The decade leading up to the Great Depression was a period of significant technological advancement, broad cultural achievement and well-documented economic prosperity. Often overlooked, however, was that it was also a period of deep grief in the wake of World War I, the greatest trauma the world had known up until that moment. This unique combination of societal attributes contributed to an environment where many prominent thinkers, as well as a fair number of roaming charlatans, believed that it might be possible for the living to communicate with the dead.

Sir Arthur Conan Doyle, the creator of the world’s most famous detective Sherlock Holmes, and who lost a son at the very end of World War I, wrote numerous books on the subject. Thomas Edison spent time considering whether it would be possible to build a telephone that could connect us to the ‘next world’.  And even Harry Houdini, who worked actively to debunk this particular brand of spiritualism, was thought to possess powerful psychic abilities by the public.

With these prominent thinkers in the foreground, it’s little wonder that the 1920’s became the heyday for the fortune telling business. One such fortune teller, Mary Carter, perfected a routine involving a small chalkboard in a box.  Thanks to the quick handiwork of a hidden assistant, when the box opened, the chalkboard would answer the questions of those who attended her séance.  Her routine would have been lost to history had it not been for her son, Albert. Inspired by his mother’s chalk board act, he created a toy (later perfected as a promotional item by Brunswick Billiards) that is still popular today – the ‘Magic 8’ ball.

Given the level of volatility in the first quarter, it’s starting to feel like the market’s most prominent thinkers (and its associated charlatans), are simply consulting a Magic 8 ball, making buy and sell decisions as if the answers are oscillating between ‘it is certain’ and ‘outlook not so good’.

It is easy to get caught up in the volatility of the moment, particularly when today’s most prominent thinkers have such divergent (and often extreme) opinions – and the supporting evidence for both the bull and bear camps is ample.  But the recent volatility goes beyond that normal and ever-present tug-of-war. To put it in perspective, not only was the first six weeks of the year the worst start for the markets in history, but for the first time since the Great Depression, the S&P 500 Index fell more than 10% during a quarter and rallied back to finish in positive territory.  So why is this happening?

Well, for starters, seven years into this economic expansion, economic growth has begun to cool off and the markets have, in the aggregate, stalled out as a result.  While it is true that stocks have largely traded sideways since the ‘end’ of the Federal Reserve’s quantitative easing (QE) program back in November of 2014, concerns over slowing Chinese economic growth, low commodity prices and even political developments here in the U.S. and around the world have investors on edge.

At the heart of the debate is the fundamental question – when will this particular economic cycle end?  Never ones to disappoint, several Wall Street firms now regularly publish their thoughts on the probability of a global recession unfolding over the next twelve months. While those published numbers remain low at this point, they have certainly done nothing to quiet the debate between the two camps.

Those who focus on observational trends tend to be more bearish, pointing to depressed commodity prices, a flattening yield curve, slowing corporate earnings and weakening growth in both the emerging and developed countries. Against that tentative backdrop, they worry about the tightening financial conditions as the Federal Reserve begins a new rate cycle and the Chinese occasionally adjust their exchange rate.  This group also tends to be highly focused on so-called ‘Black Swan’ risks, or the potential for financial shocks to the system, from which there are a myriad to choose.

Meanwhile, those who focus more on economic metrics tend to be more bullish, believing that the risk of recession is low and that fiscal and monetary policies are not particularly recessionary. They cite strong employment data, rising home prices and believe that sluggish corporate earnings are likely to trough and then reaccelerate this year. Furthermore, they point to household debt service ratios near record lows, businesses that continue to run lean and inflationary pressures that appear well contained.  They believe the excesses that normally precede a recession are simply not present.

While we have great respect for the observational trends in the market place – and we believe economic growth is slowing – our base case is that the recovery will persevere for some time. That said, it is important to acknowledge we have entered what is known as the ‘late expansion period’ of the business cycle.  This is a period marked by moderating economic growth, tightening monetary policy, stable unemployment trends and slowing growth of corporate profits due to wage and cost pressures.  Typically, at this point, stock market valuations are near their long-term ‘fair value’ multiples, volatility is higher and expected returns are lower.  Late expansions are just that, the final couple of years (typically) before the onset of a recession.

While we cannot pinpoint the start of the next recession with any more certainty than a fortune teller reading your palm, we can be cognizant of where we are in the business cycle today and be disciplined about our research efforts and your portfolio positioning. In a market where interest rates and returns are expected to remain low, disciplined portfolio rebalancing, with an opportunistic investment approach and an emphasis on dividends and yield will prove important as investor sentiment, like the Magic 8 ball, continues to oscillate between optimism and pessimism.

With that in mind, we have already taken the first step, recently reducing your market exposures to a ‘neutral’ level for your chosen strategy. This reduction in exposure comes from trimming back purchases that were tactically made when the financial markets were previously over-anticipating recession risk.  Additionally, even though government bond yields remain historically low, we do not foresee a rapidly rising rate environment given the stated policy of the Federal Reserve and the low global yield environment.  Therefore, we see bond returns beating cash returns over the intermediate period.  We have also reduced our exposure to smaller securities, European securities and to high yield bonds for a variety of fundamental reasons and in an effort to lower the volatility in your overall portfolio.

We would emphasize that any investment plan, including the details shared above, is always subject to change, at least at the margin and as the world evolves (and often surprises). Remember that even the supposedly unstoppable Houdini passed away in his prime in 1926 after being punched in the stomach, ironically as a stunt to prove his imperviousness to such blows. While we see the current economic cycle continuing to advance for longer than most – due to the apparent strength of many current economic metrics as well as the likely shallowness of any policy response – we also need to remember that, like Houdini ultimately proved, nothing is for certain or lasts forever.