Data Brief - Weighing a Recession's Impact by Asset Class

Weighing a Recession's Impact by Asset Class

Monday, January 7, 2008

A couple of days ago, we took a look at how three of the major stock market indices fared during past recessions.

While there is a lot wrong with such a study, such as the somewhat subjective definitions and late-to-the-party analysis by the National Bureau of Economic Research, seeing how assets have performed during past contractions can give us a heads-up if we are indeed headed towards a similar fate this time around.

In the last Data Brief, we showed a chart of the odds for recession given by the prediction market Intrade, which were hovering at 55%. While there is no shortage of recession-predicting indicators, one that garnered a lot of attention recently is the ISM Manufacturing Survey, which dipped to one of its lowest levels in years.

The following chart shows the ISM survey (in blue) along with recessions (highlighted in red). The survey did have a decent record at indicating that we were in or about to enter a recession when it dipped to as low a level as it's at now (the red dotted line), with only a few false signals (the red dots).

If we assume that we're in or headed into recession, then it may pay to see how other asset classes performed during past contractions. The table below shows recession-era returns for the 3-Month Treasury Bill Yield, 10-Year Treasury Note Yield, CRB Commodities Index, Gold and the US Dollar.

The clearest trends among them were weakness in Treasury yields (both short- and intermediate-term durations) and also weakness in commodities. That makes sense - if economic growth slows, then there is typically less demand for commodities, and less inflation risk.

The most interesting finding was the collapse in short-term interest rates, which ended the recessions an average of nearly 40% lower than where they began (it's also notable that the Fed's Discount Rate was lower every time as well).

Given the questionable performance in almost every asset class, including stocks, and the fact that past recessions lasted an average of 220 trading days, it seems like the safest and maybe even one of the higher-yielding bets would be to lock in current short-term rates via Certificates of Deposit or similar instruments with durations of one year, even if we're already in the midst of a recession that has yet to be officially recognized.

We'll certainly have some excellent trading opportunities along the way in stocks or other assets (gold held up quite well), but in general buying-and-holding pretty much any common asset was an unrewarding and risky strategy.

Assuming we're in or imminently headed for recession, of course.