What type of recession is coming?

June 16th, 2008

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Currently, there is a lot of chatter on the topic of recession in the United States. A wide spectrum of opinions on this topic exists, from the belief that the US will avoid a recession (e.g. Matthew Johnson- his view is at Treasury Two-Year Notes Head for Biggest Weekly Loss Since 1982) to the conviction that the US is already in recession (e.g. Warren Buffett). What is our view on that? They can be found at Example of precisely inaccurate information.

Among those who believe that the US is heading for a recession, there are wide ranging views on what type of recession it will turn out to be be, namely V-shape, U-shape or L-shape recessions. What do these shapes mean?

A V-shape recession is one that is short and sharp, which is then followed by a rebound back into economic growth. An example of such a recession is the one in 2001. Right now, the stock market is roughly priced in for such a recession. This is also the official viewpoint of the Federal Reserve.

A U-shape recession is one that will be deeper, longer and thus more painful. But eventually, there will be a recovery back into economic growth. This is the opinion of one of the more bearish economist, Nouriel Roubini, who, up till now, has a very accurate forecasting track record.

A L-shape recession is one that will be deep, long, prolonged and drawn-out period of economic stagnation. An example of such a recession is what happened in Japan since the 1990s. It suffered economic contraction for the past 15 to 16 years and had recently climbed out timidly out of recession. Now, Japan looks to be falling back into recession again.

So, since the stock market has priced in a V-shape recession, guess what will happen to it if the recession turns out to be a U-shape, or even worse still, L-shape?

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