In turn, the US President and the Treasury Secretary have not ruled out the possibility of the world’s largest economy falling into recession. This raises the question of how, historically, various assets behave during such a downturn. A ‘what if’ scenario.
The facts
Recessions often take everyone by surprise. Or, as happened in 2023, sometimes when everyone is expecting them, they do not materialise.
Until less than a month ago, the probability of a recession in the world’s largest economy was very low. However, since then, the US President, his Treasury Secretary and Jeffrey Gundlach have used the ‘R word’.
Trump recently said a recession could be a necessary evil to get the economy back on track, a statement that immediately caused economists to react.
Scott Bessent, the Secretary of State for the Treasury, shares a similar view, believing that brutal adjustments may be inevitable to clean up a system saturated with excess money and debt.
However, most analysts remain sceptical about the supposed benefits: a recession triggered by protectionist policies and increased geopolitical instability could have consequences that are much harder to control than expected.
Growing uncertainty is also prompting many investors to review their strategies to protect themselves against more volatile market scenarios.
What is a recession?
It may seem a basic question, but it is a necessary one. A recession is characterised by a phase of economic contraction lasting more than 6 months – only 2 quarters represent a ‘technical recession’.
Generally, a country is said to have entered a recession when the economy declines for two consecutive quarters, mainly based on gross domestic product (GDP).
According to the National Bureau of Economic Research, the average duration of recessions since 1945 is just over 11 months, with long periods averaging 58 months.
Why would Trump want to push the United States into recession?
Trump seems ready to orchestrate a controlled recession to redefine the foundations of the US economy. His administration, with the support of figures such as Treasury Secretary Bessent and Commerce Secretary Howard Lutnick, is seeking to eliminate excessive reliance on public spending by drastically reducing the deficit, even if this means causing an economic slowdown.
The aim is twofold: to put an end to the era of ‘all credit’ introduced under Biden and to impose a restructuring in which the private sector takes over from the State as the engine of growth.
The logic behind this strategy is based on a ‘purge effect’: a temporary economic shock to eradicate imbalances and allow a recovery on sounder foundations, notably through tax cuts and massive deregulation.
Politically, a short-term recession would also allow Trump to blame the previous administration for the slowdown, while promising a spectacular rebound in the run-up to the mid-term elections.
In short, this is not a collapse, but an abrupt transition to a new economic cycle, where the immediate sacrifices would be used to redraw a landscape more favourable to private growth and Republican domination.
How assets have performed historically during a recession
During recent recessions, there have been a number of reactions on many assets, including:
- The S&P 500
It is of course interesting to know how indices evolve during a recession, but also – and above all? – before and after one.
If we agree with the figures from the NBER (US Business Cycle Expansions and Contractions | NBER), we can make the following observations:
- Before a recession: The S&P 500’s cumulative return was, on average, the lowest in the 12 months before a recession (-3%) and in the six months after (-2%).
- During a recession: During a recession, the average performance is -1%. However, if we exclude the 2007 recession, the average performance is +2.8%! A very interesting graph from Forbes shows how an investment of $10,000 would have performed in a recession over a 24-month period. While recovery times and strength vary, a positive performance has always been the most likely outcome.
- After a recession: Not surprisingly, cumulative returns become increasingly positive as we move further away from the recession. 6 months after the recession, performance averages +7%. After 12 months it is +16% and after 2 years 20%.
- Earnings and valuations
According to NBER figures, on average, S&P 500 earnings fall by 16.4% during a recession. It should be noted that in two of the last ten recessions, there has been no decline in the index’s earnings.
During the recessions of 1973-1975 and 1980, profits at index level actually increased. Both periods were marked by high and rising levels of inflation, which probably enabled large US companies to maintain their nominal earnings growth.
During the 1973-1975 recession, earnings per share for the S&P 500 index rose by 18.4%. During the 1980 recession, earnings rose by 7.1%.
The average compression of the price/earnings ratio was 26.0% and the S&P 500 index multiple fell during each of the recessionary periods.
In conclusion, during recessions, US companies generally suffer a contraction in their earnings as well as their price/earnings ratios. The last ten recessions have all been marked by declines in the P/E ratio of the S&P 500 index, while earnings have fallen in eight of the ten recessions.
- Bonds
During an economic slowdown, the Fed historically lowers the federal funds rate as part of its monetary policy.
As you know, the bond market is inversely correlated with the federal funds rate and short-term interest rates. When interest rates fall during a recession, bond prices rise, and bond yields fall.
During periods of economic growth following a recession, interest rates begin to rise. Bond prices fall and bond investors receive higher yields.
Not all bonds perform in the same way during a recession. Historically, the best performers during this period of the economic cycle are:
- Federal bonds issued by the Federal Reserve
- Municipal bonds issued by local and state governments
- Taxable corporate bonds issued by private companies
In terms of duration, long duration is favoured when a recession is expected, and short duration when the recession is expected to end.
The 2 main advantages of investing in the bond market during a recession are:
- A source of fixed, stable income: During an economic downturn, bonds can provide a predictable source of fixed income.
- Strong demand: During a recession, bonds are more in demand than dividend-paying equities.
- Materials
Industrial metals are generally the hardest hit, falling by 35% from one peak to the next. Energy price spikes are partly responsible for two-thirds of recessions, and then generally return to pre-recession levels. Here’s what the data on US recessions since 1970 tell us:
- Industrial metals are generally the hardest hit, with a 35% fall from peak to trough and a 20% fall in the year following the end of a recession compared with the year before the recession began.
- The energy sector is more mixed, with a 23% peak-to-trough decline, but in two-thirds of recessions, energy prices continued to rise for an average of six months after the start of the downturn, suggesting that energy shortages were the cause.
- Gold is an exception. During the median average recession, real gold prices rose by 5% in the 12 months following the end of the recession, compared with the 12 months before it began. Other precious metals tended to fall by 10%-15%.
However, each recession is of course unique.
During the Great Recession of 2008-09, for example, six of the twelve commodities shown in this chart experienced the worst peak-to-trough (i.e. highest to lowest) decline of any recession, while three others of the twelve experienced their second worst decline.
The sectors
As economic growth stagnates and contracts, historically the most economically sensitive sectors lose favour and defensives outperform. Consumer staples, utilities, telecoms and healthcare do better.
Industrials, technology, materials, property and financials generally underperformed the market. Naturally, we pay close attention to expectations of a return to recession and expectations of an exit from recession.
In other words, if at the start of the recession we are already anticipating an exit, it is obviously the sectors linked to the rebound – financials, technology, etc. – that will perform best.
Conclusion
If we look at history, in the hypothetical case of the United States entering a recession – which is not our scenario today –, this will not necessarily mean a collapse in the S&P 500. The idea is that when you enter a recession, you expect to come out of it, that there is a light at the end of the tunnel. The question is, of course, how long a potential recession could last. We are not there yet, and we must not underestimate the US Federal Reserve’s ability to intervene ‘at any time’ if a dramatic slowdown is feared.
By John Plassard, senior investment specialist at Mirabaud GroupÂ
