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BLOG: The alphabet of recovery – what can we expect?

Written by: Julian Chillingworth
Astronomer Carl Sagan said: “You have to know the past to understand the present”. As we emerge from the global coronavirus pandemic, it’s worth understanding what forms economic recovery can take, and where we might have seen examples in the past.

The coronavirus crisis, as it has played out in Britain, has been most closely compared with the great frost of 1709. This was thought to be the coldest winter in Europe of the past 500 years. It brought famine and food riots, and sparked unrest.

But although both caused recessions, there may be subtle differences in the shapes of each recovery.

Recovery from the great frost can be described as a bumpy W. Europe was driven into a deep recession for two years, and food shortages and a war over succession in Spain were some of the things that created dips in the recovery – hence the up and down shape of the W.

Another example of a W-shaped economic recovery was the great financial crisis in Europe in 2007-2008. Although Europe had begun to recover from the global recession of the time, the currency crisis sent it back down the second dip of the W. Triggered by Greece’s large amounts of debt, the currency crisis and pressure on the Euro meant things became worse before they got better.

Covid recovery

The coronavirus crisis, on the other hand, is more likely to result in a recovery that takes on more of a ‘tick’ shape. Pickup will not be fast, and the likelihood of the economy returning to the levels it was on 1 January 2020 by 1 January 2021 is slim. Chances of a second lockdown, the continuation of regional lockdowns, the potential of winter spikes in the virus itself, and uncertainty in the progress of a vaccine are all things that will slow recovery.

Certain industries will suffer more than others. Hospitality has been hit and will continue to struggle as businesses operate reduced services. A pizzeria running at 50-70% capacity will struggle to be profitable, for example.

This means unemployment will rise, consumption will drop because people will be concerned over their job stability, and consumer sentiment will be low. In the UK, unemployment levels could rise to where they were at the end of the financial crisis, which was around 8.5%. On top of that, Brexit tensions don’t paint a pretty picture for recovery.

The reason we appear to be on the turn of a tick currently, and not descending the downward slope, is indicated by June’s positive GDP numbers. Although in the quarter to end of June GDP was down 20.4%, which was one of the worst quarterly downturns in the history of economics, in June the economy rose 8.7%, indicating recovery has begun.

Another positive is that certain sectors have, and will continue, to do well out of the coronavirus crisis. Technology will continue to thrive, and companies that make long-lasting household products, such as washing machines, will be OK. Demand for commodities will remain, particularly in China, where growth will be faster than other parts of the world, and anything healthcare-related also receives the thumbs up.

K, V and L

A recovery in which some areas do well and others do worse has led some economists to call the current situation a K-shaped recovery, rather than a tick. For example, technology giants and their owners will expand their wealth, rising on the upward arm of the K, but conditions for gig economy leisure, retail and hospitality workers will worsen as they descend the leg of the K.

When the cost of living rises but wages do not, and jobs are hard to come by, many people invariably struggle. Historically this has also been a good breeding ground for populism.

One thing we can be fairly certain of is that we will not see a V-shaped recovery, where the bounce back is relatively fast. The classic example of a V-shape was the US recession of 1953, where the economy went down for three quarters and then bounced back through 1954 to full recovery in 1955.

In my view, the best thing to do in these scenarios is to be in defensive stocks – businesses that deal with things that people need regardless of the economic situation, such as water or food, on the way down, and then switch to less essential, cyclical sectors on the way back up. But this is easier said than done.

The other shape we can hope not to see is the L-shaped recession, in which the economy goes through a prolonged period of very low growth. The best example is Japan in the late 1980s into the 1990s, where the Japanese economy stagnated for nearly 10 years. Property and other assets were overvalued, and it took a long time for the Japanese authorities to rectify the situation.

These days, in the UK, we’re more likely to experience a great heat than another great frost (in itself another issue), but it is useful to draw comparisons of recovery in order to make sense of the alphabet soup of scenarios we find ourselves in.

Julian Chillingworth is chief investment officer at Rathbones

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