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Deciphering Asset Performance: Insights from Four Historical Economic Periods

Updated: Dec 4, 2023

1. Introduction

In the complex world of finance, understanding how different asset classes perform under varying economic conditions is a key factor in shaping investment strategies. In this research, we have undertaken a comprehensive analysis of nine diverse asset classes, shedding light on their performance during four distinct historical periods defined by variations in Gross Domestic Product (GDP) and variations in the inflation rate. These periods have been classified as A, B, C, and D, each representing unique combinations of GDP and inflation rate fluctuations. In this article, we delve into the historical performance of different assets across four distinct economic periods: Period A (Declining Inflation and GDP growth), Period B (Accelerating Inflation and Decline in GDP growth), Period C (Increase in Inflation and Increase in GDP growth), and Period D (Declining Inflation and Increasing GDP growth). By examining the factors underpinning these performances, investors can glean insights to optimize their portfolios.

2. The asset classes under the microscope

To analyze the nine asset classes of interest, we primarily depended on market indexes that we identified as sufficiently indicative of the overall performance of each class. Here below are indicated such indexes associated to their asset classes.

  • Equities - S&P 500 Composite Price Index: A benchmark for U.S. equities, the S&P 500 is a staple in investment portfolios, aggregating the 500 stocks with the largest market capitalization.

  • Investment Grade Corporate Bonds - FTSE USBIG Bond Index, Total Return: This index encompasses a broad spectrum of U.S. investment-grade bonds, serving as a key indicator for fixed-income securities.

  • High Yield Corporate Bonds - S&P US HY CORP BOND INDEX, TOT RETURN IND: This index refers to the S&P U.S. High Yield Corporate Bond Index, Total Return Index. This index is used to track the performance of high-yield, or junk, corporate bonds in the United States.

  • Long Term Bonds - VANGUARD FXD.INC.SECS. FD.LTM.US TRSY.PRTF: This index focuses on fixed income securities, particularly those with a longer-term maturity from the United States Treasury. This fund is designed for investors looking for stability and income from government-backed securities.

  • Short Term Bonds - S&P US TREASURY BOND 1-3Y INDEX, PRICE INDEX: This index tracks the price movements of U.S. Treasury bonds with a short-term maturity of 1 to 3 years. It reflects the changes in the prices of these bonds over time and is often used as a benchmark for the performance of short-term U.S. Treasury securities.

  • Commodities - S&P GSCI Commodity Total Return - RETURN IND. (OFCL): This index reflects the total return performance of a broad range of commodity futures. It includes various commodities such as energy, agriculture, industrial metals, and precious metals. The ”Total Return” version of the index takes into account not only the price changes of the commodities but also the income generated by holding the futures contracts.

  • USD Forex – US DOLLAR INDEX DXY, PRICE INDEX: This index measures the value of the United States dollar relative to a basket of other world currencies. The ”PRICE INDEX” in its name indicates that it’s a price return index, which means it tracks the changes in the prices of the included currencies over time, reflecting how the U.S. dollar’s value is changing relative to these currencies.

  • Cash and Cash Equivalents - Money Market Mutual Funds; Total Financial Assets, Level (MMMFFAQ027S): This particular data series measures the total financial assets held by money market funds at a specific point in time or over a particular period.

  • Real Estate - US S&P/CASE-SHILLER NATIONAL HOME PRICE INDEX SADJ: This index refers to the S&P/Case-Shiller National Home Price Index adjusted for Seasonal and Daylight Saving Time (SADJ). This index is a widely followed and respected measure of home prices in the United States.

3. Our findings

3.1 Equities

The most noteworthy moment for equities occurred during Period D. Investors experienced an average return of 3.6% during this phase, significantly higher than the 2.1% average return in Period C. This divergence in performance can be attributed to several factors. Factors Behind the Success in Period D:

  • Economic Stability and Growth: Period D marked a period of economic stabilization with an increase in GDP. During such times, equity markets thrive as positive economic sentiment bolsters corporate earnings and drives stock prices higher. Businesses are more likely to report robust profits and growth, attracting investors to equities.

  • Lower Volatility: Volatility plays a pivotal role in assessing an asset’s attractiveness. In Period D, equities exhibited lower volatility of 6.9%, enhancing their appeal. Reduced volatility suggests a more stable and predictable market, an attractive proposition for investors.

