Investment Portfolio for a Down Market - October 12 2011
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Transcript of Investment Portfolio for a Down Market - October 12 2011
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Roubini Global EconomicsRoubini Global Economics
By the RGE Economic Research and Market Strategy Teams
Roubini Global Economics Copyright 2011
No reproducing or redistribution without written consent.
October 12, 2011
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Roubini Global Economics Copyright 2011
No reproducing or redistribution without written consent.
roubini.com | [email protected] Tel: 212.645.0010 | [email protected] / [email protected] Tel: +44 (0) 207 420 2800
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3
Recessions Covered in This Presentation
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1980-82 U.S. Double Dip 1990 Japan
1990-91 U.S./Global
1990s EM Crises: Asia/Russia/Brazil/Mexico
2001 U.S.
2008-09 Global/U.S.
2011 Global Double Dip
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4
Time Periods Used for Dating Recessions
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2011 - Global Double Dip
2008-09 - Global/U.S.
2001 - Argentina/Global/U.S.
1999 - Brazil
1998 - Russia
1997 - Asian Crisis
1990-91 - U.S./Global
1994 - Mexico
1981-82 - U.S. Double Dip1980 - U.S./Global
Source: NBER
U.S. Economic Recession Dates
The NBER does not define a recession in terms of two consecutive quarters of
decline in real GDP. Rather, a recession is a significant decline in economic activity
spread across the economy and lasting more than a few months, normally visible in
real GDP, real income, employment, industrial production, and wholesale-retail
sales.
Non-U.S. Recessions (for Graphing
Purposes)
Mexico 1994-Start Jan 1994 through
Dec 1995Asia/Russia/Brazil: Trigger was the
sameAsia. Start Jan 1997 through
Dec 2000
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Protecting the Portfolio in a Downturn:
Lessons from Past Recessions
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1980-82 Double Dip
Induced by monetary policy. Policy was already restrictive
following the great stagflation of the 1970s. The Oilprice shock in 1979 prompted further monetary
tightening, which caused the first recession.
A pause in tightening cycle led to a brief recovery, but
before manufacturing and construction recovered,
inflation resumed; a second phase of monetary
tightening was ushered in, leading to a double dip.
Unemployment soared but Fed gained inflation
credibility. A three-year tax-cut planEconomic
Recovery Tax Act of 1981 announced by President Reagan.
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1980-82 Recession
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(Shaded Areas Represent Monetary Tightening)
Oil Price Shock of 1979 and First Recession
Second Monetary Tightening in 1980 Led to Soaring
Unemployment
(Shaded Area Represents Recession)
But the Fed Succeeded in Clamping Down on Inflation
Source: Federal Reserve Bank of St. Louis FREDSource: Federal Reserve Bank of St. Louis FRED
Source: Federal Reserve Bank of St. Louis F RED
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1990-91 Recession
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Black Monday Crash
Source: Robert J. Shiller, Irrational Exuberance, 2nd. Edition, Princeton University Press, 2005
1990-91 Recession
Lingering effects of 1980s including restrictive
monetary policy, tight credit conditions.
1987 Black Monday equity crash (over 22%
drop in DJIA) was a factor, as was the Gulf War-
related oil shock.
Recession saw financial contagion to G10, U.S.
energy and real estate sector affected; high
unemployment, budget deficits.
1990s Gulf War Oil Shock and Loss of ConfidenceReal Home Prices Fell 12.3% in the 1990s Recession
Source: Federal Reserve Bank of St. Louis FRED
Source: Federal Reserve Bank of St. Louis F RED
http://www.econ.yale.edu/~shiller/data.htmhttp://www.econ.yale.edu/~shiller/data.htmhttp://www.econ.yale.edu/~shiller/data.htmhttp://www.econ.yale.edu/~shiller/data.htm -
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50
60
70
80
90
100
110
120
130
140
t-383 t-333 t-283 t-233 t-183 t-133 t-83 t-33 t+17 t+67 t+117 t+167 t+217 t+267 t+317 t+367 t+417 t+467 t+517 t+567 t+617
GSCI DXY MXEF SPX
1990-91 Recession: Asset Performance
Note: All asset values indexed at 100 at beginning of the recession, time t=0 at beginning of recession. GSCI: S&P/ Goldman Sachs Commodity Index; MXEF: MSCI Emerging Markets Index; DXY:
Dollar Index Spot; SPX: S&P 500 Index
Source: Bloomberg
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Low interest rates fed speculative demand in property, especially
commercial, contributing to property price spike. Reduction in
returns on investment. Japans real estate bubble burst in 1991;rise in public debt absorbed by households.
Response: Eventual cut in interest rates, fiscal stimulus. But
stimulus was withdrawn too soon, especially fiscal, and Japan
re-entered recession.
Hidden nonperforming loans; Japanese authorities did not deal
with vulnerabilities in banking sector zombie banks that could
not fund investment and support growth.
Japan saw three cyclical downturns prior to the great recession;
job losses were not severe, but grinding deflation.
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1990-91 Japan Crash and Lost Decade
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Source: Federal Reserve Bank of St. Louis FRED Source: Federal Reserve Bank of St. Louis FRED
Source: Federal Reserve Bank of St. Louis FRED
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1990s EM Crises
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EM Crises: Similar balance sheet
vulnerabilities, twin fiscal and trade
deficits, rising public debt, overvaluedcurrencies and de-facto pegs, which allowed
greater debt accumulation.
Crises tended to be combined currency and
banking crises, triggered by currency and
maturity mismatches in balance sheets
(short or LT FX debt-financed LT domestic
infrastructure projects).
Beyond similar triggers, but the Asian crisis
made investors look more closely at
vulnerabilities in other EMs.
In almost all cases, devaluation improved
export competitiveness, reduced imports.
Affected countries restructured bankingliabilities. Stronger global environment
helped eventual recovery.
Most Countries Had Twin Deficits
-12
-10
-8
-6
-4
-2
0
2
4
Current Account Deficit (% of GDP) Fiscal Deficit (% of GDP)
0
1020
30
40
50
60
0
50
100
150
200
250
300
350
Public Debt (% of revenues) Short-term foreign debt (% of reserves) Public debt (% of GDP)
Excessive Short-Term Debt
Source: RGE, Bloomberg
Source: RGE, Bloomberg
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1994Mexico
Real exchange rate was rising in early 1990s; rising current account deficit; reserve growth was strong, but inflows went more into short-
term financial instruments rather than FDI.
Current account deficit-fueled worries of overvalued peso; U.S. rate hikes, political uncertainty in 1994 aided reserve flight.
