In news reports covering the stock markets, certain phrases seems to be repeated more than anything else: ‘the FTSE rises despite…’, ‘the S&P surges despite…’.

There is a whole range of bad economic data to finish those sentences, and yet after hitting a low on 23 March markets have bounced back strongly.

A lot of economists have been busy trying to work out what ‘shape’ the global economic recovery will take, using the same models that apply whenever there is a recession.

In this article we will delve deeper into how the recovery from the coronavirus crisis might pan out and identify four stocks to fit different ‘shapes’ of recovery.

WHAT SHAPE WILL RECOVERY TAKE?

The recent performance of the markets seems at odds with what is happening in the economy, as unemployment claims soar on both sides of the Atlantic, growth is wiped out and all surveys of how businesses are feeling point to an extremely pessimistic viewpoint.

The most commonly used terms when looking at recovery from a downturn are V-shaped, U-shaped, W-shaped and L-shaped recessions.

The markets appear to be pricing in a big, swift bounce back in the economy, what’s known as a V-shaped recovery.

Because the US is the world’s biggest economy, with a trading hub, i.e. Wall Street, that contains the biggest financial markets, what happens in America provides a big cue for investors in the UK.

Across the pond, analysts are still factoring in a V-shaped recovery in earnings, fired by the financials, consumer discretionary, industrials and energy sectors in particular, with further expected growth in the tech sector in late 2020 and 2021 providing additional support.

Estimates from FactSet imply US corporate profits will be growing again on a year-on-year basis by the first quarter of 2021.

For insight into why this is the case, George Lagarias, chief economist at Mazars, says financiers are ‘natural optimists’.

For pessimism to prevail in markets, he says ‘a direct threat to the decision makers must become credible, like threats to their own lives’.

Lagarias adds: ‘Global finance reacts to what it sees as a threat to global finance. Traders hardly see companies and earnings any more. They see “risk assets” collectively, especially after the proliferation of passive trading.’

He says the sector to watch in order to understand markets in times such as this is finance.

‘Traders are eager to spend all the money central banks have printed, but prohibitively expensive bonds, stocks and gold give them pause,’ Lagarias continues.

‘Real assets may seem like a good option, but commercial real estate probably doesn’t feel too well these days, nor do commodities in the face of sapping demand. So they wait.

‘What can change that narrative? Bank layoffs, hedge funds and private equity vehicles failing, borrowing costs soaring, exactly all the things that quantitative easing (QE) seeks to prevent. So, for financial market sentiment to change, we would need to see pressure on the financial sector. As long as this does not happen, QE-backed optimism should prevail.’

THE FACTORS TO WATCH

According to analysts at investment bank Berenberg, the shape of an economic rebound will depend on four key factors: i) the shape, depth and duration of the downturn, ii) the way in which lockdowns will be eased, iii) the reaction of demand to the easing of restrictions, and iv) the monetary and policy support.

The latest monthly survey of fund managers’ views by Bank of America has shown 52% expect a U-shaped recovery, with 22% expecting a W-shaped one and 15% believing we’re in a V-shaped bounce. Only 7% take the more pessimistic view that there’ll be an L-shaped economic recovery and 3% think there’ll be some other shape.

The base case scenario outlined by economists at ING also suggests there’ll be a U-shaped recovery. For this to happen, ING says lockdown measures need to begin to be relaxed across all countries toward the end of this quarter, while policy measures to support businesses need to have been effective, with a resumption in production and investment as well.

In another scenario where lockdowns resume this winter, the hit to demand lasts halfway through 2021, and recovery to pre-crisis levels of activity takes a further year, ING estimates.

A best case scenario, they say, sees lockdown measures lifted for good by the end of this quarter, allowing activity to bounce back strongly. A worst case scenario involves a deeper recession this year and recovery taking until 2023.

However, analysts at Berenberg are lot more upbeat. They expect a ‘tick-shaped’ recovery, namely a sharp downturn followed by a slightly flatter upturn that ultimately goes beyond the pre-coronavirus level of gross domestic product (GDP).

For every month of a harsh lockdown, Berenberg would subtract at least 2.5% from annual 2020 GDP, while adding at least 1.5% to 2021 GDP due to base effects and a post-lockdown rebound.

It would also raise 2022 growth by up to 0.5% as the rebound continues, supported by the measures from governments and central banks.

