BCA is one of the great research houses in the world.  They are usually spot on and great at separating the hysteria from reality and translating noise into signals to drive investment decisions.  They recently have made interesting parallels between historically sharp recessions and the corresponding vigorous recovery in Equity markets. In other words the sharper the drawdown in the economy, the fiercer the recovery rally when it comes. 

Here they differentiate between a normal economic cycle downturn and one associated with a financial crisis.  Their conclusions indicate that they believe that this will not be a V shaped recovery.  One of our previous posts pointed to the fact that “bad news is good news” in that bad news (or news confirming a weak recovery) is good for asset markets because it implies that the governments will be there eager to provide liquidity and stimuli. 

BCA: Financial crisis recoveries (red) vs Normal

From BCA:

Economic cycles associated with financial traumas such as banking crises or asset price collapses tend to have deeper downturns and weaker upturns. The current uptrend in U.S. economic growth should be sustained, but the rebound will remain subdued compared to recent recoveries.

In the past, there has been a close correlation between the severity of downturns and the vigor of subsequent recoveries, arguing that a V-shaped expansion in the U.S.  may be in order. In this context, the consensus forecast of 3% growth in U.S. GDP in 2010 seems low relative to past cycles. For example, the economy grew at an average 7.7% annualized pace over the six quarters that followed the deep 1981-82 recession. Optimists also note that the slope of the yield curve historically has been a good indicator of the economic cycle. Thus, the current steep yield curve in the major economies would be another reason to expect a vigorous economic expansion. However, the lingering after-effect of the financial bust will remain a serious headwind to growth in much of the developed world for the next few years. Indeed, recoveries that follow financial recessions tend to be much weaker than what follows non-financial recessions. Significant damage was done to the financial infrastructure in the past year, consistent with a weaker-than-normal economic expansion. Bottom line: While the global economic recession has ended, growth in the major developed regions will be slower than would normally occur after such a deep recession. This should limit consumer price pressures and keep policy conditions constructive for risk assets.

 Hope you enjoy the read,

The Covert Analytics Team