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Altaf Kassam

Altaf Kassam
Equity Applied Research

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ANALYZING INDEX PERFORMANCE DURING ECONOMIC REGIMES CLASSIFIED USING CLI AND CPI

Institutional investors are trying to better understand how their portfolios benchmarked to factor indexes may behave in different economic regimes.  In previous posts, we tried to answer the question: "I think economic activity/inflation is going to increase/decrease over the near term - how has this historically affected my portfolio?"

But an analysis that would fit better with their views of the world would be to look at variables in conjunction: the Business Cycle and Inflation.

Indeed, when assessing future economic conditions, institutional investors look not only at growth, but also divide growth into "good" and "bad" regimes depending on inflation.

So a more realistic question is: "I think economic growth is going to dip and inflation is going to pick up - what has happened to portfolios like mine under stagflation in the past?"

We try to answer this question by dividing economic regimes into four outcomes, depending on economic strength and whether inflation is rising or falling.

  • "Modest Growth" - Rising Growth and Falling Inflation
  • "Slow Growth" - Slowing Growth and Falling Inflation
  • "Stagflation" - Slowing Growth and Rising Inflation
  • "Heating Up" - Rising Growth and Rising Inflation

Over 38 years of analysis, we see that Modest Growth has been the most common regime, followed by Slow Growth, Stagflation and finally Heating Up.

In Heating Up, Momentum and Minimum Volatility showed higher relative performance, with Momentum delivering its largest average active monthly return in this regime. In Stagflation, Minimum Volatility is again the standout, showing the mirror of its active return in Heating Up, with the more cyclical Equal Weighted and Value Weighted Factor Indexes performing the worst. Finally, the most common Modest Growth macroeconomic scenario sees Equal Weighted as the top performer, closely followed by Momentum, whereas Minimum Volatility and Quality underperform.

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