Views on the shape of the recovery

Last week I met the Iveagh fund manager who touched on the shape of the recovery and it got me thinking about it in more detail. He says we are probably experiencing a v-shaped recovery and that he doesn’t see a double dip coming for economies or markets (although he has only become confident about this during the past 3 months). It made me think about what people would actually be seeing and feeling even if a double dip scenario was ‘in progress.’

The double dip scenario looks like a large W.

We have been down the first part of the w and are now climbing up the second part, so it could still be a V-shaped recovery. However, in order for markets to start this climb up the central part of the W there has to be something driving it. Therefore, one would need to see positive economic indicators and positive stock market sentiment to drive the rise, which is exactly where we are today.

If we were seeing predominantly negative indicators for the economy and stock market then it is unlikely that we would be climbing out of the trough and we would be experiencing something that more closely resembles an ‘L’.

In short, the optimism that we are seeing now, that is built on the belief that the worst is behind us and we are on a sustainable up-trend, is an essential part of a W-shaped recovery which means it is too early to discount the possibility of one occurring.

For the next stage of the W to pan out there would need to be something on the horizon that could derail an economic recovery and knock stock market sentiment. With interest rates at close to zero and government debt levels at record levels a combination of rising rates, higher taxation and government spending cuts is a foregone conclusion and could be the catalyst.

For the V-shape recovery to pan out we need to see growing consumer spending in the West, falling unemployment and stronger corporate investment. This will need to occur against the headwinds mentioned above.

I can see why an optimistic investor could argue that we are enjoying a V-shaped recovery but I also think that it is still too early to say that we are out of the woods as the current economic environment is as much a prerequisite for a W-shaped recovery as it is for a V-shaped recovery.