Thursday, 2 April 2009

What shape should we expect the recovery to be (when it comes)?

One senses that the mood in the markets is shifting - there is definitely a growing sense that the trough may be in and now the speculation is one about the shape of the recovery. Just for one moment suspend any disbelief that you have that we are near to a major turning point and contemplate the scenarios behind the recovery stories.

The choices - ranked in terms of descending optimism are:

1. V Shape with quick recovery beginning later this year and with accelerating growth in 2010 and beyond. In other words the recent troubles were a temporary interruption and normal service will be resumed sooner rather than later

2. U Shape - somewhat like the above but the recovery will be far more gradual and will take longer to materialize with perhaps lingering growth concerns into 2010 and 2011

3. L Shape - although we may be near the bottom things are not going to improve for a very long time and any recovery will be anemic at best.

4. W Shape - this is the more complex scenario and suggests that we do get a fairly sharp rebound which could take us back to GDP growth levels in the mature economies at least of > 2% over the next year or two but then we run head on into another crisis which sends us back down again (possibly to new lows on equity prices). This second crisis could be brought on by any number of nasty shocks such as a sovereign debt crisis, a commodities boom as hard assets lose their appeal or even a US dollar crisis as Martin Wolf at the FT has suggested (see my earlier post on this).

Personally I am still rather skeptical that we should be getting too excited about the recovery happening during the next 12 months or so, but if I had to pick amongst the recovery scenarios - number 4 - the W shape - seems to be about right.

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