Context
The latest economic data released on Thursday 12 January 2022 seems to suggest that inflation may have peaked. Now, there is just one topic of interest for market participants: recession. Market sentiments suggest this may be one of the most anticipated economic downturns in recent history with economists stamping a high 70% probability in 2023 and 45% of investors believing that the recession will have a duration of approximately 12 months. This has led the most optimistic of bulls to believe the worst has already been priced in.
It matters not whether the optimistic bulls are correct. What matters more is the impossibility of being bullish until you can see the light at the end of the tunnel – that is, when you can approximately forecast the shape of the recovery. The recovery shape will be contingent on three factors: (1) the length of the recession, (2) the steepness of the dip, and (3) the timing of the recovery. Once you are able to approximately forecast the shape of the recovery, you will be in a better position to strategize and position your portfolio for success. The five most common recovery shapes are as follows:
The Z-Shaped Recovery
The Z-shaped recovery is arguably the most optimistic scenario, if such a thing exists. It is characterised by the strong economic growth following a crash. The economic growth is so strong that it actually more than makes up for lost ground before settling back to the normal trend-line. In such instances, it is often the market participant’s ability to spend that was restricted, rather than a decrease in household income.
The V-Shaped Recovery
The V-shaped recovery is the second most optimistic scenario following the Z-Shaped recovery. The economy drops into a sharp but brief economic decline before rebounding and returning to the path it was on prior to the disruption. Cyclical industries tend to do well during V-shaped recoveries.
The U-Shaped Recovery
The U-shaped recovery is akin to the V-shaped recovery save the recovery period belong prolonged. In U-shaped recoveries, there is often increased unemployment rates for extended periods forcing market participants to rely on their savings. Defensive industries could be a save investment during this period.
The W-Shaped Recovery
The W-shaped recovery is also known as the double-dip recession. It is characterised as a V-shaped recovery on repeat. W-shaped recoveries are especially dangerous since the brief recovery often fools investors into reinvesting too early, thereby leaving them vulnerable to loosing substantial amounts of their investments at least twice.
The L-Shaped Recovery
An L-Shaped recovery is the most dreaded outcome whereby the economy fails to regain the level of GDP even after many years passes. The Great Depression and Japan’s Lost Decade are two prominent examples of an L-Shaped recovery. Save-haven assets such as gold and tangible assets such as real estate may serve as the preferred class of investment.
Concluding Remarks
If the old adage ‘hope for the best and prepare for the worst’ holds any weight, then hope for the V and prepare for the L may merit some consideration in helping you formulate a profitable investment strategy.