V for Victory or VVV for Surreal?

Chidem Kurdas, Apr. 13, 2009

It’s been an alphabet soup of a recession. Some expected a V-shaped sharp decline and sharp recovery. Others, notably Nouriel Roubini, predicted a double-dip W. Then there is L, or Japan-style long-drawn out stagnation.

At this juncture, V-for-Victory probably has the majority vote. “I think this is a V-shaped recession,” said David Kelly of JP Morgan at a teleconference last week.

He gave several reasons to think the worst is past, in some areas anyway. Thirty-year mortgages are the lowest on record and combined with low home prices make housing affordable. Lending criteria for consumer and commercial loans have eased a little. International stocks are especially cheap.

If you go by this view, you’ll start loading up on international and cyclical stocks like technology.

Yet the global economy continues to decline—bad news about Chinese unemployment was the latest installment. True, stock markets usually lead the economy. You expect markets to bottom out while output and employment are still going down. US equities appear to be on the rebound, as shown by the significant gains since early March.

The minority opinion, expressed by people in hedge funds and other money management firms, is that the stock surge is a dead cat bounce. Very bad economic news is to come, in particular bankruptcies by companies. Defaults on debt continue to rise. Some of the defaults will shock the stock market and the recent weeks’ gains will likely disappear.

In other words, the pessimists say we’re in the middle section of the W and there’s another downturn before recovery begins in earnest. Stay with cash, government-backed debt and high-quality bonds.

The reason for the alphabet soup is the slow-motion unfolding of financial and economic distress. Judging from the past two years, it is taking longer and following a much more convoluted course than past recessions. Consider that the housing downturn started in 2006. By some measures we’ve been through two dips in 2007-2008. That’s a W already.

Optimists like Mr. Kelly point to Washington’s giant stimulus package and various bailout programs as reason to discern light at the end of the tunnel. But so far nothing in this downturn has gone as expected. Could there be a third drop, as in VVV—that’s the name of a one-time surrealist art magazine. Surreal might be the right term for a triple-dip recession.