The keys to take
- Credit Suisse analyst Zoltan Pozsar sees the US economy plunging into an L-shaped recession before inflation eases
- An L-shaped recession occurs when the economy falls and takes a long, slow recovery
- L-shaped recoveries are associated with some of the worst economic periods in history and can include massive changes in fiscal and monetary policy.
- Some of the best industries to invest in during a recession include healthcare, utilities, energy and consumer staples.
As inflation creeps up and another Fed rate hike looks increasingly likely, the prospect of a recession is more likely. However, the exact severity of this potential recession varies depending on who you ask.
Some, like economist Sam Snaith, predict a mild “pasta bowl recession” in which we’ll float gently in and out.
But others, such as Zoltan Pozsar, global head of short-term interest rate strategy at Credit Suisse, are not convinced. According to its latest economic analysis, the US USA will need a deeper and longer recession to control inflation and moderate the economy.
In particular, he believes we are headed for a so-called “L-shaped recession.”
L-shaped analysis by Zoltan Pozsar
According to his latest research paper, Pozsar believes that the current trend of high inflation requires a more serious economic solution.
Due to macroeconomic changes (ie the Russia-Ukraine war and China’s continued blockades), he thinks the Fed’s “soft landing” is little more than a pipe dream. He also cited immigration restrictions and pandemic-induced immobility as major contributors to the tight labor market.
“War is inflationary,” he said. “Think of the economic war as a struggle between the consumer-driven West, where the level of demand has been maximized, and the production-driven East, where the level of supply has been maximized to meet the needs of the West.” After these relations soured, he continued, “the supply turned.”
As a result, he argues that inflation is now a structural problem, not a cyclical one. The war, ongoing blockades and tighter labor markets have led to supply chain disruptions and inflation that cannot be resolved by a short period of rate hikes.
Instead, Pozsar sees the Fed raising interest rates to 6% and “[keeping them] high for a while to ensure that rate cuts won’t trigger an economic upturn… The risks are such that Powell will do everything he can to rein in inflation, even if it comes at the cost of a ‘depression’ and not being re-elected.” The result, he predicts, could be an L-shaped recession, which would be deeper, longer and slower to recover from than the alternatives.
Pozsar’s views are at odds with many economists and the Fed. Current estimates peg the peak interest rate hike at around 3.5%, with many predicting little lasting damage due to the current inflationary environment. Investors also disagree with the analysis, if last month’s Treasury market rally is any indication.
What is a recession?
We’ll dive into the nuances of an L-shaped recession momentarily. First, let’s go back to define what a recession itself is.
A recession is a significant economic downturn (usually measured by a decrease in GDP or gross domestic product) that lasts at least two quarters. Although unpleasant, they are considered a regular feature of the business cycle.
All recessions begin the same, with a period of sudden or gradual economic decline. But how they end up varies widely, from recovering immediately, dipping twice into a secondary recession, or taking years to recover.
Name the recessions
Economists have called the months or years after the recession period the “recovery period.” They name recoveries based on their similarities to letters of the alphabet when metrics like GDP or employment rates are plotted on a chart, such as:
- V-shaped recessions. V-shaped recessions begin with a sudden drop and an almost as quick recovery. Economists generally consider V-shaped recessions to be the best case scenario. (Think of the post-dot com bubble recession of 2001).
- U-shaped recessions. These recessions decrease and the recovery is a little slower, but they stay longer at the bottom. The recession of 1971-1978 is an excellent example.
- W-shaped recessions. A W-shaped recession is essentially two V- or U-shaped recessions in a row. Also called “double-dip recessions,” they occur when the economy pulls back, recovers (often quickly), and plunges again. The recessions of the early 1980s can be considered W-shaped recessions.
- K-shaped recessions. K-shaped recession is a newer term coined to describe the post-pandemic recovery. Essentially, a K-shaped recession occurs when one part of the economy recovers, while another sinks or recovers more slowly, drawing a “K” on a graph.
And finally, let’s look at the recession predicted by Zoltan Pozsar: the L-shaped recession.
What is an L-shaped recession?
An L-shaped recession, or L-shaped recovery, is a type of recession characterized by a sudden drop followed by a slow recovery. Shaped like an “L” on a chart, these recessions often come with persistent unemployment and stagnant growth.