The Berenberg analysts do acknowledge the rebound may be muted in many sectors because households and companies may hold back on spending as they are still scarred by the whole lockdown experience, and consumers may not dare to venture out again as much as before, adding that anecdotal evidence from China points this way.

‘UNPRECEDENTED’ POLICY RESPONSE

The rebound should be supported by the unprecedented policy response to the pandemic, with a lot of the stimulus still in the pipeline if and when the shock to the real economy starts to ease, while pent-up demand for many goods and some services will also help, says Berenberg.

This more upbeat position is echoed by Stonehage Fleming Global Best Ideas Equity (BCLYMF3) fund manager Gerrit Smit, who calculates that markets are 75% ‘through the fear’ associated with the pandemic.

Smit also says fears that today’s recession is comparable to the global financial crisis are misplaced, as that was about a liquidity crisis created by a flawed banking system, which has since been reformed.

Whereas with today’s crisis, as it involves human life, the responses from central banks and governments has been ‘incredible’, he adds, saying we’re at the point where the worst is behind us.

Perhaps giving some insight into why the market has been rallying since 23 March, Smit explains, ‘Compared to a few weeks ago we now have more information about better diagnostic testing, more testing capacity, potential anti-viral drugs and a number of vaccine results holding some promise.

‘We now also know that social distancing measures are effective in flattening the infection rate. We also know that if a second wave occurs, the market and authorities are pretty well informed of the risks we face and are in a better position to consider clearly how to manage the situation.

‘It is largely due to this increase in information and a greater understanding of the risks that the worst of the fear, it seems, may be over.’

ECONOMIES REOPENING

Some countries have started reopening their economies, including Germany. As the continent’s largest economy, it is being seen across Europe as a test case with shops reopening again.

While this gives people hope of a swift recovery, it’s worth noting what business owners are actually saying. In a Financial Times report on Germany’s economy reopening, the manager of a small shop in Berlin selling espresso machines was quoted as saying: ‘Our sales will collapse…. No-one really wants to go shopping right now. They’re still too scared they’ll get infected.’

Retail and other areas like tourism and leisure are expected to be the most impacted from the pandemic anyway, but an unwillingness on the part of the consumer to venture outside and buy things other than necessities would have much further-reaching consequences.

According to the aforementioned Bank of America survey of fund managers, 93% expect a global recession in 2020. Investors think global GDP cuts are largely over, but cuts to companies’ earnings per share are just beginning, as recent results from Apple and Amazon are starting to show.

It’s difficult to draw definitive conclusions about how economies will recover, particularly given that everyone is still learning about all aspects of this coronavirus. Epidemiologists are still discovering how the virus spreads, while virologists are still learning about its structure.

Economics and strategists are also continually adapting their forecasts, models and assumptions, as medical knowledge of the virus continues to evolve.

UNDERSTANDING THE DIFFERENT RECOVERY SHAPES

V-SHAPED RECOVERY

This is where the economy suffers a sharp but brief period of economic decline with a clearly defined trough, followed by a strong recovery.

V-shapes are the normal shape for recession, as the strength of economic recovery is typically closely related to the severity of the preceding recession.

Historic example: V-shaped recovery

In the early 1950s the US economy was buoyant and, fearing rampant inflation, the US Federal Reserve hiked interest rates. This briefly tipped the economy into recession before a sharp V-shaped recovery.

U-SHAPED RECOVERY

Longer than the V-shape, a U-shaped recovery has a less-clearly defined trough and GDP may shrink for several quarters, only slowly returning to growth.

Simon Johnson, former chief economist at the International Monetary Fund, describes it like a bathtub: ‘You go in. You stay in. The sides are slippery. Maybe there’s some bumpy stuff in the bottom, but you don’t come out of the bathtub for a long time.’

Historic example: U-shaped recovery

In the mid-1970s the economic shock from a spike in oil prices and the fall of the Bretton Woods system of monetary policy resulted in a prolonged U-shaped recovery in the US and UK.

W-SHAPED RECOVERY

In this type of recovery, the economy falls into recession, bounces back with a short period of growth, then falls back into recession before finally recovering, giving a ‘down up down up’ pattern resembling the letter W. It is also known as a ‘double-dip recession’.

