The Alphabet of Recovery

The corona crisis has popularized the use of letters to describe the recession and stock market movements that are occurring. We hear political leaders talk about V-shaped, U-shaped and L-shaped recoveries all the time, the media have picked it up as well. Time to delve deeper into the stock market and real economy from this perspective.

V-shaped recovery stock market

When a recovery is said to be V-shaped, economists mean that the economy has crashed hard and deep, followed by a swift and sizable recovery. A “V” emerges in the chart. This logic can also be applied to the stock market, which currently seems to go through such a cycle. When we look at the Dutch AEX, we see that its steep declined started by the end of February and continued until halfway March.

"The AEX is now on its way to complete the formation of the V"

After its low of just over 400 points, it is now on its way to complete the formation of the V. Very similar movements are observed in Germany, the United States and Japan.


Source: Google Finance

No “V” for the real economy

It is nice to have a V shaped recovery on the stock exchange, but it is ultimately the real economy that counts. Shortly after the outbreak of the economic crisis, economists argued that the economy would recover quickly after a short period of sharp decline. It quickly became clear that this would not be the case, which was recognized by ministers Hoekstra, Wiebes and Koolmees. There would be no V-shaped recovery. However, the positive jobs report in the United States last Friday sparked renewed hopes that the economy will follow the financial markets in that country. The American economy created a surprisingly large number of 2.5 million jobs in May, lowering the unemployment rate down to 13.3% after peaking at 14.7% in April. In normal times, about 200.000 new jobs are created monthly in the US.

"Positive jobs report in the United States last Friday sparked renewed hopes"

Around 20 million workers lost their jobs due to the Corona virus, but now that the country is easing up again businesses are quick to hire back the people they fired. Is a V-shaped recovery in the cards? Time will tell, but for now most economists predict a U-shaped recovery. This implies a recovery only after a prolonged time of economic slowdown. The Saving & Loan crisis of the 1990’s is a good example of such a U-shaped recession. En then there is the scenario of a W-shaped recession, in which the economy dips again after a sharp rebound. In case of a second lockdown, this would be a very real scenario. Fortunately, the infection rates continue to decrease, and a second lockdown seems to be only a remote possibility. Still, it cannot be excluded from the recovery alphabet.

Central banking stimulus

Whether the real economy will continue to follow the markets in its V-shaped recovery means to be seen. Concerns about a U-shaped, or even W-shaped recovery continue to linger on. Should a second lockdown be necessary, a double dip can easily occur. Central banks are therefore doing everything they can to support the economy through massive asset purchasing programs. The ECB recently announced to enlarge its flagship program, the Pandemic Emergency Purchase Program (PEPP), from 750 billion to 1350 billion euros. It does so in order to keep liquidity flowing and support the real economy in its fight against the virus. The PEPP program will last as long as the virus poses a threat to the economy and will in any case not be stopped before June 2021. This enormous amount of stimulus is one of the drives behind the V-shaped recovery on the financial markets. As long as the central bank keeps easing monetary policy, increasing amounts of money flow to the markets which pushes up prices.

"The enormous amount of stimulus is one of the drives behind the V-shaped recovery on the financial markets"

The big question is whether the real economy will follow suit. One swallow does not make a summer, but it is a good sign. Worst case scenario, the economy continues to struggle over an extended period of time, leading to an L-shaped recession with no significant recovery in sight. Best case scenario, the economy follow the markets and brings about a V-shaped recovery. The middle way would be a U-shaped recovery, which seems likely for now.

Conclusion

The Dutch stock market is currently going through a V-shaped recovery after a sharp decline. Similar patterns are observed around the world. These developments are arguably caused by extremely accommodative monetary policy, since the real economy seems to be lagging behind. However, positive job new sparked the hope that the economy will follow the rising stock markets. For now, a V-shaped recovery is still far away. Assuming that an L-shaped recession would be too negative, a U-shaped recession seems to be in the cards.

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