Because of their severity and length, L-shaped recessions can also be described as economic depressions. Although GDP eventually rises after bottoming out, the recovery process takes years or even a decade.
An example of L-shaped recoveries is the Great Depression, which extended into the 1930s. Some economists also group the Great Recession into this group. Although it only lasted two years by GDP metrics, the economy lagged pre-recession projections for more than a decade.
L-shaped recoveries are often considered the most damaging type of recession because of their sudden onset and lingering impacts.
The impacts of L-shaped recessions
During these periods, the economy may struggle to regain pre-recession growth and employment figures.
Often, businesses have to close or lay off workers, extending recovery time and leaving consumers out of work (and money).
In turn, businesses can’t achieve the growth they need to start hiring again, preventing the economy from readjusting.
Because of their devastating impacts, governments often try to intervene in L-shaped recessions to soften the blow and boost growth. Unfortunately, historically, this often involves allocating the bulk of resources to the financial sector (i.e. banks), which some economists believe further slows the recovery.
Industries that do well in a recession
L-shaped or not, recessions are often brutal for investors. When less money flows through an economy, companies can see reduced profits and increased belt-tightening, leading to lower share prices and dividends. Cyclical and discretionary stocks (such as hospitality) may be particularly affected.
But some industries do well – or even thrive – during recessions. Often, these are the “inelastic” industries, or those where consumer demand remains stable regardless of economic conditions. Historically, many defensive stocks fall into this category, such as consumer staples, healthcare, and utilities.
If you’re looking for places to park your money in turbulent times, the following are industries that do well in a recession.
Food and groceries
No matter the economic climate, people need food, personal products, and some household items. (Think toothpaste and soap). As such, companies that make or sell these products remain quite resilient during recessions.
Consumer staples stocks that can do well in a recession include names like Kroger, PepsiCo, General Mills, Tyson Foods and Proctor & Gamble. Even chains like McDonald’s tend to do well (or at least better than expensive alternatives) as people can substitute eating out for cheap fast food.
DIY and repair
When money is tight, consumers can save by repairing, renovating and maintaining their own homes, vehicles and gardens. Maybe that’s why companies like AutoZone and Sherwin-Williams Co. they performed well in 2008, and so DIY home improvement stores like Lowe’s and Home Depot outperformed in the pandemic.
Discount and cost conscious retailer
Sure, people need food and paint during a recession, but that doesn’t mean they have to pay full price. When it’s time to stretch that budget, consumers can turn to cheaper substitutes like store-brand items or discount chains for their needs.
Discounters that can (and have) performed well during a recession include big names like Walmart, Dollar General and Dollar Tree. Big box stores that offer discounts for buying in bulk like Costco and Sam’s Club can also shine.
Freight and logistics
Recession or not, luxury or discount, goods must move from point A to point B. While personal travel and vacations often fall during recessions, freight lines (and companies that make goods-related products, such as containers or gas) can also work well. .
For example, in 2008, Old Dominion Freight and Westinghouse Air Brake Technologies performed above average. And in the modern, Amazon-heavy climate, companies like FedEx and UPS can make good bets, too.
Healthcare is another essential service that most people cannot do without. While some healthcare companies (such as startups and biopharmaceutical companies) are less resilient during downturns, the industry as a whole is relatively inelastic.
And it’s not just hospitals, insurance companies and pharmaceuticals: related products like band-aids and peroxide are also still in demand.
Some examples of healthcare stocks that tend to shine during recessions include CVS Health, UnitedHealth Group, Pfizer and Johnson & Johnson.
Utilities and energy
In addition, we have utilities and energy, which includes water, electricity, waste collection, oil and gas, and (of course) internet. These companies and related companies tend to see relatively stable profits regardless of the economic climate. As such, they often make ideal investments to increase their returns or reduce losses in a downturn.
Potential investors in the space include companies such as Brookfield Infrastructure, ExxonMobil, American Water Works and AT&T.
Don’t go pear-shaped for an L-shaped recession
During a recession, it’s impossible to know what shape the recovery will take or which companies will perform better. It is also important to note that while an industry may do well in a recession, its profits may fall during the recovery or post-recession phase.
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