Central bank sterilized intervention unsustainable; forced to de-peg; peso collapsed and recession ensued.
Policy response: U.S.-, IMF-backed financial stabilization package (loan guarantees).
1997Asia Crisis
Causes: Overinvestment financed by unsustainable foreign borrowing, contributing to lower returns on investment. FX/maturity
mismatches on investment, excessive public and private debt, twin deficits (fiscal and current account).
Unsustainable debt/debt service and flight of capital prompted Thai baht devaluation, contributing to a sudden stop of capital to other
Asian economies. Key economies affected: Thailand, Malaysia, South Korea, Indonesiabut all Asian countries faced some effects.
Financial contagion spread to other EMs, and negatively affected global sentiment. Devaluation of exchange rate increased the size of
private debt in local currency terms dramatically, boosting debt service costs.
Policy response: Liquidity support, bank restructuring, currency devaluation restored competitiveness, structural reforms etc.
Countries like China, HK used reserves to maintain currency peg. HKMA expanded balance sheet dramatically, increasing reserves and
buying extensive quantities of local equities to counter short-selling.
Policy prescriptions from IMF/WB to raise interest rates to attract capital likely exacerbated the effect of the recession, while lack of fiscal
space meant that public and private demand collapsed simultaneously.
1998Russia
Triggered by Asian Financial Crisis driven capital flight; reduction in global demand and continued oil supply reduced oil pr ices, reducing
government revenues.
August 1998, default on US$40 billion bond payment; Russia de-pegged.
Russia faced LT competitiveness issues following breakup of USSR, shock therapy led to recession in mid-1990s.
Output loss was actually quite small as underlying consumption was little tied to banking system
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Historical ReviewEM Crises
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1999Brazil
Asian Financial Crisis led to capital flight, drop in commodity
revenues, sharp rise in public debt service costs, sluggish growth, pressureon fixed exchange rate; capital flight (Brazil lost US$50 billion in reserves) .
Policy response: Sharp currency devaluation (over 40% in total) to restore
competitiveness, IMF support (US$41.5 billion) did not prevent
devaluation. Growth slowed again in 2001 during U.S. recession.
Thereafter, strong global growth, better macro framework, helped
support growth.
2000-01Turkey
Trigger: FX/maturity mismatches, highly dollarized economy, wide twin
deficits. Sudden stop of capital convulsed banking system.
Policy response: restructuring of banking sector. IMF support. Currency
devaluation.
2001Argentina
Argentina currency board (peso fixed to dollar facilitated excessive
borrowing), Brazil devaluation made exports even more
uncompetitive, debt service costs too high.
IMF package initially unsuccessful in avoiding currency collapse.
Policy response: Sharp devaluation, pesification of debts, strong global
growth helped Argentina out of crisis .
12
Historical ReviewEM Crises
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Source: Gruben and Welch, Federal Reserve Bank of Dallas
BankingFinancial Leverage in Crisis Countries
Post-Crash Output Declines
Source: Bloomberg
http://dallasfed.org/research/efr/2001/efr0104b.pdfhttp://dallasfed.org/research/efr/2001/efr0104b.pdfhttp://dallasfed.org/research/efr/2001/efr0104b.pdfhttp://dallasfed.org/research/efr/2001/efr0104b.pdfhttp://dallasfed.org/research/efr/2001/efr0104b.pdf -
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Asset Performance During Asian Crisis
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70
80
90
100
110
120
130
140
150
t-145 t-95 t-44 t+6 t+56 t+106 t+156 t+206 t+256 t+306 t+356 t+406
GSCI DXY MXEF HY Spread
Note: All asset values indexed at 100 at beginning of the recession, time t=0 at beginning of re cession.
GSCI: S&P/Goldman Sachs Commodity Index
MXEF: MSCI Emerging Markets Index
DXY: Dollar Index Spot
HY Spread: BarCap US Agg. Corporate Avg. OAS
Source: Bailouts and Bail-ins (Roubini and Setser 2004)
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Preceding years saw U.S technology/internet investment
boom (1995-2000) and an accompanying stock market
bubble. The Fed hiked rates by 150 bps between 1999 and early 2000.
Investment peaked in 2000, tech bubble burst and recession
ensued. Globally, mostly affected Asian tech exporters, Israel
given sectoral links. September 11 shocks slowed recovery.
2001 was a mild recession: Loss of financial wealth, but real
estate values were rising, aided by aggressive (excessive) ratecuts by Fed (550 bps by mid-2004). Housing bubble ensued.
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2001 Recession
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Note: All asset values indexed at 100 at beginning of the recession, time t=0 at
beginning of recession
Source: Bloomberg
Source: Federal Reserve Bank of St. Louis F RED Source: U.S. Bureau of Economic Analysis
R U t 2008 R i L d H i
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Run-Up to 2008 Recession: Leverage and Housing
Bubbles Across Several DMs
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Source: Glick and Lansing, Federal Reserve Bank of San F rancisco
Low interest rates, securitization and lax lending
standards boosted speculative housing demand
in prior decade. (U.S. household debt level
soared to over 130% of GDP. )
Housing bubbles in U.S. and across advanced
economies. In U.S., the bubble drove over-
investment in unproductive real estate. Wealth
effects encouraged mortgage equity withdrawal
and dis-savingboosting consumption.
Source: Federal Reserve Bank of St. Louis FRED
Source: Federal Reserve Bank of St. Louis FRED
P ll l R U EZ i i Li i Di l
http://www.frbsf.org/publications/economics/letter/2010/el2010-01.htmlhttp://www.frbsf.org/publications/economics/letter/2010/el2010-01.htmlhttp://www.frbsf.org/publications/economics/letter/2010/el2010-01.htmlhttp://www.frbsf.org/publications/economics/letter/2010/el2010-01.html -
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Parallel Run-Up to EZ crisis: Living Divergently
Under the Same Roof
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Rigid labor markets; global demand shocks did not slow wage
growth; this, combined with low productivity, raised unit labor costs
in periphery that exacerbated the initial competitiveness loss. First decade of EMU saw booming global liquidity, credit and
growth; divergent macroeconomic performance and imbalances
remained masked.
Early interest rate convergence became damaging as it allowed a
severe lack of fiscal discipline in some countries (such as Greece and
Portugal) and the build-up of asset bubbles in others (such as Spain
and Ireland).
2008 crash even seemed to enhance EZ financial stability. Risks
finally surfaced with a vengeance in Q2 2010; questioning sovereign
debt sustainability of the EZ periphery.
