In the early 1940s, America mobilized its manufacturing sector to become the “arsenal of democracy.” That meant converting plants that once made Chryslers and Fords to churn out thousands of Sherman tanks a day. GM plants made Flying Fortresses for the U.S. Army Air Force.
And when the war was over, the country’s “all-in” production mode turned on a dime, with federal outlays returning virtually overnight to what they had been before the war. Every economic crisis that followed—markets roiled by the war in Vietnam, 9-11, and, yes, the Global Economic Crisis of 2008—pales in comparison in terms of its complete stranglehold on the national economy. Then came the coronavirus. Keep calm and carry on?
Fast-Forward to Recovery?
Dhar and Tenengauzer discussed how they expect textbook V-, U-, and L-shaped recoveries to manifest themselves given the two unknowns: just how much money the government will inject into the economy this year and the course of the pandemic. Afterwards, we couldn’t help plotting potential scenarios using the Federal Outlays as a percentage of GDP chart. We lengthened the timeline to 2030, sufficient time for the three recovery scenarios to play out. We also assumed that the $2.2 trillion stimulus package —about 10 percent of current GDP—could very well double by the end of this year, making the percentage of Federal Outlays eerily similar to what they were at the height of World War II.
On the chart, three dotted lines diverging at the 2019 budget year show what V, U, and L recoveries might look like. The V would be a spike not unlike 1944, with Federal spending rapidly decreasing and going back to some semblance of normal the following year. A U recovery shows a less dramatic return to pre-coronavirus spending levels. And then there’s the L (an inverted Nike swoosh, as Dhar’s colleague likes to call it) where spending would spike and then remain high over the next decade. When you hear talk about the new normal, the L-shaped recovery would be it.
Dhar is leaning in the camp of a V-shaped recovery. Tenengauzer is contemplating yet another letter entirely: W. Suppose you feel sick and don’t know if you have the flu or the coronavirus, he says. Either way, you immediately change your day-to-day behavior and await the diagnosis. After receiving the diagnosis, you alter your behavior yet again. As you recover from the illness, you rebound and eventually return to your daily routine.
Volatility in the Forecast
Investors experiencing a W-shaped recovery face a similarly volatile environment. They’ll have to test the health of the markets in which they want to invest, as well as gird themselves for lots of volatility and potentially lower Sharpe ratios across the board. But with the right amount of research and appetite for risk, investors will be in for an exciting and potentially lucrative market, according to Tenengauzer.
Although investors face an uncertain future, the “known unknown” is that it will be a volatile one. So as Keynesians begin spending to get the world out of a big foxhole, investors might look for some new opportunities—no matter the shape of the recovery.