Special report: how do global indices and commodities trade at the onset of a recession?

The onset of recessions in the United States typically results in reoccurring financial market trading patterns. While not all of them will be the same, we can look back and see how key assets have performed. This is a special report that analyzes how the US dollar, gold, S&P 500, Australian dollar and 10-year Treasury yield traded during the first three months of economic downturns.

The length and severity of each recession will vary. This means the usual reaction you might expect from an asset during the onset of a downturn will not always repeat perfectly. For example, during the 2000s housing crash, the US entered a recession in Q4 of 2007. While the stock market declined during these three months as one might have expected, peak market volatility occurred much later towards the end of 2008.

Before diving into this topic, I need to set the ground rules, starting with the definition of a recession. In this study, I will be using a GDP-based recession indicator, which attempts to assign dates to downturns based on a mathematical model. This is as opposed to the NBER’s Business Cycle Dating Committee playbook, which can at times be subjective.

This definition is also different from the widely referenced two consecutive quarters of negative growth, which is unofficial and often too simplistic, failing to capture other economic trends. For example, in 2022, the economy experienced two quarters of negative growth in Q1 and Q2. But, the labor market outperformed.

For analyzing the US and Australian dollars, I will be using a correlation-weighted currency index instead of an exchange rate. This helps us capture the broader direction of a currency against the world rather than any individual unit. Otherwise, comparing AUD/USD with the DXY Dollar Index runs the risk of placing too much emphasis on the greenback.

Average Snapshot

The chart below is a snapshot of how these assets performed during the onset of recessions ordered from best performing to the worst. The sequence is as follows: US dollar, gold, 10-year Treasury yield, Australian dollar and S&P 500. The availability of currency data meant I could only look back to 1979. For the rest of the assets, I was able to look back to 1969. The remainder of this article breaks down the individual performance beginning with the US dollar.

• US dollar

Looking back to recessions since 1979, which adds up to 6, the Bloomberg Correlation-Weighted US dollar Index rose 3.3% on average in the first three months of economic downturns. That is not to say each time it climbed. The up/down ratio is 50%. But, as you can see in the chart below, when the dollar rallies, it tends to do so strongly.

During periods when the currency fell, the downside reaction was much weaker. This should come as little surprise. In the currency spectrum, the US dollar functions as a haven given its status as the world’s reserve currency.

• Gold

Meanwhile, gold also tends to perform decently at the onset of recessions going back to 1969. On average, the yellow metal returned +2.3% with a win/loss ratio of about 62.5%. Like the US dollar, the wins were stronger than your average losses, excluding the early 1980s recession (-17.1%).

Does this make gold a haven? Remember that gold is not as liquid as a currency. XAU/USD tends to function as an anti-fiat instrument. When the return on cash dwindles, which is what usually happens during recessions, gold becomes relatively more attractive and vice versa.

• 10-Year Treasury yield

From this point forward, we are moving on to assets that underperform. Since 1969, the 10-year Treasury yield has declined by -1.6% on average during the onset of recessions (excluding Covid, which was a major negative outlier that skews the mean). Factoring in Covid though, the up/down ratio is about 29%. Bonds tend to receive a high amount of demand during economic uncertainty due to perceived safety, pushing up the price at the cost of yields.

• Australian dollar

Looking at the Bloomberg Correlation-Weighted Australian Dollar Index, the Aussie returned on average -2.1% during the first three months of a US recession since 1979. AUD also has a depressingly low win/loss rate of 16.7%. In currency markets, the Aussie is known for its sentiment-linked status, often closely following equities.

Australia’s economy is closely tied to the global business cycle due to commodity exports, making it important to watch growth in the United States. When the latter sneezes, the world can catch a cold, driving up market volatility and negatively impacting the Australian dollar.

• S&P 500

Finally, we arrive at the S&P 500, which is one of the key US benchmark stock indices.

Unsurprisingly, the S&P 500 has returned on average -7.0% at the onset of recessions since 1969. But, unlike the Australian dollar, the win/loss ratio is slightly better at 25%. This is unsurprising. Depending on the severity of the recession, uncertainty plays a key role in how much the stock market declines and how fast it does.

Recessions raise the risk that companies can go out of business and/or lay off workers, resulting in stock market crashes. Often, a bubble popping can lead to a recession, such as the dotcom bust in the early 2000s and the housing market leading in 2008. There are also leading indicators of a recession that you might be interested to learn about.

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