Source: European Commission
Source: Bloomberg
Source: RGE, Bloomberg
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U.S. subprime mortgage defaults began climbing, lending dried up
and housing bubble burst; financial crisis ensued with global
contagion. Drop in asset prices (both housing and financial) and
unsustainable debt burdens drove a balance-sheet
recession, beginning December 2007. Unemployment soared.
Sharp falloff in aggregate demand; credit freeze transmitted via
global financial linkages and exacerbated trade collapse, driving
severe global recession by late 2008. Fall in industrial production
and trade worst since great depression.
Backstopping of the financial system via emergency liquidity
facilities, coordinated global fiscal and monetary stimulus
averted second great depression in 2008-09.
Recovery from recession predictably anemic, subpar.
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Source: Eichengreen and ORourke, VoxEU
Greatest Drop in Global Trade Volumes Since Great
Depression
2008-09 Global RecessionU.S. Job Losses Far Exceeded Postwar Recession
Experience
Source: Federal Reserve Bank of St. Louis FRED
Source: Haver
http://www.voxeu.org/index.php?q=node/3421http://www.voxeu.org/index.php?q=node/3421http://www.voxeu.org/index.php?q=node/3421http://www.voxeu.org/index.php?q=node/3421http://www.voxeu.org/index.php?q=node/3421http://www.voxeu.org/index.php?q=node/3421http://www.voxeu.org/index.php?q=node/3421http://www.voxeu.org/index.php?q=node/3421 -
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Asset Performance2008-09 Recession
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GSCI: S&P/Goldman Sachs Commodity Index; MXEF: MSCI Emerging Markets Index; DXY: Dollar Index Spot; HY Spread: BarCap US
Agg. Corporate Avg. OAS; CRY: CRB Commodity Index; EURCHF: Euro/Swiss Franc
Source: Bloomberg
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Balance Sheet Issues Are Still Present
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Many of the balance-sheet issues that contributed to the 2008-09 recession are still here, or have
worsened as private debts have been taken on to public balance sheets.
Deleveraging, and fiscal austerity to reduce the unsustainable fiscal trajectory, raises risk of double dip.
Source: IMF
Indebtedness and Leverage in Selected Advanced Economies
(percentage of 2010 GDP, unless otherwise noted)
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Aftermath of Balance-Sheet Crises
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Source: Glick and Lansing, Federal Reserve Bank of San Francisco
Deleveraging Portends Low Growth in Advanced
Economies
How Much More U.S. Deleveraging: Is Japan an
Example?
Recoveries form financial crises are historically slow.
Deleveraging will cause anemic subpar growth in DMs for a long
time.
DMs are pulling back on fiscal stimulus too soon, high risk of
repeating mistake of 1937.
U.S. and other DMs seem on course for another recession; EZ
crisis a major risk; policy makers running out of bullets. EMs
have recovered faster given higher potential growth and
healthier balance sheets, but a DM downturn will affect the
global economy.
Slow Labor Market Recovery Follows a Financial Crisis; Japan Job
Losses, Small; Albeit Grinding Wage Deflation
Source: HaverSource: Haver
http://www.frbsf.org/publications/economics/letter/2010/el2010-01.htmlhttp://www.frbsf.org/publications/economics/letter/2010/el2010-01.htmlhttp://www.frbsf.org/publications/economics/letter/2010/el2010-01.htmlhttp://www.frbsf.org/publications/economics/letter/2010/el2010-01.html -
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Sovereigns have assumed higher private sector debt and overall levels are unsustainable. Heavy burden of
private and public debt in a number of periphery countriesGreece, Ireland, Portugalis so large that debtrestructuring and reduction will eventually have to occur.
Current muddle through approach is not working. Even if sovereign debt issues are addressed, still need to
restore competitiveness for the periphery to bring back growth.
Greece is still insolvent and uncompetitive, and Portugals public, private and external debt dynamics are not
sustainable without a growth boost. Despite comparatively better fundamentals, Spain and Italy are at risk of
losing market access if no action is taken immediately.
Unless the EMU moves toward a broader fiscal, economic and political union that resolves the fundamental
problems of divergence (economic, fiscal and in terms of competitiveness) within the union, the system will
move first toward disorderly debt workouts and then, eventually, even break-up, with weaker members
departing.
Greek and Portuguese fundamentals put them most at risk of an exit from the EZ within the next five years.
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EZ Crisis Continues
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In RGEs view, Chinas growth model is not sustainable.
Episodes of overinvestment in manufacturing and
industrial capacity (not just housing booms) end in a hard
landing, with no exception: From the Soviet Union in the
1960s-80s; to Latin America in the 1970s-early 1980s; to
Japan in the 1980s; to the U.S. in the 1990s; to East Asia in
the 1990s.
Investment (now almost 50% of GDP) must slow down and
banks will need more capital. The question is whether thishappens with a soft or hard landing.
Recession in DMs might delay a crisis in China as it
dampens inflationary pressures and encourages further
stimulus, but it might increase the eventual cost of (partly)
bailing out the Chinese financial system.
End of investment-led growth implies weaker commodity
demand pressure on metals and energy in particular.
EMs exposed to China (commodity producers, other Asia
exporters) are vulnerable.
China sharp slowdown would reduce global growth, and
could encourage flight to safety.
22
Risks From a Chinese Hard Landing
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Rising Debt Burdens (RMB, trillions)
Source: Nehru and Dhareshwar (1993), IMF, World Bank, National Bureau of
Statistics, RGE
Source: Peoples Bank of China, Ministry of Finance, Asian Development Bank, RGE
estimates
Investing for GDP, Not Profit (RMB, trillions)
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None of the China Mid-Term Scenarios Are Rosy
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Global Scenario Analysis Flowchart
Present to End-2011 2012
DMs are at stallspeed, while EMs are
growing near potential.
DMs face a risk of
falling into recession in
2011
DMs fall into
recession, likely in late
2011 or early 2012. Triggers
include a financial crisis
following disorderly
default(s) in the EZ and
policy mistakes (lack of or
insufficient timely support)
The growth environment isvolatile, but DMs avoid
technical recession (thoughnot growth recession) andEMs keep growing around
potential
2013-15
A weak, U-shaped recovery
continues, with volatile
growth in DMs (amid
balance-sheet repair and
possible EZ uncertainty) and
EMs growing near potential.
China's broken investment-
led growth model gives out.
Gradual rebalancing ensues
A deep recession takes hold
of DMs and possibly
globally, requiring an
aggressive, coordinated
policy response
~55%
~45%
Probability
Adequate policy
support (QE and
fiscal stimulus
across DMs and
possibly some
EMs) staves off
the failure of
systemic
institutions
The policy
response is
inadequate (no QE
or too-little, too-
late QE; a lack of
adequate fiscal
stimulus and
possible fiscal
drag)
Probability
60%
40%
Policy Response
We now see a negligible chance of strong global growth
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Asset Performance in Past Recessions
and Recommendations by Asset Class
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A notable feature is a significant increase in correlations across asset classes in past years, which results in
indiscriminate rallies and sell-offs.
