Which alts are most cyclical? Non-cyclical? Counter-cyclical?

William Freedman

Topics: Alternative Investments


  • Metal and energy futures correlate with the business cycle, as do private lending and most private equity.
  • Real estate investment needs to be timed precisely, as a recession is coming to an end. Healthcare- and infrastructure-related real estate is more recession-proof.
  • Hedge funds, agricultural futures, and precious metals tend to outperform during recessions, as do specific corners of the private equity market.
  • Cryptocurrency appears to be cyclical for now but might not be long-term.
  • Collectibles appear to be non-cyclical.
  • Carbon credits, insurance-linked securities, and intellectual property constitute relatively new markets and thus represent a secular rather than cyclical change.


There don't appear to be any solid economic trends at this rare moment in time. Jobs are plentiful, and pay is increasing, but consumer sentiment is declining – how does that happen? Is inflation transitory, or is it here to stay? The Federal Reserve is likely to start raising interest rates in a few weeks – but how high and how fast? And then there's the big question:


Are we heading into a recession?


Recent GDP growth statistics suggest that we’re not in one now and are unlikely to sink into one this year but, as the money supply tightens, aren’t we at risk of falling into economic contraction?


Who knows? The only thing you can get two economists to agree on these days is how much a third economist should donate to charity. And that makes this a dicey time to dole out financial advice, especially to the risk-tolerant investor whose gaze bypasses stocks and bonds.


So let's plan for all contingencies and discuss which alternative investments are best during an expanding economy, best during a contraction, and good regardless.


Here comes the boom

Fidelity Investments lists Materials as a more-or-less cyclical sector. It comes on strong early in a recovery, then underperforms until the expansion peaks, then enjoys a resurgence late in the cycle. One way to play this with alternative investments is to trade in commodity futures for industrial metals. There’s also a relatively small window late in the cycle to trade in Energy futures following much the same logic.


Private equity might not be cyclical itself, but it is tied to credit cycles. So there's a correlation, if not the strongest one. There are counter-cyclical exceptions, and we'll discuss those shortly. On the other hand, private lending is all about those credit cycles and is very tightly correlated with the business cycle.


Here comes the bust

What to buy during a recession, then?


This is probably where real estate – the most pervasive alternative investment – belongs. While property generally gets thrashed during recessions, it's often among the first sectors to come back in the earliest stages of a recovery. That goes whether your clients are content with owning REITs – which aren't alts – or if they prefer to buy real estate directly, or if they want to participate in a limited-liability vehicle that develops or manages commercial sites. By the way, any real estate that relates to health care – such as assisted living residences – might be particularly well-suited to the bottom of the cycle. The same goes for data centers because infrastructure – unlike the rest of the Information Technology sector – is what companies spend on during lean times.


It's jarring how infrastructure performs during times of economic stress. According to Copenhagen-based alternative investment analyst Christoph Junge, as the S&P 500 sank 39% during the dot-com crash of 2000-2003, the infrastructure sector actually gained 50%. More recently, as the broader market lost 46% in the global financial crisis of 2007-2009, infrastructure lost less than 6%.


For everything else, though, it might be a good idea for real estate investors to hold their fire until the inevitable crash is pretty much over.


One last comment about real estate, then we'll push on: As sensitive as it is to the business cycle, it's even more sensitive to interest rates. If the Federal Reserve induces a recession by hiking interest rates, there might not be any suitable place in the entire sector to invest.


Private equity, as noted above, bifurcates with the economy. We've already discussed how it broadly advances during times of economic growth, but there are a couple of counter-cyclical niches. A client looking to match investments to the cycle might consider a venture capital fund, especially one focused on buyouts. In the depths of a recession, this might be the only money available to rescue a distressed business with a strong chance of making huge returns if it can just hang on until the economic climate improves.


Lastly, there are hedge funds. The biggest knock on them is that they rarely, if ever, outperform the index funds in a bull market. Guess what? They're not supposed to. It's at the bottom of the cycle where they shine. Junge's research shows that, during the 2007-2009 recession, they gained an unparalleled 16%.


And to return to the topic of futures, let’s consider agricultural products. As a sector, Consumer Staples outperforms very late in the cycle and continues to thrive during recessions.


But the ultimate counter-cyclical alt is gold. Precious metals are a safe haven. They’re where you go when there’s nowhere else. The only question is in what form you’ll own it: as physical assets or financial assets.


Always? Never?

Is cryptocurrency cyclical? There's no way of knowing that with any empirical certainty. The person or persons are known as Satoshi Nakamoto spent the 2007-2009 recession developing the code for bitcoin, writing the white paper, and securing the bitcoin.com domain name. It launched in January 2009, just as the economy stabilized, so the entire asset class knows little else than economic expansion.


There was, of course, the short but intense recession during the early days of the covid-19 pandemic. As did the rest of the markets, the one for bitcoin dropped sharply but, five months later, had clawed all the way back. There’s other evidence that crypto markets coincide with stock markets and are thus cyclical, but it’s not compelling. In 2018, both asset classes lost value. That’s where the resemblance ends. Crypto took a swan dive in the first quarter and didn’t recover until the following year. Stocks, on the other hand, were strong for the first nine months of 2018 then tanked at the end. There was no recession, just overheated markets that got ahead of themselves. That’s where the resemblance ends.


If I were to guess, though, I'd say that crypto will eventually prove to be counter-cyclical in the near future. That's because, during recessions, central banks cut interest rates to stimulate the economy. When rates get cut, investors start looking for higher returns, and, as a result, higher-risk instruments come into focus. Nothing is higher-risk than crypto at the moment, so there you go. That said, if the crypto market continues to mature as it has been doing, it might come to be more widely accepted as a store of value and medium of exchange. In that case, it starts looking more like bearer bonds, which are cash-equivalent and thus a safe place to wait out a recession.


We should also consider the unique situation of collectibles. People who are suddenly awash with cash during boom times are easily enticed into buying stuff that they don't really need, think it is kind of cool, and convince themselves that they're actually investing. During recessions, though, the people who are stewards of generational wealth find themselves with little else to invest in, so they buy cars, antiques, art, comic books, militaria, or whatever else strikes their fancy. The faces change, but the dealers make out just fine during fat years and lean years.


There are also opportunities that are not so much cyclical in nature as secular. The market changes with the culture and the technology, so there are several choices that just didn’t exist in a meaningful way before. But they do now.


You’d be remiss not to at least mention to your risk-tolerant clients such possibilities as those that stem from carbon credits, insurance-linked securities or intellectual property.


At the close

Let's not forget that just because an asset generally moves in a certain direction given a spot in the economic cycle doesn't mean it absolutely always will. Also, the investor might have a bigger picture in mind. Maybe they want to make a counter-cyclical play, either to hedge against a larger position or to make a contrarian, buy-on-the-dip play.


You don’t have to make these decisions for your client. You don’t have to say, “get into this now” or “get out of that.” If you can just advise them which direction an asset class is likely to go as the business cycle swings, you’ve added value.

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