Recession Recovery: will it be U, V or W?
— How will the market recover from the COVID-19 recession?
The current situation of the Coronavirus effect can be understood with the analogy of flood. The current situation is no different than a flood. When it comes, it takes away whatever comes in its way. The immediate casualties happen in the form of human life and life gets stuck within the flood effected region (Here you can argue about the rescue plan but I am not going into that yet). The actual evaluation of the total damage can only be done once the flood is over and the water level has normalized until then we can make estimation with an extremely high error rate.
Recently, in the last two weeks, the market has shown a trend for V-shaped recovery despite every day the number of new cases and the number of deaths is breaking previous records and that raised my eyebrows. I started looking into the historical data and try to understand how the market reacted in the past whenever there is some major downfall.
The Current Economic Scenario:
So, the first thing to understand is how is the current scenario. If I take the 100 years’ data until April 1, 2020. We can see the sharp fall of -20% in the economy this year.
The worst experience market had, was from 1929 till 1932 (resulted as the Great Depression). However, the market recovered above 66% in 1933. In 1974 the market went collapsed 27% but in the next year, it returned with a 38% upward move. In the past 100 years market has seen 8 other market crashes with an intensity of >20% in a year. Despite the Global Economic shut down, we haven’t seen the worst, the market has only collapsed ~20%.
Also, we get some hope looking into the above figure where the market bounces back with a very positive return right after a crash.
Understanding the Definitions:
V-shaped Recovery:
A V-shaped recovery involves a sharp decline followed by a sharp rise back to its previous peak.
In a V-shaped recession, the economy suffers a sharp economic decline, but quickly and strongly recovers. Such recoveries are generally spurred by a significant shift in economic activity caused by increased consumer demand and spending.
The recession of 1953 is an example of a V-shaped recovery.
U-shaped Recovery:
A U-Shaped Recovery describes a type of economic recession and recovery that charts a U shape. A U-shaped recession is longer than a V-shaped recession and has a less-clearly defined trough. GDP may shrink for several quarters, and only slowly return to trend growth
The 1973–5 recession and the 1981–82 recession are the examples of U-shaped recession.
W-shaped Recovery:
A W-shaped recovery involves a sharp decline followed by a sharp rise back upward, followed again by a sharp decline and ending with another sharp rise.
Countries normally experience decreased economic growth every few years, and when economic growth decreases for roughly six months and then recovers, it is considered a recession. However, when economic growth drops more drastically and lasts for a year or more, economists typically classify it is as a depression. (Source: investopedia)
For now, I am avoiding the L-shaped recovery because I haven’t felt the need for it. L-shaped recovery is generally the representation of a depression.
Duration of Recession:
On the other hand, if we analyze, how long the recession may last based on the previous incidents, we will find it may range between 9–16 months, only in the case of the great depression it lasted longer. (here it will be incorrect to make a prediction of the duration at this stage)
Market Recovery:
Now the bigger question is, how the market recovery could look like?
A quick answer would be, either a quick V-shaped recovery or a slower U shaped recovery. Let’s try to understand the market in a non-economist way.
The current situation can be interpreted in two ways, either by a short-term consequence of disrupted supply-chains or setting the base for a mid-term bearish market.
Two situations may appear,
- The market will consolidate for a few months and later become bullish which is a case of U-shaped return.
- The market will recover fast as a V-shaped recovery with an attached risk of crashing worse in a year or two. However, looking at the size and depth of supply-chain disruption, chances of a V-shaped recovery is very low in my understanding (I would be surprised if it happens).
The Behaviour of the Market after a Crash:
I have taken Dow Jones Industrial Average also popularly known as Dow which price-weighted average of 30 blue-chip U.S stocks. These 30 stocks are generally the leaders of the market.
Let’s spend some time observing visually how the market recovered in the past:
Two months of consolidation was not enough and the worst was yet to come.
It is possible that a V-shaped recovery in its way, but a V-shaped recovery has never brought stability in the market and resulted in creating further pressure in the economy in the long term. Whereas a U-shaped recovery with some consolidation in the bottom stage brings log-term stability in the system.
Recovering from the collapse to the previous high:
- In 1987, the market dipped -36% in two months. It took 22 months to recover from the bottom to the previous high.
- In 2001- 2002, market downturn -38% in his 33-month decline. The recovery took 48 months from the bottom.
- In the 2007–2008 financial crisis the market in 17 months declined -54% and the recovery period was 48 months.
- The market until now: a partial bounceback
With the above examples, we can conclude that even with the most rapid recovery market will continue to struggle for a year or two to get back to its previous high (assuming, the market starts recovering soon, else the period will be longer than expected)
In the shorter-term, the market will make a correction again before moving forward and this reversal can be noticed with a week or two.
Note:
I am not a market specialist, nor I have any certification on the market or in economics. I have started following the stock market seven months ago, so I don’t have such experience as well. Technical analysis could be a separate topic of discussion. However, as a Data Scientist, I tried to look into the market data with a different perspective and tried to interpret what I observed while looking into the historical market data. Here I am only sharing my observation and not making any forecast or market analysis.
You can also have a look at A Review of Past Recessions.
Thank you.
