Trader Notes: Recession Playbook Trader Notes: Recession Playbook Trader Notes: Recession Playbook

Trader Notes: Recession Playbook

Danny Khoo

Sales Trader

Trader Notes : Recession playbook

The economy typically goes through a few business cycles namely Expansion, Peak, Recession, Depression, Trough and Recovery. This article aims to show how investors and traders can position during the recessionary phase of the cycle.

What Happens During A Recession?
The National Bureau of Economic Research (NBER) definition of a recession is a significant decline in economic activity across the economy lasting more than a few months that will affect employment and real incomes. Aggregate demand will fall as consumers tighten their belts, especially in discretionary spending. Industrial commodities will underperform as companies cut back on spending and investment anticipating lower demand ahead. Typically, the central bank will begin easing monetary conditions to help cushion the impact of the economic downturn by lowering interest rates. Investment managers tend to turn defensive during such times and allocate more to sectors like utilities and consumer staples which tend to outperform growth sectors during a recessionary environment. The tech sector tend to be tricky this time as it will experience the effects of decreased spending but would also see better valuation with lower interest rates. With the market expecting rates to fall, we could possibly see NDX outperforming the SPX in the period leading up to a recession.

What Can We Do During A Recession?
Investors
For long-term investors, a recession provides the opportunity to accumulate equities at a cheaper valuation. From an allocation perspective, it might be a good opportunity to diversify into other markets like Europe and Japan that are cheaper and further away from the credit contraction the US is experiencing. To hedge against a recession, investors can look to:

  • Increase allocation to Treasury bond ETFs like TLT:xnas or IEF:xnas expecting rates to fall and safe havens to do well. Reduce allocation to equities.
  • Buy Gold ETFs like GLD:arcx or Gold Spot (XAUUSD)
  • Selling equity covered calls on existing holdings to generate yield
  • Selling equity puts as a way to accumulate equities for the long-term and generating yield in the process.
  • Selling an Index CFD like US500 or a small cap future like Russell 2000 (RTYM3). Small caps tend to underperform in a recession.
  • Increase allocation to Utilities ETFs like iShares S&P Global Utilities Fund (JXI:arcx) or The Utilities Select Sector SPDR Fund (XLU:arcx)
  • Increase allocation to consumer staples ETFs like VDC:arcx and KXI:arcx

Traders
For traders who wish to take advantage of a possible slowdown in economic activity / recession, you can look to:

  • Selling an Index CFD like US500 or a small cap future like Russell 2000 (RTYM3). Small caps tend to underperform in a recession.
  • Long Interest rate futures like 2 year treasury futures ( ZTM3), 10 year treasury futures ( ZNM3) or Selling short the micro 2-year yield contract (2YYK3) / micro 10-year yield contract (10YK3)
  • Reduce/go short high growth consumer discretionary ETFs (XLY:arcx, IYC:arcx, VCR:arcx,) via CFD.
  • Go short Copper futures (HGN3) / Copper CFD (COPPERUSJUL23) and Crude oil futures (CLM3) / Crude oil CFDs (OILUSJUN23)
  • Go long Gold spot (XAUUSD) or Gold futures (GCM3)
  • Typically in a recession, carry trades get unwound and currencies like JPY and CHF tend to strengthen. Traders can look to sell USDCHF, EURCHF, GBPCHF or USDJPY, EURJPY, GBPJPY crosses. Commodity currencies (AUD,NZD and CAD) also tend to underperform - AUDJPY, NZDJPY, CADJPY are attractive pairs to consider on top of the direct play against USD.

In most cases, the recession typically begins before we see major news agencies reporting that a recession is here. Markets move in anticipation of economic activity slowing down and hence the moment we see trends in inflation falling, credit activity declining and labour market slowing, sensitive markets like bond futures will tend to move higher in a flight to safety and in expectation of lower rates while commodities tend to underperform. The price action in these markets would usually offer some insight to where the economy might be heading before slower growth numbers are officially reported and hence it can be useful to watch these markets.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
- Full disclaimer (https://www.home.saxo/en-mena/legal/disclaimer/saxo-disclaimer)


Boulevard Plaza, Tower 1, 30th floor, office 3002
Downtown, P.O. Box 33641 Dubai, UAE

Contact Saxo

Select region

UAE
UAE

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

Saxo Bank A/S is licensed by the Danish Financial Supervisory Authority and operates in the UAE under a representative office license issued by the Central bank of the UAE.

The content and material made available on this website and the linked sites are provided by Saxo Bank A/S. It is the sole responsibility of the recipient to ascertain the terms of and comply with any local laws or regulation to which they are subject.

The UAE Representative Office of Saxo Bank A/S markets the Saxo Bank A/S trading platform and the products offered by Saxo Bank A/S.