THE SHAPE OF THINGS TO COME?

What Do The Letters Given To Describe The Shape Of Our Economic Recovery Mean?

V-shaped, U-shaped, the dreaded L. Kevin Grogan describes what these letter-shaped labels mean when used in the financial media to describe the various scenarios of an eventual economic recovery.

Transcript

Tim Maurer:
Hello, I’m Tim Maurer, back with another episode of Ask Buckingham, a new video podcast designed to bring clarity in the midst of confusion, by connecting your great personal finance questions with straightforward answers from industry thought leaders. Today’s question will be answered by Kevin Grogan, Managing Director of Investment Strategy for Buckingham Wealth Partners.

Tim Maurer:
Kevin, what are the shapes people keep assigning to the economic recovery in the form of a few letters, V, U, and the dreaded L? What do these letters mean?

Kevin Grogan:
Sure. So we certainly are seeing a lot of talk out in the media about these different letters and what they might tell us about how the recovery will look and what that means for stock market investors. So just to kind of tick through each one really quickly.

Kevin Grogan:
So the V-shaped recovery, you can think of what an image of what the letter V looks like, that would indicate a sharp decline, which we saw, and then an equally sharp recovery, is what people are saying would be a V-shaped recovery. The International Monetary Fund is one entity that’s actually predicting a V-shaped recovery out of the current crisis.

Kevin Grogan:
A U-shaped recovery is more of a recession that then recovers in a gradual fashion. So things get a little bit better every day, and there are no major setbacks, but it takes months or even more than a year to get back to where we were at the beginning of the crisis. So if you want to look at a historical analogy of a U-shaped recovery, that was essentially ’08, ’09, where we saw things get bad gradually over 2007, ’08, ’09, and then gradually come back over a period of years after the ’08, ’09 crisis. And if you look at surveys of professional economists, the U-shaped recovery seems to roughly be the consensus from the people who follow this really closely.

Kevin Grogan:
And then the last shape is an L-shaped recovery, where things decline sharply and then they never get better. Or it takes a very long time for things to get better, where you see years and years and years of very weak growth. The main example of this would be Japan in the late 80s, early 90s, where things were looking really good, and then all of a sudden they weren’t for 20 plus years. This, at least historically, has never happened here in the United States and would be really bad news obviously, if that were to be what the outcome is coming out of this.

Tim Maurer:
Well, so when you talk about the economists out there that are making predictions about what it might be, of course we don’t know yet, right? How much weight do you actually put into these predictions?

Kevin Grogan:
Not much. I mean, it’s good to talk about and understand from an economic perspective, but these things are very difficult to predict. As an example, no one, or almost no one, was predicting a recession coming in to 2020, and then something happened out of nowhere, relative to what was being forecast by the economists out there. Even as this was starting, so this was starting in December, January, was starting to be talked about here in February, and even then, there weren’t that many economists predicting a recession due to this virus. There was still some hope that it would get contained and it would be not as big a deal as it unfortunately has turned out to be.

Kevin Grogan:
And then I think the other thing that’s important to understand too, is that even setting aside the ability of economists to predict recessions or recovery, is that the economy is very different than the market. So the market moves well in advance of any economic recovery. We saw that in 2009 where the market bottomed out in March, but it took, again, years for the market to recover. I think we’re seeing a little bit of that now. There’s lots of questions out there about why isn’t the stock market doing worse, given all of the economic data that we’re starting to see on the employment front? And really, I think the best explanation for it is that the market is being forward-looking. It’s looking beyond the next 12 months and saying, “Well, what will things look like a year from now, two years from now?” And as baking that into prices, and it isn’t being a super short term focused on what we’re seeing in the here and now.

Tim Maurer:
So Kevin, is this discussion purely academic then or is it actionable? I mean, how should any of these letters inform our investing or our broader financial planning?

Kevin Grogan:
So I can answer that in a couple ways. So one way, in a sort of a hypothetical, is if you knew with certainty which type of recovery we were going to have, then maybe you could make some trading-based decisions along those lines. So if you knew for certain that we would have a V-shaped or even a U-shaped recovery, then you would say, “Let’s load up on stocks because things are going to get better.” And particularly, you might load up on small cap stocks because historically in recovery, small cap stocks tend to do better than large cap stocks. On the flip side, if you were absolutely certain that this was going to be an L-shaped recovery, then you should load up on fixed income because things aren’t going to be looking good from a growth perspective, which is what typically would benefit stocks.

Kevin Grogan:
Now, with all of that said, we don’t have any ability to predict what kind of recovery we’re going to see. And again, it’s important to note that stocks will recover before the economic news gets good. That’s what we’ve seen historically, because the stock market is forward-looking and is baking in what is about to happen, as opposed to what’s being reported, backward looking, which is what most economic data will be.

Tim Maurer:
Okay. So if indeed, we won’t take much in the way of action in a situation like this, I wonder, does an investor just sit idly by? Is there nothing to do? Or in the midst of portfolio volatility, are there some actions that we can take as investors to either buffer ourselves from the downside or take advantage of that potential recovery when it happens?

Kevin Grogan:
So the main things I think about in environments like this, is getting back to basics and focusing in on owning a diversified portfolio. So that’s important to have, both in good times and in bad, because you never know when things will flip from bad to good or vice versa. So if you own different asset classes that will perform differently in different environments, then you are well-prepared in any kind of environment that will come your way. So if you have both stocks and bonds in your portfolio, your position, in either case, because you have a well thought out plan that takes any environment into account.

Kevin Grogan:
In terms of tactically what could be happening right now, is number one, rebalancing your portfolio back to its target. So that helps enforce the discipline of buying low and selling high. As well as if we do see a pullback, again, going through and doing some loss harvesting. So realizing losses within your portfolio that can be used to offset gains in the future, or offset some income on an annual basis on your tax return.

Tim Maurer:
All right. So I know you’re not making any predictions and you’re not acting on any of this stuff, but is it preemptive do you think, just from an opinion perspective, is it preemptive to even start using the word recovery at this point in time, when we are seeing unemployment numbers and some of these other economic factors looking as dismal as they’ve ever been?

Kevin Grogan:
It could be. Yeah. I mean, I think it’s, there’s lots of different possibilities with this. I know when we did our last video a couple of months ago, my position really hasn’t changed along these lines, that I still think there’s a lot we don’t know, even about the virus itself. Now, we’re learning more every day, but again, I would say it’s similar to what I shared a couple of months ago, which is the experts in this space are still very unsure about how this is going to turn out. Whether we’ll see cases decline, what will happen as the economy that starts to open back up.

Kevin Grogan:
I think there’s still a lot of uncertainty as to whether or not we’re going to remain open after we open up here, as we open up in certain states over the next weeks and months. So who knows what will wind up happening from a public health perspective and that will influence, I think, what happens from an economic perspective, from an unemployment perspective. But, it all comes back to what is happening with the virus. And by the way, even in states that are opening up, we’re still not seeing economic activity get back to what it was pre-crisis. Just because you are allowing people to open up, it doesn’t force people to go out and eat in restaurants, and fly on planes, and do all sorts of other activities that they were originally planning on doing that have now gone by the boards as a result of the crisis.

Tim Maurer:
Well, I appreciate you acknowledging what we can’t know and what we shouldn’t be acting on, and then pointing us in the direction of that which we can control. Rebalancing, tax loss, harvesting, and just proper diversification in the portfolio. Thank you so much, Kevin.

Tim Maurer:
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