets seem to be saying that there's no threat to global growth, but there certainly is a threat.

Q: How are you analyzing the impact of the U.K. referendum’s effect on the global banking system?

A: The bulk of our research focus will be within the European Union, particularly in areas like Italy. First, we are looking to identify the weakest banks. We don’t want to expose our investors to them, either through our investments or the use of those banks as counterparties. A second consideration is the potential for contagion. If one of those banks goes down, even though we don’t have direct exposure, it may influence or damage other banks that we do deal with in Europe. We recently received the results of the European bank stress tests, and my initial response is that the results are encouraging but need a lot more scrutiny. We're pretty comfortable about the situation in the U.K. and the U.S. The regulators in both countries have insisted that both banking systems recapitalize and they are at levels that can absorb any stress that will be put on them by the U.K. referendum itself.

Q: Central banks continue to be a big influence on the market. What can they accomplish now?

A: Central banks can help ease the market’s fear factor. For example, right after the U.K. referendum, the Bank of England and the European Central Bank stepped up and essentially said, “We will maintain adequate liquidity in the marketplace. You don't need to worry." That had an immediate effect and I praise them for it. But when we talk about these additional stimulus tactics, I have believed for years that they are relatively ineffective in creating growth. Think of it this way: You're saying to someone, "I'm creating these extraordinary measures, creating negative interest rates in some countries, but you should feel confident about going out and building a new factory or hiring new people. I want you to invest in the future even though I'm telling you that I'm creating extraordinary measures to combat a potential crisis." Those two are just not behaviorally consistent.

Q: You mentioned negative interest rates. Even positive rates are at or near record lows. In some cases markets appear a bit distorted. As an investor, how should I think about that?

A: Understanding the risk-free rate is essential to evaluating any investment. Whether it's a bond or an equity or a new house, you have to have some sense of what your risk-free return is and the additional return you require to warrant the risk of your investment. If that risk-free rate is being distorted in some way, then how do you evaluate investments? Zero or negative interest rates also undermine banks’ profitability and their willingness to lend, and are a challenge for people who depend on “normal” levels of interest income. I'm very concerned because we're getting to the point where we're dependent on extraordinary policies. It is an addiction.

Q: With all that in mind, how do you evaluate markets now?

A: The equity market is pretty richly valued. U.S. equities are probably more attractive than others around the world because we have relative stability. But our expected return from U.S. equities is modest at 5% or 6% and you're picking up 12% to 18% volatility when you invest. That's not a particularly attractive risk/return tradeoff. So, yes, U.S. equities look attractive compared with other asset classes, particularly U.S. Treasuries, but they're not necessarily that attractive on their own merits.