Reasons for Lower Performance in Period C: In contrast, Period C witnessed slightly lower average returns for equities. This can be attributed to various factors.

  • Rate Hike Expectations: During Period C, expectations of interest rate hikes by the Federal Reserve (Fed) loomed. Anticipated rate hikes can affect equity valuations by increasing borrowing costs for businesses, potentially leading to a reduction in corporate profits and impacting equity prices.

  • Market Cycle Dynamics: Another key factor contributing to the lower average returns in Period C is the impact of market cycles. It’s plausible that the equity asset class reached its peak value during the early stages of Period C and subsequently experienced a decline. In the latter part of Period C, market cycles may have exerted a negative influence on equity prices.

(In Figure 1 through 9, we have analyzed the indexes in terms of log returns, denoted by the blue line. We defined periods with declining (increasing) GDP growth and inflation as those in which the period’s value deviated from the mean by more than minus (plus) 1/n times the standard deviation (STDEV).)

3.2 Investment Grade Corporate Bonds

Investment grade corporate bonds play a vital role in the economic landscape, their performance reflecting the economic climate. Their performance in Period A and Period C presents interesting insights. Period A (Stability Amidst Uncertainty): During Period A, investment grade corporate bonds historically showcased their strength with an impressive average return of 2.4% and low volatility at 4%. The following factors explain this performance:

  • Central Bank Actions: During economic downturns, central banks often implement monetary policies aimed at stimulating the economy. This can include lowering interest rates to encourage borrowing and spending. As central banks reduce interest rates, bond prices tend to rise, contributing to the appreciation of investment-grade corporate bond indices.

  • Flight to Quality: Economic uncertainty and declining GDP can lead to a ”flight to quality,” where investors move their funds from riskier assets to safer ones. Investment-grade corporate bonds are often perceived as a safe haven in such scenarios as well as being endowed with higher yields than government bonds. This can drive up demand and increase bond prices.

Period C (Economic Prosperity): Conversely, in Period C, investment grade corporate bonds observed their lowest returns. This phenomenon can be attributed to a contrasting set of conditions:

  • Economic Prosperity and Lower Default Rates: Period C is characterized by flourishing economic activity, higher profit margins, and a lower default rate. Businesses thrive, and the creditworthiness of investment grade corporate bonds is robust. As a result, these bonds have a lower risk premium and exhibit lower yields, translating into the lowest returns during this period.

3.3 High Yield Corporate Bonds

Period B emerges as the prime time for high yield corporate bonds, offering an average return of 2.4% and demonstrating a volatility of 6.3%. The key drivers of this robust performance include:

  • Negative Macroeconomic Conditions: In Period B, economic conditions are marked by turbulence and distress. Accelerating inflation coupled with a declining GDP raises concerns about the overall economic health. During this time, companies face increased financial stress due to adverse economic conditions. This asset class being uncorrelated with fixed income security offers risk taker investors high returns with relative high volatility, offering also a better hedge against inflation.

  • Rising Default Rates: Adverse economic climates often lead to an uptick in default rates, especially among companies with weaker financial standing. High yield corporate bonds, typically associated with lower credit ratings, are issued by companies with a higher probability of default.

  • Elevating Risk Premium: To attract investors and compensate for the elevated default risk, companies must offer higher yields on their bonds. This is reflected in the increasing risk premium attached to high yield corporate bonds during Period B.

  • Repair: During the repair phase of the economic cycle, businesses generally seek to improve their balance sheets by trimming unproductive assets and paying off or restructuring debt. Default risk during these periods tends to decline as economic activity increases and it becomes easier for companies to service their debt. High yield bonds tend to outperform in these environments as default rates fall, credit spreads narrow, and higher coupons contribute to returns in excess of Treasuries.

3.4 Short term and long term bonds

Period A and Period B offer distinct insights into the performance of short-term and long-term government bonds.

Short-Term Bonds in Period A. During Period A, short-term bonds take the spotlight with their highest average return of 0.9% and remarkably low volatility at 1.4%. This robust performance is underpinned by the following factors:

  • Lower Risk Profile: Short-term bonds, characterized by shorter maturities, inherently carry lower interest rate risk. As interest rates peak during Period A due to lower GDP growth and inflation, investors flock to these bonds to minimize exposure to interest rate risk.

  • Attractive Returns: Investors seeking stability and a steady income stream find short-term government bonds an appealing choice. Modest returns, coupled with low volatility, make them an attractive option during this economic period.

