The US economy has been on the brink of a recession for quite some time now, with various indicators pointing towards an economic slowdown. While the recession has not materialized yet, signs of a labor market slowdown are starting to emerge. This is significant because the labor market has undergone significant changes due to demographic shifts since the 1970s.
Initial jobless claims have been steadily increasing since last fall, adding to the growing concern about an impending recession. With this gloomy outlook in mind, investors are now wondering which asset classes would be considered good investments during a recession, and which ones should be avoided. To answer this question, a comprehensive analysis has been conducted.
The analysis takes into account the five distinct phases of a recession, as outlined in the Incrementum Recession Phase Model (IRPM). By dividing a recession into these phases, investors can better manage the risk of losses and maximize their gains. Each phase of a recession has its own unique characteristics, and different asset classes may perform differently in each phase.
The first phase of a recession, known as the run-up phase, is characterized by increasing volatility in financial markets as they start to price in the impending recession. The second phase, the initial phase, marks the transition between increased uncertainty and the peak of economic slowdown. Negative macroeconomic data becomes more evident during this phase. The third phase, the middle phase, is when the negative economic data becomes more pronounced and marks the low point and turning point of the recession. The fourth phase, the final phase, sees a gradual stabilization of the economy, leading to a return of optimism in the markets. Finally, the fifth phase, the recovery phase, marks the return of positive growth figures in the economy.
For the purposes of the model, a recession is defined as a significant decline in economic activity that spans the entire economy and lasts longer than a few months. The model takes into account the fact that official recession declarations are often announced with some delay, posing a challenge for investors who need to stay ahead of the actual development. Recognizing a recession early on is crucial for positioning oneself as an investor in the best possible way.
The key findings of the Incrementum Recession Phase Model shed light on the performance of certain asset classes during the different phases of a recession. Looking at the S&P 500, gold, and the BCOM index for commodities, it is clear that equities experienced an average loss of 5.3% over the entire recession period. However, this average is heavily influenced by the 2007/2008 Global Financial Crisis. When looking at the median, equities experienced a lower negative performance of -1.6% during a recession.
Furthermore, equities exhibit significant differences in performance across the different phases of a recession. The peak of the recession, or phase 3, is particularly challenging for stocks, as heavy losses are observed during this phase. However, equities perform exceptionally well once the last three months of the recession, or phase 4, are reached. This positive trend persists in the first months after the recession, highlighting the importance of reducing the share of equities in the portfolio early on and then increasing the equity share to benefit from the subsequent recovery rally.
Gold, on the other hand, proves to be a reliable recession hedge, with an average performance of 10.6% throughout the recession. Gold consistently performs well in all phases of a recession, with the most significant price increases observed in phases 1 and 2, which are characterized by increased market uncertainty. As the economy starts to recover and market uncertainty subsides, equities often outperform gold in the terminal and recovery phases of a recession.
Commodities, as represented by the BCOM index, show an average performance of -6.3% during a recession. However, a closer look reveals clear differences in performance in each phase of the recession. Commodities perform well in the run-up and recovery phases, but no clear trend can be identified in the initial and final phases. The negative performance is mainly concentrated in the middle phase, when the economy reaches its low point. From a portfolio perspective, it is beneficial to have an increased weighting of commodities during the run-up and recovery phases of a recession.
Silver, seen as more of a cyclically sensitive industrial metal than a monetary metal, does not prove to be a reliable recession hedge, with an average performance of -9.0% throughout the recession. Mining stocks, while showing positive performance over the entire recession, fall short compared to gold. The decline in the low point of the recessionary trough, or phase 3, contributes significantly to this performance, highlighting the challenges faced by mining stocks during this phase.
In conclusion, the analysis reveals significant differences in performance among various asset classes during a recession. Gold stands out as the ultimate recession hedge, consistently performing well with positive returns in each phase of a recession. Equities and commodities, on average, experience negative performance during a recession, with equities performing best in the recovery phase and commodities performing well during the run-up phase. Mining stocks, while showing positive performance, do not match the performance of gold. Understanding these trends and strategically managing one’s portfolio in each phase of a recession is crucial for investors to navigate through economic turbulence successfully.