Alternative Allocations: Navigating Through Economic Regimes

Certain asset classes thrive or lag as economies move through one cycle to the next. Franklin Templeton Institute’s Tony Davidow shares how to analyze different economic indicators and how asset classes perform through economic regime changes.

In the last several years, we have experienced the longest equity bull market in history, a global pandemic and the highest level of inflation since the 1980s. And since March 2022, the US Federal Reserve (Fed) has raised interest rates 525 basis points (5.25%). Throughout this period, we have seen a natural rotation of leading and lagging asset classes as we’ve moved from one economic regime to the next.

We recognize the difficulty in trying to time the market—but also accept that certain environments reward assets classes while punishing others, only to reverse course as we move through economic and market cycles. As the exhibit below illustrates, economic cycles follow a path of inflation rising, economic growth weakening, inflation falling and economic growth recovering—and there are certain asset classes that thrive as we move through these cycles.

Inflation Rises

For example, as the economy recovers, private equity and growth stocks do better; and as economic growth weakens, fixed income and private credit do better. Intuitively, we can all agree that equities outperform in “risk-on” environments, and fixed income does better in “risk-off” environments. However, there are often mixed signals, where some indicators are positive, while others are negative.