Recessions, crises, asset classes

The risk of recession is rising, but so are share prices; the inflation problem has not been solved, but long-term interest rates are falling. In this unclear environment, we try to analyze the outlook for all major asset classes (equities, investment funds, real estate, gold and bonds) based on the experience of previous crises and recessions.

In our last Capital Market Outlook, which you can find here, we presented the development of government bond prices, share prices and the economy during the 13 most important recessions of the last 50 years in the USA, the eurozone and Germany (chart 1a shows the summary). This showed that share prices always reached their lowest level a few months before the low point in real national income and that above-average price gains were achieved in the following quarters until the end of the recession (chart 1b).

We will now first examine which regions and which sectors (industries) on the global stock market were particularly vulnerable or stable in the crisis and recession phases of the last 30 years (chart 2: technology and telecoms bubble from 2000, financial crisis from 2008, euro crisis from 2011, coronavirus crisis in 2020 and inflation/war crisis in 2022).

The first crisis was special because it mainly consisted of the collapse of two overpriced sectors, technology and telecom stocks.

There was no recession in the major regions in this context, but there were very sharp share price losses, which were particularly high in Germany with the collapse of the "Neuer Markt" (-97%), an index for internet and other fashionable stock corporations at the time. The rest of the German stock market also recorded conspicuously high price losses during this phase (chart 3a). The financial crisis of 2008 was caused by the US residential real estate market. Years of overly lax lending to financially weak buyers had led to high losses for the global banking system, because the Americans were clever enough to pass on a large proportion of these loans to foreign banks, as it later turned out. Initially, however, this crisis was seen as an American problem, which is why the US stock market recorded above-average losses (chart 3b). Conversely, the euro crisis from 2011 onwards, triggered by fears of a sovereign default in Italy and Spain, was a European problem and resulted in a weaker performance of European and - as is so often the case - German equities (chart 3c). The coronavirus crisis brought the same result in the first quarter of 2020 (chart 3d), albeit for different reasons. Internet-based technology companies such as Amazon and Netflix benefited particularly strongly from the mass relocation of many jobs to home offices as a result of the lockdown (chart 6d). Most of these companies are based in the USA. In the current crisis (chart 3e), German equities are again attracting negative attention because they could be particularly hard hit by the growing supply chain problems caused by the war and the high dependence on Russian natural gas supplies.

Overall, US equities produced the best results in the 5 crises analyzed, Germany the worst. The analysis of the 6 global sectors (industries) of the stock market during the same 5 crises shows why this was and perhaps will remain the case (chart 4).

At first glance, the IT sector has been the most attractive since 1995 (chart 4). At second glance - including the fluctuation risk (chart 5a) - the healthcare sector was clearly better because it had to withstand significantly lower price fluctuations with almost the same performance. The third look comes to a slightly different conclusion. The high risk of IT shares stems mainly from the years 2000 to 2003, when IT shares recorded a price loss of 80% (chart 6a). If we start the analysis in 2003, the risk of IT shares has fallen sharply because the sector has matured and grown up (chart 5b).

In addition to the aforementioned slump in IT and telecommunications share prices, chart 6a shows that the less cyclical healthcare and consumer staples sectors (companies such as Nestlé, Procter&Gamble, etc.) performed well, only to lead by a wide margin during the financial crisis from 2008 onwards (chart 6b). Cyclically sensitive sectors such as commodities, energy and, of course, financial stocks suffered the biggest losses at the time. The euro crisis (chart 6c) only had a negative impact on some sectors worldwide at the beginning, particularly energy and commodity stocks again. Healthcare and consumer staples stocks were again at the top of the winners' list. These also recorded the lowest losses at the start of the coronavirus crisis (chart 6d). Energy and financial stocks again lagged behind. In the current crisis, energy stocks have taken the lead due to soaring oil and gas prices. Defensive healthcare and consumer staples stocks were followed at some distance by the equally low-risk utilities (chart 6e, see also charts 5a and 5b).

To summarize, we can say that healthcare and consumer staples stocks have weathered all five crises well. IT stocks also proved to be more crisis-resistant than average, provided they did not slide into the crisis from an overbought wave of speculation such as after the year 2000 or in 2021. As all of these sectors are highly weighted in the US equity index, US equities have proven to be particularly resistant to crises and recessions, while the sectors mentioned are rather poorly represented on the German equity market.

German equities are therefore relatively susceptible to crises. However, following their strong underperformance (see chart 3e), German equities have currently reached a historically rare undervaluation and should remain in the portfolio.

Private equity funds have a similar performance curve - also in relation to the development of national income - as equities (see also chart 1). However, they also have the pleasant characteristic of recording significantly lower losses than equities in times of crisis (chart 8a: bursting of the bubble in technology and telecoms stocks, chart 8b: financial crisis, chart 8c: coronavirus crisis).

