- Credit Suisse analyst Zoltan Pozsar sees the U.S. economy diving into an L-shaped recession before inflation eases
- An L-shaped recession occurs when the economy plunges and takes a long, slow trudge to recovery
- L-shaped recoveries are associated with some of the worst economic periods in history, and may include massive fiscal and monetary policy changes
- Some of the best industries to invest in during a recession include healthcare, utilities, energy, and consumer staples
As inflation marches on and another Fed rate hike looks increasingly likely, the prospect of a recession grows more likely. However, the exact severity of this potential recession varies based on who you ask.
Some, like economist Sam Snaith, predict a mild “pasta bowl recession” that we’ll gently float in and out of.
But others, like Credit Suisse’s global head of short-term interest rate strategy Zoltan Pozsar, aren’t convinced. According to his latest economic analysis, the U.S. will require a deeper, longer recession to tame inflation and moderate the economy.
In particular, he believes that we’re headed for a so-called “L-shaped recession.”
Zoltan Pozsar’s L-shaped analysis
According to his latest research paper, Pozsar believes that the current trend of high inflation requires a more serious economic fix.
Due to macroeconomic changes (namely, the Russia-Ukraine war and China’s ongoing lockdowns), he thinks the Fed’s ‘soft landing’ is little more than a pipe dream. He also cited immigration restrictions and pandemic-induced immobility as key contributors to the tight labor market.
“War is inflationary,” he stated. “Think of the economic war as a fight 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 serve the needs of the West.” After these relations soured, he continued, “supply snapped back.”
As a result, he contends that inflation is now a structural problem, not a cyclical one. The war, ongoing lockdowns and tighter labor markets have led to supply chain disruptions and inflation that can’t be solved through a short period of rate hikes.
Instead, Pozsar sees the Fed hiking interest rates as high as 6% and “[keeping them] high for a while to ensure that rate cuts won’t cause an economy rebound…. The risks are such that Powell will try his very best to curb inflation, even as the cost of a ‘depression’ and not getting reappointed.” The result, he predicts, could be an L-shaped recession, which would be deeper, longer and slower to recover than the alternatives.
Pozsar’s views sit at odds with many economists and the Fed. Current estimates set the interest rate hike peak around 3.5%, with many anticipating little long-lasting damage from today’s 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 sweep back to define what a recession itself is.
A recession is a significant economic downturn (usually measured by declining GDP, or gross domestic product) that lasts at least two quarters. Though unpleasant, they’re considered a regular function of the business cycle.
All recessions start off the same, with a period of sudden or gradual economic decline. But how they end varies widely, from bouncing back immediately, double-dipping into a secondary recession or taking years to recovery.
Economists have named the months or years after a recession’s trough “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 graph, such as:
- V-shaped recessions. V-shaped recessions begin with a sudden fall and a recover that’s nearly as quick. Economists generally consider V-shaped recessions to be a best-case scenario. (Think the 2001 post-dot-com bubble recession.)
- U-shaped recessions. These recessions decline and recovery slightly slower, but linger at the bottom for longer. The 1971-1978 recession is a prime example.
- W-shaped recessions. A W-shaped recession is essential two V- or U-shaped recessions back-to-back. Also called “double-dip recessions,” they occur when the economy recedes, recovers (often quickly) and dives again. The recessions in the early 1980s can be considered W-shaped recessions.
- K-shaped recessions. The 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, plotting a “K” on a graph.
And finally, let’s take a 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 kind of recession characterized by a sudden drop followed by a slow recovery. Shaped like an “L” on a graph, these recessions often come with persistently high unemployment and stagnant growth.
Due to their severity and length, L-shaped recessions may also be described as economic depressions. Though GDP eventually increases after bottoming out, the recovery process take takes years or even a decade.
One example of L-shaped recoveries is the Great Depression, which by stretched well into the 1930s. Some economists also lump the Great Recession into this group. Though it only lasted two years by GDP metrics, the economy lagged behind pre-recession projections for over a decade.
L-shaped recoveries are usually considered the most harmful type of recession due to their sudden onset and lingering impacts.
The impacts of L-shaped recessions
During these periods, the economy may struggle to reattain pre-recession growth and employment numbers.
Often, businesses have to close or lay off workers, extending recovery time by leaving consumers out of work (and money).
In turn, businesses can’t achieve the growth they need to start hiring again, which prevents the economy from readjusting.
Due to their devastating impacts, governments often try to intervene in L-shaped recessions to lessen the blow and kickstart growth. Unfortunately, historically, this often involves allocating the bulk of resources to the financial sector (i.e., banks), which some economists believe slows recovery further.
Industries that do well in a recession
L-shaped or not, recessions are often brutal for investors. When less money flows through an economy, businesses may see reduced profits and increase belt-tightening, leading to lower stock prices and dividends. Cyclical and discretionary stocks (such as those in the hospitality industry) may be particularly hard-hit.
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 situations. Historically, many defensive stocks fall into this category, like 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 goods. (Think toothpaste and soap.) As such, companies that make or sell these products remain fairly resilient during recessions.
Consumer staple stocks that may 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 may replace eating out with cheap fast food.
DIY and repairs
When money gets tight, consumers may save by repairing, renovating and maintaining their homes, vehicles and gardens themselves. That may be why companies like AutoZone and Sherwin-Williams Co. performed well in 2008, and why DIY home improvement stores like Lowe’s and Home Depot outperformed in the pandemic.
Discount and cost-conscious retailers
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 tighten that budget, consumers may flock to cheaper replacements like store-brand items or discount chains for their necessities.
Discount that may (and have) perform 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 may also shine.
Freight and logistics
Recession or no, luxury or discount, goods need to move from Point A to Point B. Though personal and vacation travel often plunges during recessions, freight lines (and companies that make freight-related goods, like packaging or gas) may also do well.
For instance, in 2008, Old Dominion Freight and Westinghouse Air Brake Technologies both saw above-average performance. And in the modern, Amazon-heavy climate, companies like FedEx and UPS may also make good bets.
Healthcare is another essential service that most people can’t go without. While some healthcare companies (like startups and biopharmaceutical firms) are less resilient during recessions, the industry as a whole is relatively inelastic.
And it’s not just hospitals, insurance companies, and pharmaceuticals – related goods like band-aids and peroxide remain in demand, too.
Some examples of healthcare stocks that tend to shine during recessions include CVS Health, UnitedHealth Group, Pfizer, and Johnson & Johnson.
Utilities and energy
To top it all off, we have utilities and energy, which includes water, electricity, waste collection, oil and gas and (arguably) internet. These and related companies tend to see relatively stable earnings regardless of the economic climate. As such, they often make ideal investments for boosting your returns or reducing losses in a recession.
Potential investments in the space include firms like Brookfield Infrastructure, ExxonMobil, American Water Works and AT&T.
Don’t go pear-shaped for the L-shaped recession
During a recession, it’s impossible to know what shape the recovery will take, or which companies will perform the best. It’s also important to note that while one industry may do well in a recession, its profits may drop during the recovery or post-recession phase.
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