How to be an all-weather investor with ETFs

The direction and the pace of economic activity identify these cycles.

• An expansionary environment is when growth is expanding, and at a faster rate;
• A slowdown occurs when economic activity is slowing down after an expansion;
• A contraction occurs when economic growth is negative, and it is still falling; and
• A recovery is when, after the trough of a contraction, the economy starts to head toward growth.

The Purchasing Managers' Index (PMI) is an index used to measure the prevailing direction of economic trends in the manufacturing and service sectors. It measures the change in production levels across the economy from month to month, so it’s considered a key indicator of the state of the economy.

The chart below shows the three-month rolling PMI changes since 1997, highlighting the stage of the economic cycle at that time. You can see recently, since December 2022, the economy has been in a period of contraction (purple dots) and recovery (blue dots) with the notable exception of the March 2024 expansionary (green dot) reading.

Over the same period of the chart above, the global share market, as represented by the MSCI World Index, has risen despite the well-noted falls experienced in the dot.com bust, the GFC and the COVID crisis. If we also consider MSCI’s quality and enhanced value indices, you can see that over the longer term, these have outperformed the share market index’s rise.

If you consider charts 2 and 3 together, what is evident is that value and quality perform differently during different economic regimes. We analysed the performance of MSCI’s equity style factors of enhanced value and quality since November 1997 to understand their performance during the four different economic stages of the cycle. The performance of each factor broken up by each economic ‘season’ is presented below.

You can see that over the past 26+ years, the quality factor has experienced total positive performance in all the economic regimes over the past 25 years. Meanwhile, value, as represented by MSCI’s enhanced value, had positive performance over all of the economic cycles over 26 years, except during contractions. The total performance of both factors exceeds the benchmark index.

If you consider the above relative to the benchmark, you can see that quality’s relative underperformance during expansion is dwarfed by its strong relative outperformance during recoveries and contractions. Enhanced value, meanwhile, outperformed strongest during recoveries, but unlike quality, experienced outperformance during the subsequent expansions.

You can see from the above, that the quality factor does have periods of underperformance, but its potential to outperform through the cycle, we think, means that it could potentially be used as the factor for all seasons. During those economic periods of recovery into expansion, the enhanced value factor could also be considered. Or perhaps a blend of the two.

It is challenging for investors to navigate economic conditions and prevailing markets. ETFs that capture the factors outlined above are being utilised by savvy investors, to either hold through the cycle, or blend, to help mitigate the troughs of the cycle.

Out of interest, since November 1997 using PMIs, recovery has been the least common economic regime, occurring only 8% of the time, while expansions have been the most common (39%). Over that same period, the global economy has been in a slowdown for 35% of the time, and 18% of the time it has experienced contraction.

Factor ETFs help investors navigate the seasons of the global economic cycle. VanEck is one of the largest ETF providers in the world, and in Australia, we are leaders in smart beta including factor ETFs. Find out more here.