It may not be how you expect.
- We analyzed the performance of various asset classes across five economic phases: recovery, expansion, slowdown, downturn (not recessionary), and downturn (recessionary).
- Our analysis shows that stocks outperformed high yield bonds across all economic phases and that risk products generally performed most strongly during the recovery phase.
- Currencies performed most strongly during the expansion phase, while U.S. government bonds and gold delivered positive returns across all phases.
Financial assets perform differently in different phases of the economic cycle. Consequently, investors will likely adjust their portfolios over time in accordance with changing circumstances and expectations. This requires making assumptions about how individual assets will perform at different stages of the cycle. But how can we be sure these assumptions are correct—and which assets are needed to meet individual changes given the economic outlook?
With the global economy under significant and unprecedented pressure arising from the coronavirus pandemic and financial assets experiencing heightened volatility, we looked for patterns of cyclical performance that may provide a guide for prospects for individual asset classes.
The Five Economic Phases
(Fig. 1) The US ISM Manufacturing PMI Index, March 1960 to May 2020
As of May 31, 2020.
Source: Institute for Supply Management/Haver Analytics.
Understanding Patterns of Asset Class Performance Across an Economic Cycle
To determine how assets have performed historically in different phases of the economic cycle, we defined the economic cycle using the US Institute for Supply Management (ISM) Manufacturing PMI Index from 1960. We smoothed the series by using a symmetrical moving average and broke it down into five economic phases: recovery, expansion, slowdown, downturn (not recessionary), and downturn (recessionary) (see Figure 1). We divided the downturn category into not recessionary and recessionary downturns to examine the differences in performance of assets based on the severity of the slowdown. We defined each phase as follows:
- Recovery: From when the ISM begins to move up from a trough
- Expansion: From when the ISM rises above 52 and continues upward
- Slowdown: From when the ISM begins to fall from a peak to around 52
- Downturn (recessionary and not recessionary): From when the ISM falls below 52 and continues downward
For performance within each phase, we used the month‑on‑month return (i.e., month’s return compared to the previous month) of the following asset classes and indices in each of those phases: the S&P 500 Total Return Index, 10-Year Treasury Note Constant Maturity Total Return Index and Three-Year Treasury Note Constant Maturity Total Return Index, industrial metals, gold, investment‑grade excess return, high yield excess return, emerging market currencies, and advanced market currencies.1 Finally, we aggregated the performance of each asset class to determine its mean annualized return in each phase of the economic cycle.
Figure 2 shows the performance trajectories of each of the asset classes across their full history. As the data available for each asset class cover different time periods, each asset class is shown in a separate chart. The important point these charts demonstrate is how each asset has historically performed at each stage of the economic cycle.
Asset Class Performance Varied Widely During Different Phases
(Fig. 2) How stocks, credit, metals, U.S. government bonds, and gold performed over time
Past performance is not a reliable indicator of future performance.
As of May 31, 2020.
1 The excess returns are to U.S. Government Bonds.
Sources: U.S. Treasury, Bloomberg Finance L.P., Federal Reserve Board, Standard & Poor’s, and Commodity Research Bureau/Haver Analytics.
Asset Classes Compared—Pinpointing Trends Across the Same Time Frame
For a more direct comparison of asset class performance trends, it is necessary to review the data over common time periods. Figure 3 compares the performance of several assets from August 1988 to May 2020. It shows that:
- The S&P 500 Index outperformed high yield excess returns in each economic phase, including recessions. This probably will come as a surprise to anybody who experienced the major S&P 500 drawdowns of 2002 and 2008–2009. However, a closer look at the performance of the S&P 500 shows that its performance in recent recessions has been very poor by historic standards and that over the longer term, recessions have had a less severe impact on the S&P 500 Index.2
- Risk and spread assets such as the S&P 500, investment grade, and high yield performed best in the recovery phase.
- Metals performed best in the expansion phase—suggesting that industrial metals are impacted more by real economic activity than expectations.
- High yield and investment‑grade credit excess returns were negative in downturns irrespective of whether they were recessionary or not. However, the S&P 500 return in a not recessionary downturn was positive.
Figure 4 illustrates the performance of gold and currencies from November 1997 to May 2020.
Emerging market currencies typically benefit from carry and delivered their best returns during the expansion phase. They also delivered positive returns in all stages apart from recessionary downturns. These positive returns were due to carry as spot returns were close to zero, or negative in some cases.
In advanced economy foreign exchange, carry is less important and so is excluded from our analysis. Like emerging market currencies, advanced economy currencies performed best during the expansion phase of the cycle. There was a clear distinction between returns for advanced economy currencies in recessionary and not recessionary downturns, indicating that advanced economy currencies performed positively in a less severe U.S. downturn but not when there was a recession.
Gold delivered positive returns during all phases and performed best during the recessionary downturn. It is notable that gold’s worst performance was in the not recessionary downturn, indicating that the severity of the slowdown was a key determinant in its performance.
Figure 5 illustrates the performance of gold and U.S. government bonds from January 1970 to May 2020. Like gold, government bonds delivered positive performance during all phases of the economic cycle due to the very long bull market in fixed income. It is noteworthy that recovery was not the worst phase for government bonds even though it was the best phase for the S&P 500. Perhaps most surprising is the stronger performance of U.S. 10‑year total returns in downturns that were not recessionary versus downturns which were recessionary. While gold performed better than government bonds during the slowdown phase, bonds performed more strongly during the downturn phase.
1 Industrial metals uses the Commodity Research Bureau Spot Metals Index; gold uses the Gold spot price from Bloomberg; investment-grade excess return uses the Bloomberg Barclays US Agg Corporate Excess Return series; high yield excess return uses the Bloomberg Barclays US Corporate High Yield Excess Return series; emerging market currencies uses the MSCI Emerging Markets Currency Index; advanced market currencies is calculated using the the Nominal FRB Advanced Foreign Economies Trade-Weight Dollar Index.
2 It is important to note that our analysis does not measure drawdowns from the peak to the trough of the business cycle; it measures the month‑on‑month return of the asset in each of the five economic phases described above. Peak-to-trough drawdowns can extend over several economic phases and, therefore, tend to be more severe than drawdowns in each phase.
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