What are the Scenarios for Economic Recovery?
What kind of economic recovery will there be? That’s an important question to ask in planning your investment strategy to take advantage of an upswing and protect yourself in the event that things stay sour.
Let’s consider six possible scenarios:
1) Rapid snap back. Suddenly the market takes a strong upward turn towards pre crisis levels.
Likelihood: Very low. Was considered a reasonable possibility early in the crisis but now the damage is so ingrained that short-term recovery would be nearly miraculous.
2) This year or soon after.
Likelihood: Possible but odds are fading fast. As long as unemployment continues to fall housing will continue to fall, and foreclosures and bank failures will continue to deteriorate.
3) Mid-term recovery, circa three to five years.
Likelihood: Likely, no good arguments that it can’t happen. Preferred stock issued to the U.S. Government by the big banks in the first round of bailouts were structured with strong incentives for payoff within five years. If the payoffs for those loans stay on track–and the more elaborate efforts to save Citibank work–it could result in increased confidence over the same timeframe.
4) Japan style long-term stagnation/deflation.
Likelihood: Not a strong comparison to the current situation, but within the realm of possibility. The U.S. (and international community) has taken more decisive action than Japan did when its commercial real estate bubble burst in 1991 and the Japanese bubble was arguably even more severe at its height, but like the Japanese situation significant deflationary pressures are present.
5) Great Depression 2 on financial markets.
Likelihood: No strong arguments for, but we are in uncharted territory, so who knows? Given contemporary mores in favor of providing a safety net against human suffering, it is not likely that the United States will allow masses of people to fall into poverty as they did in the Great Depression. However, the financial markets could take a different turn, continuing to decline, and not reaching their pre-crisis levels for a generation.
6) No full recovery.
Likelihood: Has never occurred in U.S. history, but that does not mean that it couldn’t. While the U.S. still has tremendous resources in its economy, great empires have fallen before. Our investment banking industry has been
obliterated, and our auto industry is on life support. In short, we are making fewer things that the world wants at competitive prices. If we do not retool our infrastructure to compete in the world marketplace, we may never return to where we were.
In which of these scenarios will your current investment strategy be effective? This is not to say that you should not gear your strategy towards a particular scenario, but you should consider the impact if another scenario is the path that history takes.
[...] and yield decent dividends. While the timing of the economic recovery is far form certain, I have argued that investors should plan for the possibility that it may take years or more for the …. Given the wisdom of diversifying ones portfolio for different recovery scenarios, it makes sense [...]