L-shaped recovery: An oxymoron?

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By The Staff

In April 2008, various economic forecasters, including Mish’s Economic Trend Analysis, started projecting that we’d have an L-shaped recession, where the economy falls rapidly and then flat-lines for a long time. Considering the amount of time it would take to de-leverage and the illiquid nature of the bubble asset (housing), this made a lot of sense. But then, about a year later in April/May 2009, bloggers and eventually mainstream media began talking about and L-shaped recovery in both real estate and the stock market. What the heck is an L-shaped recovery? Sounds like a U-shaped recovery without the upside. And, if it doesn’t have an upside, isn’t the term an oxymoron? It’s a recovery with no recovery leg.

The other problem is that the term is used so loosely. The shape of recovery is generally being used to refer to economic recovery … the point at which the GDP begins to recover. But that point hasn’t even been reached yet. So far, gross domestic product has only begun to get worse less fast which isn’t as good as either flat-lining or recovering. To say that our economic recovery is L-shaped may still be premature.

I’ve also seen this L-shaped terminology applied to real estate and the stock market. The problem is that while real estate sales are recovering somewhat, prices are continuing to fall … and in some areas of the country, they are only beginning their slide. We still have new rounds of foreclosures (especially in jumbo mortgages) to face. Mortgage rates have risen significantly off their lows and the refinancing boom has stalled. With prices still falling and mortgage rates rising and job losses escalating, we could be in for a lot more pain in the real estate market – particularly when it comes to prices.

As for the stock market, we’ve either had a vee-shaped mini-recovery or a brief rebound in the midst of a bear market. To apply the term L-shaped recovery to the stock market is simply erroneous. We have at least as much chance from here of re-testing our previous lows as we do of a continuation of the sharp recovery in stock prices that we’ve seen so far. And, we are still way off our previous highs. Remember when the Dow was over 14,000. We’re still sitting in the 8,300-8,500 range. That’s 39% off the highs. To have recovered to the old highs, we’d need to see an almost 65% recovery from here. Don’t forget that 30 points off 100 is a 30% loss, but would require a 42.8% gain to return to 100 again.

I’m sounding a note of caution here. This isn’t just semantics. Be careful of the subtle pump that’s being given to the news. Using recovery and L-shaped in the same sentence is stretching it. We will eventually recover. But, in the US, especially in the real estate market, it could take many, many years, rather than months. Even in the stock market, the pattern so far reminds me more of 1930-1932 than 1987-1988. After trillions of government stimulus, the economic slide has paused for a moment – and thank goodness for that. But, there are systemic issues that still need to be worked out. Banks have yet to write down the credit card balances on their books, the next wave of foreclosures hasn’t been encountered, and we’ll be seeing a lot more job losses before it’s all over. While the stock market often climbs the wall of worry, a strong retrenchment off the recent bounce (of 10-20% and perhaps even back to the March lows) is likely.

Sheri Huette, CFP® is listed as one of “America’s Top Financial Planners” by the Consumers’ Research Council of America. Founder of the advisory firm, Sherimoney, Inc., Sheri works as an author, speaker, teacher and financial advisor from her base in Marin, California. She is a 1979 graduate of Harrison High School.