Long-Term Bonds in Period B. Surprisingly, long-term government bonds register their highest returns in Period B, averaging 0.8%, despite having comparatively higher volatility at 6.5%. Several reasons contribute to their robust performance during this phase:

  • Limited Central Bank Action: In Period B, economic conditions are tumultuous, making it challenging for central banks to raise interest rates. Long-term bonds emerge as an attractive option, offering more generous returns in periods of scarce opportunities.

  • Anticipating Rising Inflation: Markets might have already priced long-term bonds for the expected increase in inflation during Period B. Investors seeking a hedge against inflation find long-term bonds an attractive prospect, leading to enhanced performance.

Negative Returns in Periods A and D. Long-term government bonds face negative returns of approximately -0.4% in both Periods A and D. These outcomes can be attributed to specific factors associated with each period:

  • Period A - Tightening Interest Rates: Period A is associated with peaking interest rates as central banks adopted tighter monetary policies in past periods, resulting in stabilization of inflation and declining GDP growth. Relentless tightening can lead to a decline in bond prices, especially for long-term bonds.

  • Period D - Attractiveness of Other Asset Classes: Period D is associated with opportunities and favorable economic conditions, making other asset classes more attractive. This relative allure might contribute to the negative returns observed in long-term bonds during this phase.

3.5 Commodities

Period C emerges as a beacon of prosperity for commodities, with an average return of 3.5% and slightly elevated volatility at 10.7%. This period’s performance is a testament to the sensitivity of commodities to economic expansion and inflation.

  • Economic Prosperity: The surge in economic activity during Period C fuels the demand for commodities. They become indispensable for producing consumer goods and capital investments. This heightened demand naturally translates into upward pressure on commodity prices, bolstering commodity indexes.

  • Inflation Hedge: Commodities serve as robust hedges against the eroding effects of inflation. Rising inflation erodes the purchasing power of currency, making more money necessary to purchase the same amount of commodities. Investors recognize this intrinsic value and turn to commodities (gold) to preserve wealth.

  • Supply Disruption: If there is a disruption to the supply of a commodity, such as a natural disaster or a political crisis, this can lead to higher prices, as it happened in the last couple of years.

3.6 Real Estate

In the world of real estate investments, Period C stands out with an average return of 2% and associated low volatility of 1.4%. This phase’s performance can be attributed to several key factors:

  • Economic Prosperity: As GDP expands during Period C, individuals and businesses experience increased income and higher profit margins. The demand for various real estate properties, from residential to commercial, surges, driving up property values.

  • Inflation Hedge: Real estate has long been considered an effective hedge against inflation. Rising inflation leads to higher mortgage rates, increasing the prices of existing properties. The costs of building new properties also rise due to increased raw material and labor expenses, further pushing up real estate values.

  • Investor Confidence: In times of economic uncertainty or rising inflation, investors often turn to the stability and tangibility of real estate investments. The ”real” asset provides security and a tangible presence, making it an attractive choice for preserving and growing wealth.

  • Limited Supply: If there is a limited supply of housing available, this can also drive up prices. It can happen for many reasons, one of them is surely a favorable demographic, since a growing population, particularly among young adults and millennials, can lead to increased demand for real estate, or even with the short term rent that are spreading on various platforms.

  • Leverage: On average Real Estate tends to appreciate over time and big losses are extremely rare. This creates the perfect environment for leveraging, since the down payment required is not 100% of the price, but it can be used as collateral, financing is really accessible.

3.7 USD Forex

The performance of the DXY Index, representing the US dollar exchange rate, varies across economic periods, offering unique insights.

  • Period A: Decline in Inflation and GDP. During periods of declining inflation and GDP, investors seek refuge in assets that offer stability. This is where the USD exchange rate historically shines. In this economic climate, characterized by tightening monetary policies and higher nominal interest rates, the USD exchange rate has seen average returns of 0.6%. With a volatility of 4.6%, it exhibits relatively stable performance, attracting foreign capital seeking reliable returns.

  • Period D: Decreasing/Stabilization of Inflation and Increasing GDP. Another period where the USD exchange rate has performed well is during decreasing or stabilizing inflation with a simultaneous rise in GDP. As economic conditions improve, attracting foreign investment becomes more likely. Stable inflation rates prevent the erosion of the currency’s purchasing power, and an expanding GDP provides opportunities for investors.