There are few uniform effects across currencies, and across recessions as exchange rates are relative
prices. Effects are most clear when recessions align with periods of risk aversion. USD tends to perform
best at times of deep crisis as opposed to mere cyclical downturns, CHF and JPY have performed well in
recent recessions.
During the past down cycle, defensive equities typically trade at a premium to cyclical as a result of better
earnings visibility and relatively low valuation ahead of the downturn.
The stagflation episodes are a reminder that Treasurys may not always be a safe haven, but Japan(liquidity trap) is a model for most DMs, with deflation a risk and low bond yields. The EZ, by
contrast, resembles EM crises, with default and deval risk.
Commodity price movements are more pronounced in recent recessions due to the greater volume of
commodities traded in the past two decades, and particularly in the past few years as investors seek
liquidity.
In all recessions, EM bonds (both external and domestic debt) outperformed equities. Asian FX tended tooutperform EMEA and LatAm, aside from in the Asian crisis.
26
Historical AssessmentMain Takeaways by Asset Class
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Performance of Bonds in Past Crises
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The stagflation episodes are a reminder that Treasurys may not always be a safe haven.
The losses in investment-grade (IG) bonds in 2008-09 were not unprecedented, though the relative
underperformance compared with Treasurys is unique in post-war developed market history.
All maximum drawdowns are fully recovered within six-12 months, even the 2008-09 losses.
Current drawdowns: IG bonds, 0%; Treasurys 0%; high yield (HY) 4%. There may be a long way to gobefore the bottom, even if spreads show value.
De-coupling? EM Crises dont seem to cause severe damage to DMs; but converse is obviously not true.
Episode Date IG Date HY Date 7-10y Tsy Date Comments
Oil Shock #1 1973-4 -10.2% Sep-74 -2.7% Jun-74 GDP falls 3.2%; 10y yields 5--> 9%
1980 -18.0% Mar-80 -15.2% Feb-80 Stagflation; yields hit alltime high >15%
1981 -15.0% Sep-81 -13.0% Sep-81 GDP falls 2.9%, unemployment >10%
S&L Crisis 1990-1 -1.8% Aug-90 -11.2% Oct-90 -2.1% Aug-90 House starts collapse 60%; unempl from 5.2 --> 7.8%
Mexico 1994-5 -6.0% Jun-94 -5.3% May-94 -8.0% Nov-94 Greenspan hikes rates 300bps to 6%
Asia 1997-8 -1.5% Aug-97 -0.1% Aug-97 -1.6% Aug-97 U.S. growing at 5+%
Russia/LTCM 1998-H2 -1.2% Oct-98 -6.8% Oct-98 -1.4% Nov-98 75bp rate cut; US grows at 7% in Q4
Arge/Dot-Com 2001-3 -2.0% Mar-02 -12.0% Jul-02 -5.0% Mar-02 9/11; WorldCom, Enron; near-double dip; Iraq invasion
Subprime/Lehman 2008-9 -16.1% Oct-08 -33.2% Nov-08 -6.3% Jun-09 14% HY defaults; GDP drops 5%, yields soar after bottom
Asset Class Maximum Drawdowns
Double Dip
Source: Merrill Lynch, RGE, Bloomberg
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What to Expect From Bonds
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The preceding table shows four types of recessions. MONETARY INDUCED SLOWDOWNS or sectoral bubbles
(dot-com, 1994-5 soft landing) are typically short lived. STAGFLATION is also not relevant in DMs, though some
EMs (India, Vietnam) may relive that nightmare if their growth models fail. LIQUIDITY TRAPS such as the Japanese experience and S&L crisis are more relevant for DMs with an ability to
monetize, such as the UK and U.S.:
Treasuries and IG should do well, even with yields low, but Financials vulnerable.
Deflation Fixed Income deep-freeze. Any safe yield/spread becomes attractive.
Beware the post-recession rally: Long duration Treasuries will sell off fast, usually a signal to buy HY andEquities which are still in deep drawdown and recover later.
In contrast, Europes crisis is more similar to a typical EM CURRENCY/BANKING CRISIS:
Default is already priced in, contagion is not fully appreciated (both financial damage and economic, i.e.
spillover to trade, investment);
Devaluation and EZ breakup risk is not priced in; corporate losses can be staggering with bankruptcy
widespread due to balance sheet effects;
The core will also suffer a prolonged slowdown; bond yields and spreads will be low.
History shows Healthcare and Utilities weather downturns better than Financials, Telecoms, and Transport
which are more cyclical, capital intensive, and highly leveraged (though history shows manias can occur in other
sectorsthink railroads, South Sea bubble, etc).
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29
Effects of Recessions on Commodity Prices
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Recession Dates
Industrial Metals Energy Agriculture Gold
Max Min % change M ax Min % change M ax Min % change Max Min % change
U.S. 1/12/1969 30/11/1970 No data No data 123.0 99.5 24% 37.5 34.9 7%
U.S. 1/11/1973 31/3/1975 No data No data 476.1 205.4 -57% 172.2 94.8 82%
U.S./Global 1/1/1980 31/07/1980 219.1 134.8 -38% No data 302.2 258.2 -15% 835.0 485.7 -42%
U.S. Double Dip 1/7/1981 30/11/1982 138.5 87.9 -37% No data 396.3 192.3 -51% 453.5 308.9 -32%
U.S./Global 1/7/1990 3/31/1991 206.0 143.3 -30% 131.3 69.6 -47% 232.1 180.4 -22% 410.6 355.7 -13%Mexico 01/01/1995 31/12/1995 231.7 198.9 -14% 64.7 54.2 -16% 281.8 238.6 18% 387.5 371.5 4%
Asia Crisis 01/07/1997 31/12/1998 194.0 135.5 -30% 81.7 47.1 -42% 268.1 179.5 -33% 324.5 286.3 -12%
Russia 01/01/1998 31/03/1999 148.3 127.5 -14% 56.6 42.0 -26% 228.6 164.6 -28% 312.7 274.4 -12%
Brazil 01/04/1999 30/09/1999 153.3 127.1 21% 74.4 43.2 72% 182.9 150.7 21% 279.9 255.3 -9%
U.S./Global/Argentina 1/3/2001 30/11/2001 165.8 123.6 -25% 133.5 67.0 -50% 182.7 151.6 -17% 291.5 258.0 13%
U.S./Global 1/12/2007 30/06/2009 510.8 188.8 -63% 501.3 143.6 -71% 480.6 246.8 -49% 1003.0 724.6 -28%
Average All -26% -26% -19% -4%
Average U.S./Global Only -39% -56% -27% -2%
General Observations: Commodity price movements are more pronounced in recent recessions due to the
greater volume of commodities traded in the past two decades, and particularly in the past few years as
investors seek liquidity. One also has to consider where, geographically, the recession materialized. In the caseof Asia, the negative effects were evident across all commodities; however, the problems following in Russia
actually mitigated the negative effects of both industrial metals and energy prices due the nations dominance
on the production side. Mexico was similar to Russia in the case of energy. A key factor is that recessions tend
to occur post sharp commodity appreciations, which are cause for a chicken and egg debatesuch that
commodity prices tend to fall from highly elevated prices to begin with, particularly in the case of energy and
more specifically, crude oil.