Historic example: W-shaped recovery

The Eurozone endured a W-shaped recovery from the financial crisis as an initial bounce back was undermined by a mounting sovereign debt crisis. This even put the future of the euro in doubt before the-then European Central Bank chief Mario Draghi came to the rescue with a pledge to do whatever it took to save the currency.

L-SHAPED RECOVERY

By far the most pessimistic outlook, an L-shaped recovery implies there will be a depression (a prolonged downturn in economic activity with a severe recession) and that economic growth will only return to normal many years later, if ever.

Classic examples include the Greek recession from 2007 to 2016, and the Japanese asset price bubble from 1986 to 1991.

Here are some stocks to play each recovery theme. It’s worth noting that all are solid companies, but certain stocks lend themselves better to a specific type of economic recovery.

Historic example: L-shaped recovery

In the late 1980s an asset price bubble developed in Japan and when this bubble burst the country fell into deflation and experienced years of sluggish growth – the dreaded L-shaped recovery.

STOCKS FOR EACH RECOVERY SHAPE

V-shaped recovery pick: Wincanton (WIN) 236p

The type of recovery everyone is hoping for. If we’re in a V-shaped recovery demand in many parts of the economy should bounce back quickly.In this case, logistics company Wincanton (WIN) should be a decent option.

Expectations for the company are currently low with its shares trading on a price-to-earnings ratio of around seven times. This is because it has low margins and quite asset-intensive operations with warehouses and lorries.

But the company is the leader in its industry, and if demand gets back to normal soon it should be well placed to benefit.

U-shaped recovery pick: Bunzl (BNZL) £17.12

The most expected type of recovery is U-shaped, this is where demand will pick back up again but it will take time. Companies well-placed for a rebound but who have the balance sheet to withstand a longer downturn are likely to come out of a U-shaped recovery in decent shape.

One stock that could be a good option is outsourcing firm Bunzl (BNZL). The company has a reputation for resilience to economic cycles – which should come in handy if we’re in for a prolonged economic downturn – achieved through diverse sector exposure and a granular client base.

Bunzl essentially supplies and manages items required to allow and service clients’ customers before they ‘come in the door’, and to meet regulatory requirements.

Around 45% of its revenues come from healthcare, groceries, cleaning and hygiene, all areas which could even see growth in the current pandemic. Around 40% comes from food service and retail, which will be negatively affected.

Shore Capital analyst Robin Speakman comments: ‘Our modelling suggests that, dividends aside, Bunzl should be well positioned to come out the other side of the Covid-19 economic shock in a strong position to resume its growth trajectory with cash generation underpinning prospects.

‘Visibility is difficult at present, but Bunzl’s diversity and its capability to service clients’ working capital efficiency management needs positions the group strongly for the future.’

W-shaped recovery pick: Reckitt Benckiser (RB.) £66.60

A W-shaped recovery implies a lot of volatility, with a sharp drop followed by a big bounce and then a sharp drop again before another big bounce.

Instead of trying to ride the wave and jump out at the top – a very difficult thing to do – a good way to play this type of recovery is to try to avoid that volatility.

Consumer goods giant Reckitt Benckiser (RB.) could be a good option. Its shares have gained 7.5% year-to-date, as the Dettol and Nurofen maker saw record like-for-like sales growth of 13.3% in the first quarter of this year.

The firm has long been seen as a defensive stock largely resilient to economic turmoil. Investors could also benefit from a turnaround story, with the company working to a recovery plan orchestrated by new CEO Laxman Narasimhan.

L-shaped recovery pick: Coca-Cola (KO:NYSE) $45.89

In this scenario, there’s not that many winners given the economy could take up to a decade to get back to the level it was before, if at all.

But one company which might be worth buying is a well-known name whose products feature in our lives very frequently – Coca-Cola (KO:NYSE).

Long seen as a ‘safe-haven’ stock across the pond, Coca-Cola boasts a strong balance sheet and high levels of profitability with an operating margin of 29% in 2019.

The drinks maker has been hit by the pandemic with sales falling 25% as restaurants, bars and cinemas all close. This has been reflected in an almost corresponding drop in its share price from around $60 a few months ago to around $46.

But that could make it an attractive buying opportunity. Never one for rapid growth, Coca-Cola would likely underperform slightly in a strong bull market, but fairly resilient demand and exceptional brand strength should see it do well if we’re in for a prolonged bear market.

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