In the past week many economists and policy makers have been referring to different types of recession shapes, often by using letters representing the path GDP could take. There is no broadly accepted academic theory or classification system for recession shapes. The terminology is rather used as an informal, easy to understand shorthand notation to characterize recessions and their recoveries. The most commonly used terms are V-, U-, W-, and L-shaped recessions. And finally, we introduce the “swoosh-shaped” recovery.
- V-shape: In a V-shaped recession, the economic fallout is quick and sharp, as is the recovery. V-shapes are the normal shape for recessions, as the strength of economic recovery is typically closely related to the severity of the fallout. A textbook example of a V-shaped recession is the 1953 US recession. The economy shrank three consecutive quarters and clearly troughed in the first quarter of 1954, followed by a sharp recovery until 1955.
- U-shape: A U-shaped recession takes longer than a V-shaped recession, and has a less-clearly defined turning point. In a U-shaped scenario the economy could shrink for several quarters before returning to growth. The US 1973-75 recession can be considered a U-shaped recession. That economic contraction started in November 1973 after which growth osculated around zero until 1975 when growth really picked up again. It took until the first quarter of 1976 for the economy to reach the pre-recession level. In the current situation, a U-shape would mean that the economy plateaus for a period before a slow recovery starts.
- W-shape: In a W-shaped recession – or a double-dip recession – the economy falls back into a recession after an initial recovery. This could for instance happen when policy support is withdrawn too quickly. The European debt crisis is a recent example of a W-shaped recession. After the 2008-2009 financial recession the eurozone entered a second recession from 2011 to 2013.
- L-shape: An L-shaped recession, also known as a depression, occurs when an economy has a severe recession and does not return to trend line growth for a long period of time. The steep economic slowdown that is followed by a flat line makes the shape of an L. This is the most severe and long-lasting of the different shapes of recession. A classic example of an L-shaped recession is the lost decade in Japan, a period of economic stagnation in Japan from about 1991 to 2001, caused by the Japanese asset price bubble's collapse in late 1991.
- Introducing: the "swoosh" recovery. Currently, our outlook resembles another type of stylized recovery, the so called "swoosh-shaped recovery", similar to the Nike logo. In this scenario the economy has followed the strong downward path of the swoosh in the past three months and is now turning towards the upward trajectory of the swoosh. This means that the recovery starts at a moderate pace in the second half of 2020 as lockdowns are eased. Still, the economy shrinks over 2020 as the economic loss in the first half of the year cannot be regained in the second half. This will coincide with elevated unemployment levels, economic uncertainty and a cycle of bankruptcies. Yet, structural economic damage is limited and the recovery continues into 2021. In our swoosh scenario the economy reaches pre-coronavirus levels by 2022.
Figure 1: Alphabet scenarios. Source: Aegon Asset Management
Now more than ever our economic outlook is uncertain. We believe the probability of an L-shaped economic outlook is low as policy makers are employing a wide range of tools to avoid a long-lasting negative impact. Fortunately, the global economy is showing signs of life as activity levels are picking up, indicating that the probability of an L-shaped recession is declining. Simultaneously, the chance of a real V-shaped recovery is also decreasing. The lockdown measures are slowly being reversed, but this is done at a more cautious and slower pace than when the measures were imposed. Incoming survey data and high-frequency economic activity trackers are showing signs of a bottoming-out alongside the gradual easing of the containment measures. Still, the pickup in economic momentum has so far been tepid compared with the pace at which the indicators plummeted in the previous months.
At the same time, it seems that restrictions will remain in place in certain sectors until a vaccine is available or the coronavirus can be controlled more effectively. Moreover, countries in different parts of the world are in different containment phases and it is likely that global supply chains will remain partly disrupted, even as some countries reopen their economies. These two factors, the cautious reopening at lower activity levels and the disrupted supply chains, are headwinds for a quick and full-blown economic V-shape recovery. The U- and W-shaped scenarios – and our expected swoosh-shaped outlook – seem reasonable at this point in time.
Looking at financial markets, it seems that investors currently don't expect either a W- or a L-shaped recovery. In equity markets lower earnings are anticipated for 2020, but most stocks are priced for earnings growth next year. In commodity markets it seems that cyclical commodities such as oil and some metals are anticipating prices to rise gradually. Government bond markets discount "low rates for long" with policy rates strongly anchored around zero. Central banks are flooding the markets with liquidity and are likely to keep policy rates low to support the recovery. In the aftermath of the current crisis governments will face high debt levels, which can become unsustainable at higher interest rates. Central banks are therefore cornered and forced to keep interest rates below inflation levels for a prolonged period. This form of "financial repression" is already common in Japan and the eurozone, but now the US will also be dependent on central bank support.