Differences Today vs. the Past: While patterns in commodity prices during recessions are evident, there are
fundamental differences between today and recent history by sub-sector.
Sub-sectors represented by GSCI sub-components.
Some futures markets did not form until the mid 1980s, therefore data not available for all time periods.
Source: RGE, Bloomberg
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Industrial Metals
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Industrial metals have performed poorly
throughout recessionary times, due to their direct
ties to global growth. Their price drops occurredafter recessions had already begun, due to the time
required for metals to move through the supply
chain and experience the price effects of economic
downturns. In most cases, prices began to improve
well before the end of the recession, likely instigated
by forward purchases by consumers in the effort to
take advantage of depressed prices and flat term
structures.
Differences Today vs. the Past: Ore grades are
deteriorating while production input costs such as
energy and labor rise and water become scarcer. In
times of recession, there is less scrap available for
recycling as fewer vehicles and white goods are
traded in and far less construction takes place.
Industrial metals have become more vulnerable to
EM (Chinese demand).
GSCI Industrial Metals Index
0
100
200
300
400
500
600
Jan-77 Jan-83 Jan-89 Jan-95 Jan-01 Jan-07
Global/U.S. Mexico Asia Crisis Russia Brazil
Source: RGE, Bloomberg
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Agriculture
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GSCI Agriculture Index Agriculture: The sector is a mixed picture during recessions
due to the more regional and weather-dependent dynamics
of most food and soft commodities, and their being less priceelastic to the global economy. The Asia crisis and the
Argentina recession had the most dramatic downward effects
on prices, indicative of the profound influence of EMs on the
sector.
Differences Today vs. the Past: Today, there is a need for
more output as the worlds population grows, as the percapita income of EM middle classes rises and diets switch
from grains to protein. There is a greater scarcity of land and
water; while efficiency rates are growing, they are doing so at
a depreciating rate. With the surge in biofuel
initiatives, commodities such as corn and sugar serve as both
food and energy. Recent high inflation in EMs has resulted in
the hoarding of food commodities with the goal of keeping
inflation at bay and appeasing disgruntled
populaces, resulting in a further commodity scarcity.
Finally, weather patterns, as measured by the oscillator index
(El Nio/La Nia) have become more pronounced, resulting
in greater frequency and severity of floods and droughts.
0
100
200
300
400
500
600
Jan-70 Jan-76 Jan-82 Jan-88 Jan-94 Jan-00 Jan-06
Global/U.S. Mexico Asia Crisis Russia Brazil
Source: RGE, Bloomberg
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Energy
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GSCI Energy Index Energy: Energy prices have seen more
pronounced effects in recent recessions, but
typically followed a period of rapidly risingenergy prices, which likely had a significant
influence on why the recession materialized in
the first place.
Differences Today vs. the Past: Breakeven costs
for crude oil are higher now than ever and
national balance sheets are in need ofrepair, particularly in OPEC nations. Energy is an
input into all commodities and therefore
increases the cost of production across the
board. Today, the downside of energy prices is
more limited and the likelihood of OPEC cuts are
more probable with MENA uprisings and
governments (i.e. Saudi Arabia) implementing
more social programs as a "pay-for-peace"
policy.
0
100
200
300
400
500
600
Jan-83 Jan-89 Jan-95 Jan-01 Jan-07
Global/U.S. Mexico Asia Crisis Russia Brazil
Source: RGE, Bloomberg
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Gold
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Spot Gold Gold: Golds performance in the past decade is
unlike any other period we have seen. What this
period has shown is that, in times of free-floatinggold, prices rise both in recessionary and
deflationary times as investors seek
safety, particularly when interest rates and
currencies depreciate. Today, gold performs like a
currency without a country, and in pure form
(bullion) as an asset without credit risk. Yet, in time
of strong rallies, gold tends to sell off rapidly when
capital is needed to cover losses in other asset
classes.
Differences Today vs. the Past: Gold experienced a
notable rally in the 1980s, but high inflation, strong
oil prices, Soviet intervention in Afghanistan and the
impact of the Iranian revolution prompted investors
to buy heavily. Yet, the double-dip recession of
1980-82 actually caused gold to fall. By August
1999, gold reached an all-time low of US$251.70 on
concerned central banks reducing bullion
reserves, while mining companies sold in the
forward markets.
0
500
1000
1500
2000
Jan-70 Jan-76 Jan-82 Jan-88 Jan-94 Jan-00 Jan-06
Global/U.S. Mexico Asia Crisis Russia Brazil
Source: RGE, Bloomberg
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34
Commodities: What to Expect Going Forward
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In Sum: Environmental issues are increasingly
becoming a concern for the world at large, and
previously an issue reserved for the developedworld; today is global.
Today, the greatest risk to the downside in
commodity prices is technology. Research and
development has brought about such new
technologies as hydraulic
fracking, unconventional oil from shale and oil
sands, innovative alternative energies and seed
technologies, synthetic rubber and
lighter, stronger metal alloys. Such inventions
allow both for substitution and for non-traditional
means of production and sources of commodities.
Recessions generally stifle technology as credit is
tight and corporates sit on cash. Producersreduce output as commodity prices drop. The
result is that supply drops and eventually prices
rise, but cycles take time, resulting in a pattern of
15-year peak-to-trough movements in the sector
(with 2008-09 being an outlier).
Trade Ideas: For the sector as a whole, history
has proved that it benefits to be either short or
neutral in a recession. Prices tend to turn beforethe onset of the recession, with a precursor
being the shape of the forward curve. Sharp
backwardations are indicative of nearby
tightness with expectations for weaker future
prices, whereas contangos occur when the
belief is that price weakness is temporary.
