There has never been a recession which has not involved an oil price shock, according to Trevor Greetham, head of multi asset at Royal London Asset Management (RLAM), who said the late stage of the business cycle could make one more likely.
During the later stages of the business cycle, when the economy has been growing for a long time and oil supply & demand levels are tight, the possibility of an oil shock increases, said Greetham.
Indeed, as the longest US economic expansion on record draws to a possible close, investors need to keep an eye on oil, he said.
“The economic cycle ends when spare capacity has been used up, inflation rises, and central banks raise interest rates,” explained Greetham, who oversees the Royal London Global Multi Asset Portfolios (GMAP).
Oil prices have fallen more recently and have remained weak because of a slowdown in global growth, but that could be an attractive entry point should they begin to rise.
Over the past 12 months, the Bloomberg Brent Crude Sub is down by 16.02 per cent – in US dollar terms – while the Bloomberg West Texas Intermediate Crude Oil Sub is down by 19.60 per cent.
Performance of indices over 1yr
Source: FE Analytics
“Commodities have been poor performers since the financial crisis ten years ago with excess capacity and high inventory levels leading to negative returns,” the fund manager said.
“Investors shouldn’t write off the asset class, however, as returns can pick up late in the business cycle due to supply shortages and increased geopolitical stress.”
While growth looks unlikely to accelerate rapidly, there is the potential for a further uptick as a result of increased geopolitical tensions.
Greeham said that some escalation in geopolitical uncertainty is to be expected, particularly with US president Donald Trump’s hard stance on Iran.
“It wouldn’t be at all surprising to see oil prices rising very rapidly due to some kind of military conflict in the Middle East next year or so,” he said. “A cynic might say it would be Mr Trump’s re-election strategy for 2020, to be a war leader.”
These concerns have ratcheted up recently following suspected attacks on oil tankers in the Gulf of Oman, which has raised tensions in the oil-rich region.
There are a number of previous examples from history where an oil price shock has either caused or worsened a recession, said the fund manager (pictured). 
“In 1973, there was the Yom Kippur war between Israel and its Arab neighbours,” he said. “In 1974 followed a terrible recession which was blamed on bankers.
“1979 saw the Iranian revolution, a series of events that led to the overthrow of the Shah by the Ayatollah. Oil prices went up massively in 1980, marking the beginning of the 1980/81 recession,” he added.
“A recession was already underway when Saddam Hussein invaded Kuwait in 1990. The first Gulf war made the bear market worse, leading into 1991, the worst year of the recession. In the late 1990s, the dotcom crash had already begun, then 9/11 and the second Iraq invasion caused an oil price shock.”
As such, Greetham said now might be a good time for investors to look at their portfolios and ask themselves: “What happens if there’s some kind of conflict in the Middle East? How can I protect my portfolio? What would happen to shares if oil prices soar?”
Normally stock markets go down sharply in times of geopolitical uncertainty, while bonds can go either way, he said.
“Having some commodity exposure is helpful,” Greeham added.
There are a number of ways that an investor can add commodities exposure to their portfolio: one way is investing in a multi-asset fund with a commodities allocation.
He said a typical fund within the Royal London GMAP range has about 5 per cent held in commodities but have the ability to take that up to 15 per cent.
Exchange-traded funds are another option, while oil stocks are another possibility.
“As an asset allocator, you might buy a sector future on the oil sector,” he added. “If the oil sector is doing well in that situation, normally the consumer sectors, [such as] consumer staples, will not be doing well. So you could trade into oil and out of consumer staples.”
A broad commodities index-tracker might also be a more diversified way of gaining exposure to the sector.
One could also look at currencies from oil exporters, like Norway or Canada.
“It’s not such a good correlation with oil, but it gives you something,” Greetham explained.
At times of geopolitical uncertainty there are other assets that investors might wish to consider, such as gold.
“Gold might be okay,” the fund manager said. “Gold tends to do well when the dollar is weak, when interest rates are very low, falling in real terms, and when there’s some systemic problem in the financial system.”
He said the precious metal might go up in a war situation as well, noting that the gold/dollar relationship seems a little more complicated now that the US is energy independent, a net exporter of oil.
For investors seeking to protect their portfolios, the fund manager advised caution, however.
“You need balance,” he said. “If you invest in something ready for World War III or something ready for a recession, and the economy continues to grow for the next three years, then you’re not going to be invested in the right place.”
The Royal London GMAP range was launched in 2016 and is comprised of six multi-asset funds spanning the risk spectrum.
The largest fund in the range is Royal London GMAP Balanced. The £142.4m fund sits in the middle of its risk/return profile and aims to deliver growth over an investment cycle of six-to-seven years.
Performance of fund vs sector since launch
Source: FE Analytics
Since launch, the fund has returned 19.70 per cent against a 20.79 per cent gain for the average IA Mixed Investment 20-60% Shares peer. It has an ongoing charges figure (OCF) of 0.61 per cent.