Another particular advantage of private equity funds is that companies acquired by the funds during and after recessions generate particularly high annual returns. Figure 9 shows the correlation between times of crisis and the subsequent high profits generated by private equity fund acquisitions in the years of the crisis and shortly thereafter. So you should subscribe to private equity funds now, because these funds can then buy cheaply in the recession that may come. This tactic has worked very well over the last 30 years.

There were several crises from 1990 to 1992. The USA suffered a severe commercial real estate crisis and in 1991 waged the first war against Iraq under the dictator Saddam Hussein. In Europe, some countries such as England and Sweden experienced severe price declines in the residential real estate market. In Germany, reunification initially led to a boom, but also to high inflation rates and thus to interest rate increases by the Bundesbank, which the struggling partner countries in the European monetary system could not withstand. They were only able to keep up with the Bundesbank's interest rate movements until the fall of 1992; then the British dropped out first, followed by other European countries, causing their exchange rates against the DM to fall by up to 30%. Germany now also fell into recession because it could hardly export at the low exchange rates of its trading partners. At the end of 1992, people were correspondingly pessimistic about an uncertain future - as they are today. Nevertheless, companies bought by private equity funds in 1993 yielded an impressive 42% p.a. in the following years until they were sold. gross return (IRR). After the bursting of the technology and telecoms bubble in spring 2000, there was no real recession, but there was markedly weak growth until 2003; the return on companies acquired in this year even reached 47% p.a.. After the financial crisis, returns were initially 24% to 28% p.a. Private equity funds that are bought before or during the crisis, e.g. now, should therefore tend to generate high returns.

A more differentiated picture emerges for real estate. In the three recessions that have also affected the USA (financial crisis in 2008, coronavirus crisis in 2020, current crisis in 2022), listed real estate companies (chart 10), also known as REITs (real estate investment trusts), have performed similarly to global equities. However, unlike equities, REITs experienced a price loss of 50% in 1998 after a severe economic crisis in Asia depressed the oil price. This brought Russia to the brink of national bankruptcy after several Asian countries and the largest hedge fund at the time, LTCM, managed by two Nobel Prize winners in economics, had to be wound up by the major international banks with assets of over USD 100 billion and only USD 4 billion in equity. The global financial system was on the verge of collapse and credit-financed real estate and real estate companies came under severe pressure. The intervention of the US central bank saved the situation in the fall of 1998.

German REITs have also not proven to be stable in the current crisis and have incurred high losses (chart 11).

Given the fact that residential real estate prices have so far remained stable, with the exception of very expensive luxury apartments in top locations, this sharp fall in prices is remarkable. Although the sharp rise in interest rates on 10-year mortgage loans by more than 2 percentage points since the beginning of the year is deterring some buyers with little equity, the extremely negative real interest rate (difference between the blue and red lines in chart 11) is a major incentive for savers with a strong capital base to invest their savings in tangible assets and thus also in residential real estate. In addition, new construction projects are increasingly being discontinued due to the high and increasingly unpredictable construction costs, resulting in a decline in housing supply.

A look at the last 47 years shows that debt-free German residential real estate (here using the example of terraced houses; other property types have a very similar history, chart 12) has been crisis-resistant, in interesting contrast to German REITs (which already suffered price losses of up to 90% during the 2008 financial crisis, but subsequently achieved breathtaking gains). Residential real estate prices in Germany have not fallen in any of the 10 recessions of the last decades, but have mostly risen.

The price of gold has risen four times and fallen four times in the eight recessions in the US since 1970 (chart 13a, gold price in US dollars) and in Germany it has risen seven times and fallen three times in ten recessions (chart 13b, gold price in DM and €). This means that gold could certainly offer some protection in a recession, at least for German investors.

In recent decades, government bonds have provided stability during periods of recession (see chart 1). In future, this stability can only be maintained in times of crisis due to the high level of debt of governments and companies worldwide if central banks keep printing money and thus keep interest rates at a low level. The resulting structural increase in inflation rates will significantly reduce the purchasing power of government bond portfolios in the long term.

To summarize, we can say that although equities, equity funds and REITs have made significant price losses before a crisis and will continue to do so in the future, they start to rise again sustainably even before the low point of a recession. Positive highlights here are equity funds and shares in the healthcare, consumer staples and increasingly also IT companies sectors, whose losses in recessions are usually significantly lower and whose long-term returns are considerably higher than the global equity market average.

In recent decades, debt-free German residential real estate has offered a high degree of stability in times of crisis, although nowadays (energy-efficient) renovated apartments are preferable in view of the energy transition and shortage of craftsmen.

Gold offers German investors a certain degree of crisis protection, but government bonds have lost this characteristic.

‍

You can also download the capital market outlook here.