Contango steepening signals optimism in future
prices. Of course, sentiment does not always
become reality. but the futures curve is
indicative of market sentiment and momentum.
A tactical trader can seek profits in relative value
(inter- and intra-commodity, or calendar
spreads) and volatility trading (options andoption spreads). When volatility trades at higher
than-historical levels, it is advisable to
tactically sell out of the money options along
the forward curve (hedged with futures or
options if so desired).
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35
FX in Historical Perspective
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There are few uniform effects across currencies, and across recessions. This reflects the fact that exchange
rates are relative prices and respond not just to cyclical developments. Effects are most clear when recessions
align with periods of risk aversion.
USD tends to appreciate, but is also the most volatile across the safe havens. It tends to perform best at times
of deep crisis as opposed to mere cyclical downturns. CHF and JPY generally perform well during downturns except during the U.S. double dip during the early
1980s and the Asian Crisis, when USD surged.
AUD, as a risk-related and high-beta currency, is the clearest sell during downturns and periods of risk
aversion. The evidence is more ambiguous on other commodity-linked currencies, such as CAD.
DXY
AUD CAD CHF JPY
Oil Shock Nov 73 - Mar 75 2mos 17% rise, followed
by a 15mos 15% fall
-10% unchgd +22% +8%
US Double Dip Jan 80 - Nov 82 +45% -15% -6% -29% -13%
S&L Crisis Jul 90 - Mar 91 -7% -1% unchgd unchgd +10%
Tequila Crisis Dec 94 - Dec 95 -5% -3% +4% +15% -4%
Asia Jan 97 - Jul 98 +16% -25% -8% -11% -18%
Russia/LTCM 1998 H2 -8% unchgd -5% +5% +25%
Argy/DotCom Mar 01 - Nov 01 +7% +8% unchgd +5% +4%
Subprime/Lehman Dec 07 - Jun 09 17% rise followed by 10%
fall
-10% -15% +4% +19%
Risk Currencies Safe Haven Currencies
Source: NBER and RGE
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FX: Valuations Matter
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Many pre-2008 mis-valuations have been overturned over the course of the crisis. The clearest examples lie at
the respective ends of the spectrum, with CHF and JPY having become the most overvalued currencies after
having been the most undervalued ones.
Risk-related currencies have moved way beyond equilibrium as aggressive monetary policy accommodation
has reflated risky assets.
But structural breaks can invalidate even the conclusions suggested by reduced form equilibrium models (e.g.
regulatory changes boosting/limiting credit provision, monetary unions under threat).
25%
20%
15%
10%
-5%
0%
5%
10%
15%
20%25%
30%
JPY CHF SEK CAD AUD NOK GBP EUR NZD
Mis-valuation against USD
Effective Mis-valuation
20%
15%
10%
-5%
0%
5%
10%
15%
20%
25%
30%
GBP SEK NOK CAD EUR AUD CHF JPY NZD
Mis-valuation against USD
Effective Mis-valuation
Deviation From Estimated Equilibrium Value (December 31, 2007) Deviation From Estimated Equilibrium Value (September 27, 2011)
Source: RGE
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FX: Trends Can Be Persistent
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0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.41.6
1.8
2.0
Jan-73 May-77Sep-81 Jan-86 May-90Sep-94 Jan-99 May-03Sep-07
US recession Non-US cri si s AUDUSD
0.00
0.00
0.00
0.01
0.01
0.01
0.01
0.01
0.02
Jan-73 May-77 Sep-81 Jan-86 May-90Sep-94 Jan-99 May-03Sep-07
US recession Non-US cri si s JPYUSD
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1.11.2
1.3
1.4
Jan-73 May-77Sep-81 Jan-86 May-90Sep-94 Jan-99 May-03Sep-07
US recession Non-US cri si s CADUSD
Long-run charts demonstrate
the dominance of structural
trends over the fleeting effects of
recessions.
They are also suggestive of
structural trends that mayinvalidate traditional equilibrium
models.
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
Jan-73 May-77Sep-81 Jan-86 May-90Sep-94 Jan-99 May-03Sep-07
US recession Non-US cri si s CHFUSD
50
70
90
110
130
150
170
Jan-73 May-77Sep-81 Jan-86 May-90Sep-94 Jan-99 May-03Sep-07
US recession Non-US cri si s DXY
Source: RGE
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FX: Volatility and Correlation
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In FX space, the crisis has been marked by two extreme developments:
Volatility has reached a new order of magnitude;
Cross-currency and cross-asset correlations have reached new heights.
Stay short volatility;
Diversification potential limited, stay in liquid bellwether currencies.
RGE FX Volatility Index, % Rolling 60-day Correlation
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
Note: Index calculated on the basis of 1m implied volatility across G10
currencies, three largest minus three smallest in each period
Currency Pair Other Asset Correlation Correlation Correlation
Jan 03 - Dec 07 Jan 07 - Dec 10 Past month
AUDJPY SPX 0.24 0.61 0.78
USDNOK oil -0.21 -0.64 -0.83
USDCAD oil -0.19 -0.50 -0.80
EURUSD gold 0.51 0.59 0.82
EURUSD 2yr rates 0.15 0.56 0.81
EURJPY 2yr rates 0.14 0.57 0.85
USDCAD 2yr rates 0.18 0.40 0.76
Source: RGE
Source: RGE
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In all recessions, EM bonds (both external and domestic debt) outperformed equities.
Despite general EM debt outperformance, only domestic debt fully recovered max drawdowns. EM
external debts performance showed mixed results in this respect. The extent of sell-offs was more
pronounced in EM external debtmost likely due to a higher proportion of non-resident holdings.
EM debt and equities are still very far from the lows of the 2008 recession/crisis.
If recession deepens, supportive local monetary policies and a smaller share of non-resident holders are
likely to ensure EM local currency debts outperformance vis--vis EM external debt and equities.
39
Performance of EM Debt and Equities in Past Crises
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Source: RGE, Bloomberg
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Great deal of divergence within EMs, often depending on a specific combination of local (Russia
1998, Indonesia 1998, etc.) and global factors.
Asia FX tended to outperform EMEA and LatAm peerswith the exception of the 1997-2000
recession, when the crisis originated in the region. This is due to the fact that Asia FX appreciation pressures
come from both current and capital accounts, while most local central banks still have the fear of free
float.
Commodity FX (RUB, ZAR, BRL, CLP, COP) and liquid currencies that trade as regional proxies (BRL, PLN) tend
to suffer more during sell-offs.
Currencies with real or perceived macro-balance weaknesses (TRY, INR) are other easy targets when risk-aversion increases.