3.8 Money Market Mutual Funds

  • Period A and B: Cash and cash equivalents have consistently demonstrated robust performance during economic conditions associated with both Period A and the subsequent Period B, delivering average returns of 14.6% and 16.3%, respectively. These assets have proven to be an attractive haven for investors during these periods. Both of these periods are typically marked by central banks increasing key interest rates, with Period B signaling the start and Period A marking the end of a tightening cycle. This environment makes cash and cash equivalents an appealing choice for investors looking to shield themselves from the impact of rising inflation. Additionally, in both of these periods, investment opportunities are scarce due to unfavorable market conditions with investors gravitating toward quality assets as they seek stability and security.

4. Analysis of risk and returns

4.1 Returns In Period A (Declining Inflation and GDP Growth), assets such as USD forex, investment-grade corporate bonds, and short-term government bonds exhibited their best performance, with average returns of 0.6%, 2.4%, and 0.9%, respectively. The associated volatilities for these assets were 4.6%, 4%, and 1.4%. Notably, short-term government bonds achieved the highest risk-adjusted returns, as indicated by the Sharpe Ratio of 1.29. In Period B (Accelerating Inflation and Declining GDP Growth), long-term government bonds, high-yield corporate bonds, and cash and cash equivalents tended to perform best, delivering average returns of 0.8%, 2.5%, and 16.3%, with volatilities of 6.5%, 6.3%, and 28.5%. Despite this, short-term government bonds remained the asset class with the highest risk-adjusted returns, boasting a Sharpe Ratio of 1.19. Period C (Increasing Inflation 10 and Increasing GDP Growth) saw commodities and real estate as the top performers, yielding average returns of 3.5% and 2.0%, with volatilities of 10.7% and 1.4%. Real estate stood out as the asset class with the highest risk-adjusted returns, boasting a Sharpe Ratio of 2.94. In Period D (Declining Inflation and Increasing GDP Growth), equities delivered their best performance, achieving average returns of 3.6% with a volatility of 6.9%. Nonetheless, real estate retained the distinction of being the asset class with the highest risk-adjusted returns, as reflected in its Sharpe Ratio of 2.35.

Similar results can be visualized with the following graphs, which depict where the positive and negative returns for the different asset classes distribute as GDP and inflation are increasing or decreasing. To better understand this graph assume that 1 = S&P 500, 2 = Vanguard Long Term Bond index, 3 = S&P Real Estate index, 4 = S&P Commodities index, 5 = USBIG Bond index, 6 = Money Market Mutual Funds, 7 = S&P Short Term Bond index, 8 = DXY Dollar index and 9 = S&P High Yield index

4.2 Volatility

Some asset classes indeed exhibit greater stability during volatile economic periods. Long-term government bonds, investment-grade corporate bonds, short-term government bonds, and real estate 11 have shown consistent stability in various economic conditions. In contrast, high yield corporate bonds, commodities, and equities tend to experience higher volatility, particularly during challenging economic phases. Cash and cash equivalents, as well as the USD exchange rate, maintain a moderate level of volatility, offering stability during different economic scenarios. The choice of asset class largely depends on an investor’s risk tolerance and their investment objectives in light of the prevailing economic conditions. Diversification across asset classes can help mitigate risk and optimize returns in a dynamic investment landscape.

5. Analysis limitation

  • Data Availability: The analysis considers nine asset classes relying on quarterly time series starting in the last quarter of 1973 until the second quarter of 2023. However, it’s essential to note that some asset classes have shorter time series due to a lack of data availability. Specifically, data for short-term and long-term government bonds, as well as high yield bonds, is limited to 30 years. This limited historical data can affect the depth of insights into the long-term performance and volatility of these asset classes. A more extended time series might provide a more comprehensive perspective.

  • Sample Size: The number of data points available for each asset class can vary significantly. For asset classes with shorter time series, such as high yield bonds, the sample size is smaller, potentially impacting the robustness of statistical conclusions and the ability to detect less frequent or more extended patterns. A larger sample size typically provides a more reliable basis for analysis.

  • Assumptions: The analysis relies on historical data to draw conclusions about the performance and volatility of asset classes during different economic periods. It assumes that past performance is indicative of future behavior, which may not always hold true. Economic and financial conditions can change, and unforeseen events can impact asset class performance in ways that historical data may not fully capture. Investors should be aware of these limitations when making investment decisions based on historical trends.

