The Franklin Institute, a science and technology museum in Philadelphia, exhibits a replica four-story Foucault’s Pendulum. This giant pendulum, set in motion every morning, swings methodically throughout the day. Over time, the rhythmic back and forth gradually slows and the pendulum eventually comes to rest in its normal state.
Markets, over the past fifteen months, have felt a lot like that pendulum. Recently, the physics behind these market forces seem centered on the Federal Reserve. During the fourth quarter of 2018, unscripted comments by the Federal Reserve chairman over higher interest rates and restrictive economic growth sent markets into tantrum. Generally, higher interest rates can cause businesses and consumers to reduce spending, potentially impacting the profitability of companies. As we start 2019, the Fed, thus far, has struck a different tone, preaching a more ‘patient’ approach to further interest rate increases – much to the delight of markets.
While markets seem delighted, it doesn’t mean all investors have clarity over the Fed’s seeming about-face. For one, there seems to be a purported narrative among some regarding the immediacy of a recession. While a few economists have forecasted a higher probability of recession, the average economist’s forecast is actually only about 26%, or for comparative purposes about the same probability as August 2016. We’ve summarized current economist forecasts in the chart below:
For many, the concern may come less from the recession itself, but more from the associated market volatility. Given the depths and recency of the 2008 financial crisis we believe this is a normal concern for investors to have. But in our opinion, the 2008 financial crisis was just that, a crisis, and not a normal recession. In the chart below, we’ve separated similar crises from more normal recessions to demonstrate the contrast between the two. Generally, a typical recession is about half the length with about half the market decline and GDP contraction versus that of a crisis:
As we move through 2019, the pendulum will likely continue to swing. As investors, we shouldn’t let early year market success lull us into complacency, nor should we let fear of unknown future risks cloud our rationality. Looking over the long term, the one constant has been that as the market pendulum has often swayed between extremes, it always seems to find a way back to a normal state.