A notable feature is a significant increase in EM FX correlations in the past years, which results in
indiscriminate rallies and sell-offs.
Despite the September 2011 sell-off, most EM FX are far from the lows of the 2008 crisiswith a notable
exception of TRY. Other weak links to watch are MXN in LatAm, INR in Asia (weak macro-balances), and
RUB, PLN, HUF in EMEA.
Overall, EMEA FX looks much weaker fundamentally and is already closer to the 2008 levels than its peers.The weak fundamentals increase the chances of EMEA FX depreciating beyond the 2008 peak if the crisis
deepens.
40
Performance of EM FX in Past Crises
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Performance of Asia ex-Japan (AXJ) FX in Past Crises
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Source: RGE, Bloomberg
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Performance of Latin America FX in Past Crises
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Source: RGE, Bloomberg
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Performance of EMEA FX in Past Crises
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Source: RGE, Bloomberg
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EM equities remain among the most correlated with other risky assets and most widely held by foreign
investors, and this might once again contribute to their overall underperformance during future recession
episodes. EM local currency debt likely to outperform other asset classes (least correlated with global risk, weak
growth and inflation environment, central banks easing), even though acute risk aversion can result in
periods of negative returns.
Asia FX is likely to outperform its peers due to a combination of higher appreciation pressures and lower
tolerance of free-floating. EMEA FX is the weakest link fundamentally and flow-wise.
44
EM Assets: Expectations for Future Recessions
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Appreciation Pressures (EMP) and Central Banks Propensity to Intervene in the FX Market
Source: RGE, Bloomberg, IMF
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Equity Fundamentals and Performance Drivers
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During the past down cycle, defensive typically trade at a premium to cyclical as a result of better
earnings visibility and relatively low valuation ahead of the downturn.
Current recent valuation levels indeed suggest significant downside risks to cyclical especiallydiscretionary industrials where valuation premium are unjustified. Staples and health are trading at relatively
low levels at this point in the cycle.
EPS momentum suggests current consensus EPS estimates in cyclical sectors remain elevated, therefore
we expect revision to further constrain performance.
Bottom Up
Consensus
Estimates
EPS-
growth
(%)
Sales-
growth
(%)
ROE-
growth
(%)
PE-NTMA
S&P 500 13.88 6.25 3.63 10.61
Energy 15.38 6.92 2.61 8.31
Materials 18.82 8.21 3.80 9.50
Industrials 17.01 7.59 9.65 10.70
Cons. Discr 14.42 7.27 5.08 12.68
Cons. Staples 9.21 6.01 1.71 13.35Health Care 6.24 3.37 (5.23) 10.45
Financials 23.47 4.38 15.08 8.31
Technology 12.53 9.12 (5.03) 11.47
Telecom 12.35 3.93 8.58 14.40
Utilities (0.84) 3.29 (5.67) 13.44
*NTMA
U.S.-based data Source: Factset
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Performance Ranking During Past Recessions
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Average Recession Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples Health Care Telecom UtilitiesMax Drawdown 5 7 6 10 9 8 1 2 4 3
Sortino Ratio 7 3 8 4 5 6 2 1 10 9
Information Ratio 10 4 8 9 5 3 2 1 7 6
Total Rank 8 3 9 6 5 4 2 1 10 6
Subprime Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples Health Care Telecom Utilities
Max Drawdown 8 9 6 7 10 3 1 2 4 5
Sortino Ratio 5 4 8 2 7 1 3 6 10 9
Information Ratio 7 3 10 8 9 2 1 4 5 6
Total Rank 6 5 9 4 10 1 2 3 7 7
Dot.Com Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples Health Care Telecom Utilities
Max Drawdown 5 7 8 9 6 10 1 3 2 4
Sortino Ratio 8 2 6 5 4 7 3 1 9 10
Information Ratio 10 1 5 9 4 3 8 2 6 7
Total Rank 9 2 5 8 4 7 3 1 6 9
S&L Energy Materials IndustrialsCons.
Discr Financials Tech
Cons.
Staples Health Care Telecom Utilities
Max Drawdown 2 6 7 9 8 10 4 5 3 1
Sortino Ratio 4 9 10 6 5 8 1 2 7 3
Information Ratio 5 9 10 8 4 7 1 2 6 3
Total Rank 4 8 10 7 5 8 1 3 6 2
Defensive sectors typically outperform, but this may vary depending on the type of recession and valuation before recession.
Sortino Ratio U.S.-based dataInformation Ratio
Preferred Sector Strategy under Recession; 1 = Highest and 10 Lowest in Ranking
Source: Haver
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Sector Performance During Recession
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Defensive sectors typically outperform, but this may vary depending on the type of recession.