  • Simplified Economic Phases: The economic phases (Period A, B, C, D) in the analysis are a simplification of real-world economic conditions. In reality, economic cycles can be more complex and may not neatly fit into these categories. The real-world economic landscape is influenced by numerous variables and external events that may not be fully accounted for in this analysis.

  • Our Interpretation. The historical analysis presented in this report is intended to provide insights into the performance of various asset classes. The explanations for the historical movements of these asset classes are generally accurate and are based on recognized economic and financial principles. However, it is important to note that these explanations are broad generalizations and may not effectively explain every individual movement in the profitability of specific assets.Financial markets are influenced by a multitude of factors, including economic conditions, geopolitical events, market sentiment, and unforeseen circumstances. These complex interactions can result in deviations from historical trends. Therefore, while historical performance and associated explanations offer valuable insights, they should not be viewed as infallible predictors of future movements in the markets.

  • Reference Periods Determination Method: We employed a systematic method to ascertain reference periods (A, B, C, D) based on variations in GDP and inflation. The goal was to identify distinct periods of economic performance characterized by either positive or negative variations. The method involved the following steps:

  1. GDP Variation Analysis: We computed the percentage change of the GDP index and then we compared it with the mean variation for the 50 year period we got and we assumed that the GDP was growing if it was higher than the mean plus the standard deviation of the GDP changes divided by 50. We assumed it was decreasing if it was less than the mean minus the standard deviation of the GDP changes divided by 50

  2. GDP Index Analysis: We initiated the process by examining the ’US GDP (AR) CONA’ index, focusing on quarterly changes in GDP.

  3. Negative Variation Detection: To identify periods marked by negative GDP variations, we compared the current quarter’s GDP deviation to historical data. If the current quarterly deviation was lower than the average historical variation in GDP minus (one-fiftieth of the standard deviation of historical GDP growth), it indicated a period of negative GDP variation.

  4. Positive Variation Detection: Conversely, for identifying periods of positive GDP variation, we compared the current quarterly GDP deviation to historical data. If the current quarterly GDP variation was higher than the average historical variation in GDP plus (one fiftieth of the standard deviation of historical GDP growth), it indicated a period of positive GDP variation.

  5. Inflation Variation Analysis: Inflation Change Calculation: In a similar manner, we calculated changes in inflation by measuring the difference between the current period’s inflation (derived from the ’US CPI - ALL ITEMS LESS FOOD & ENERGY (CORE) SADJ index’) and the previous period’s inflation.

  6. Negative Variation Detection for Inflation: To identify periods characterized by negative inflation variations, we compared the current quarterly variation in inflation to historical data. If the current quarterly variation in inflation was lower than the average historical variation in inflation minus (one-twentieth of the standard deviation of historical inflation), it indicated a period of negative inflation variation.

  7. Positive Variation Detection for Inflation: For identifying periods marked by positive inflation variations, we compared the current quarterly variation in inflation to historical data. If the current quarterly inflation variation was higher than the average historical variation in inflation plus (one-twentieth of the standard deviation of historical inflation), it indicated a period of positive inflation variation.

  • Lagged variables: GDP and CPI data are recalculated months and even years after the first publication to account for new information and improve the accuracy of the data. This can be tricky when studying the movements of certain asset classes in relation to those variables because the asset class movements may have already occurred by the time the data is recalculated. For example, if the GDP data is initially reported to be 1% growth but is later recalculated to be -1% growth (it is an extreme case just to make the example clear), this could lead to a revision of the relationship between asset class movements and GDP growth. This could have implications for investors who are trying to make investment decisions based on this relationship. We must say that the data we got about inflation and GDP is ”backward looking” meaning that it states what happened before, and knowing that the financial markets are ”forward looking” there may not be a perfect and clear relationship because in two period with the same CPI and GDP trends investors may have different expectations.

6. Conclusion

The performance of various asset classes across different economic periods highlights the importance of adapting investment strategies to ever-changing economic landscapes. Understanding the interplay between economic forces and asset classes provides investors with a powerful tool to optimize their portfolios. By carefully considering the prevailing economic conditions and aligning them with investment objectives, investors can navigate the complexities of financial markets with confidence and agility. Diversification remains a key strategy for managing risk and capitalizing on opportunities in the ever-changing landscape of financial markets


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