Average Recession Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Uti li ties S&P 500
Max Drawdown -22.9% -27.1% -26.4% -29.3% -28.7% -28.7% -14.8% -17.5% -18.6% -18.2% -22.0%
Sortino Ratio -0.63 -0.22 -0.70 -0.31 -0.36 -0.44 0.76 1.02 -1.07 -0.73 -0.18
Information Ratio -0.94 0.19 -0.66 -0.78 -0.06 0.24 0.63 0.95 -0.29 -0.19 0.00
Subprime Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Uti li ties S&P 500
Max Drawdown -42.5% -44.5% -35.0% -41.1% -47.5% -33.1% -23.3% -27.9% -33.5% -34.4% -33.1%
Sortino Ratio -1.38 -1.33 -1.79 -0.99 -1.77 -0.76 -1.17 -1.42 -1.89 -1.80 -34.4%
Information Ratio -0.40 0.30 -0.82 -0.43 -0.68 0.63 0.71 0.00 -0.02 -0.06 0.00
Dot.Com Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Uti li ties S&P 500
Max Drawdown -16.4% -23.1% -27.2% -28.4% -21.4% -34.0% -8.6% -11.6% -11.5% -12.5% -20.4%
Sortino Ratio -0.80 1.16 0.33 0.38 0.48 -0.13 0.58 1.66 -0.98 -1.95 -12.5%
Information Ratio -2.36 1.04 -0.10 -1.40 0.49 0.55 -0.94 0.99 -0.60 -0.73 0.00
S&L Energy Materials IndustrialsCons.Discr Financials Tech
Cons.Staples
HealthCare Telecom Uti li ties S&P 500
Max Drawdown -9.7% -13.8% -17.1% -18.6% -17.4% -18.9% -12.5% -13.0% -10.6% -7.6% -12.6%
Sortino Ratio 0.27 -0.48 -0.64 -0.31 0.21 -0.44 2.87 2.83 -0.33 1.57 -7.6%
Information Ratio -0.04 -0.77 -1.07 -0.50 0.02 -0.46 2.11 1.85 -0.26 0.22 0.00
U.S.-based data
Sortino Ratio Information RatioSource: Haver
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Risk Metrics During Past Recessions
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All metrics are annualized
Average Recession Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Util ities S&P 500
Volatility 24.2% 29.5% 30.7% 32.9% 37.3% 36.6% 17.4% 20.4% 22.1% 18.9% 24.1%
Downside Deviatio 39.6% 46.8% 49.3% 51.8% 59.0% 56.3% 26.0% 30.4% 38.3% 35.4% 18.9%Tracking Error 24.2% 29.5% 30.7% 32.9% 37.3% 36.6% 17.4% 20.4% 22.1% 18.9%
Subprime Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Util ities S&P 500
Volatility 37.7% 41.1% 38.1% 39.8% 56.7% 33.6% 20.0% 23.8% 30.1% 27.9% 31.0%
Downside Deviatio 70.0% 74.7% 69.8% 68.5% 100.6% 59.1% 37.1% 44.9% 56.1% 54.4% 27.9%
Tracking Error 37.7% 41.1% 38.1% 39.8% 56.7% 33.6% 20.0% 23.8% 30.1% 27.9%
Dot.Com Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Util ities S&P 500
Volatility 18.9% 26.0% 29.1% 30.3% 21.3% 45.9% 13.0% 16.4% 19.9% 17.3% 22.4%
Downside Deviatio 32.5% 38.2% 44.8% 48.7% 35.1% 71.2% 20.8% 25.6% 35.5% 38.9% 17.3%
Tracking Error 18.9% 26.0% 29.1% 30.3% 21.3% 45.9% 13.0% 16.4% 19.9% 17.3%
S&L Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Util ities S&P 500
Volatility 15.9% 21.5% 25.0% 28.5% 33.9% 30.4% 19.4% 21.0% 16.3% 11.5% 18.9%Downside Deviatio 16.5% 27.6% 33.3% 38.3% 41.2% 38.5% 20.2% 20.8% 23.3% 13.0% 11.5%
Tracking Error 15.9% 21.5% 25.0% 28.5% 33.9% 30.4% 19.4% 21.0% 16.3% 11.5%
U.S. based data
Source: Haver
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Cumulative Return Metrics During Recession
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Average Recession Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Uti li ties S&P 500
Cum Return -63.3% -8.5% -15.7% -6.7% -21.6% -7.2% 1.8% 2.3% -16.5% -17.4% -18.2%
Cum Excess Return -18.4% 3.5% -9.5% -10.3% -15.5% 5.7% 4.7% 8.6% -6.0% -3.2% 0.0%
Subprime Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Uti li ties S&P 500
Cum Return -137.6% -33.6% -44.8% -21.8% -72.1% -13.9% -13.4% -20.3% -36.5% -33.2% -34.4%
Cum Excess Return -15.8% 7.8% -19.1% -11.3% -49.6% 13.0% 17.3% 0.0% -0.8% -1.8% 0.0%
Dot.Com Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Uti li ties S&P 500Cum Return -79.6% 12.0% 4.2% 5.2% 4.8% -2.7% 3.4% 11.5% -10.6% -24.7% -12.5%
Cum Excess Return -38.6% 8.6% -0.8% -14.0% 2.8% 11.4% -16.6% 12.1% -12.7% -11.3% 0.0%
S&L Energy Materials Industrials
Cons.
Discr Financials Tech
Cons.
Staples
Health
Care Telecom Uti li ties S&P 500
Cum Return 27.3% -3.9% -6.4% -3.5% 2.5% -5.0% 15.5% 15.7% -2.3% 5.7% -7.6%
Cum Excess Return -0.8% -6.0% -8.5% -5.6% 0.4% -7.1% 13.4% 13.6% -4.4% 3.6% 0.0%
U.S.-based data
Source: Haver
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50
Protections Against Shocks
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Balance sheets have significantly changed since the last recession and the winners/losers of the early liquidity dry
up will not necessarily be the same. However, given the nature of certain business activities in specific sectors, its
safe to say that, based on the 2008 experience (where sectors in need of financing took hits from a liquidity
crunchmaterials, industrials and staples), all look well suited to better weather a similar event today. Financials
are the most at risk to this type of shock. Materials and industrials, though, look particularly vulnerable to a
Chinese/global slowdown. Financials, utilities and industrials, telecom look particularly vulnerable to a tightening
in credit conditions.
2007 2010 2007 2010 2007 2010
S&P 500 225.51 133.30 551.89 268.03 358.51 366.39
Energy 34.50 32.85 8.02 6.15 25.27 29.17
Materials 50.56 71.12 8.47 4.36 10.89 22.21
I ndustri al s 110. 99 124. 83 59.78 36. 2 20.25 40.53
Cons. Discr 91.92 78.62 23.96 14.92 34.29 31.88
Cons. Staple s 52.82 63.79 14.35 12.74 9.15 16.17
Health Care 36.05 38.21 8.14 11.7 35.39 59.52
Financials 551.46 266.95 739.75 237.36 412.84 265.11
Technology 23.15 21.20 4.53 5.45 44.73 63.61
Telecom 77.77 99.05 4.47 6.53 3.3 6.1
Util itie s 131.63 1 27.58 17.53 14.07 8.12 10.83
Debt to Equity S.T Debt per Share Cash per Share
Relative Cash per share Relative S.T. Debt per share
Source: Haver
ST Debt and Cash per Share (current relative to pre-crisis level)
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Monthly Return Distribution
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Return distribution varies by sector. Less volatile and low tail riskhealth care, telecom, staples and utilities.
Source: Haver
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What to Expect From Equity in a Recession Scenario
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While, in general, defensive sectors outperform cyclical sectors, the result may vary depending on the type of
recession and valuation level ahead of the recession.
In the subprime recession, tech performed exceptionally well for a cyclical sector, while in the post dot.com
recession of 2001, telecom and tech were the hardest hit, mainly due to overvaluation in those sectors.
While the Japanese and the S&L recession share the most similarity to the coming double dip at the macro
level, sector performance could be different as relative valuation and micro fundamentals look quite different.
Thus, an unbiased forward-looking assessment of the key drivers of future performance must be
undertaken, especially if one seeks to position for a longer time horizon.
ISM Cycle and Sectors Performance ISM and Global PMI in Past Recessions
Note: Performance based on average monthly return during the period divided by period monthly volume. Source: RGE, Markit
Source: RGE, Markit
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Macro and Market Outlook August 2011 Update
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