What Is V-Shaped Recovery?
V-shaped recovery is a type of economic recession and recovery that resembles a "V" shape in charting. Specifically, a V-shaped recovery represents the shape of a chart of economic measures that economists create when examining recessions and recoveries. A V-shaped recovery involves a sharp rise back to a previous peak after a sharp decline in these metrics.
- A V-shaped recovery is characterized by a quick and sustained recovery in measures of economic performance after a sharp economic decline.
- Because of the speed of economic adjustment and recovery in macroeconomic performance, a V-shaped recovery is a best-case scenario given the recession.
- The recoveries that followed the recessions of 1920-21 and 1953 in the U.S. are examples of V-shaped recoveries.
Understanding V-Shaped Recovery
V-shaped recovery is one of the countless shapes a recession and recovery chart could take, including L-shaped, W-shaped, U-shaped, and J-shaped. Each type of recovery represents the general shape of the chart of economic metrics that gauge the health of the economy. Economists develop these charts by examining the relevant measures of economic health, such as employment rates, gross domestic product (GDP), and industrial production indexes.
In a V-shaped recovery, an economy that has suffered a sharp economic decline experiences a fast and strong rebound. Such recoveries are generally spurred by a significant shift in economic activity caused by rapid readjustment of consumer demand and business investment spending. Because of the economy's rapid adjustment and quick recovery in the major metrics of macroeconomic performance, a V-shaped recovery can be thought of as a best-case scenario for an economy in recession.
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Historical Examples of V-Shaped Recovery
Two periods of recession and recovery in the U.S. stand out as examples of V-shaped recoveries.
The Depression of 1920 to 1921
In 1920, the U.S. entered a steep recession that was feared to have the potential to become a major depression. The U.S. economy was still adjusting from large shifts in government spending, industrial activity, and inflationary monetary policy that had been directed to the war effort during the World War I. It was also reeling from the impact of the Spanish Flu Pandemic of 1918–1920.
By 1919, World War I had ended, and more than 1.5 million soldiers returned home from the war, flooding the economy with new workers. Simultaneously, the federal government slashed spending by 65%, including closing munitions factories that were no longer needed for the war effort. The Federal Reserve's monetary policy didn't help because it hiked the discount rate, its main policy tool at the time, by 244 basis points (or 2.44%). Interest rates in the economy rose to 7% by mid-1920.
As a result, the postwar economy of 1920 experienced a decline in production of more than 32%, and unemployment surged to 12% as some businesses failed and many others saw a 75% drop in profits. The impact on the financial markets was devastating as the Dow Jones Industrial Average (DJIA) plummeted by 47% that year.
By modern standards, the monetary and fiscal policy responses were wholly inadequate to address the deep downturn. Unemployment insurance as we know it did not yet exist, though state and local committees to provide some relief were set up late in the recession.
The federal government's cut in spending throughout the 1920 recession, which would today be called contractionary fiscal policy, virtually guaranteed making the recession worse.
On the monetary policy front, the Federal Reserve increased rates in 1919 and early 1920, which is contractionary because it leads to fewer loans, reducing the money supply in the economy. The Fed then lowered interest rates late as the economy recovered in 1921, and by 1923, interest rates were 3%. The 1919–1923 monetary policy would be the reverse of what policymakers would likely do today.
These apparent policy missteps resulted in a sharp, V-shaped recovery as failing businesses were quickly liquidated and their assets reallocated to new uses, businesses, and industries. Prices and wages fell and adjusted to reflect the new structure of production and consumption in the post-war, post-pandemic, and increasingly urbanizing society.
Workers found new jobs in the new businesses and industries, and the economy quickly recovered and entered a renewed period of expansion known as the Roaring Twenties. As a result, the unemployment rate fell to 2.4% and gross national product (GNP) rose 4.2% per year through 1929.
The Recession of 1953
The recession of 1953 in the U.S. is another clear example of a V-shaped recovery. This recession was relatively brief and mild, with only a 2.2% decline in GDP and an unemployment rate of 6.1%. Growth began to slow in the third quarter of 1953, but by the fourth quarter of 1954 was back at a pace well above the trend. Therefore, the chart for this recession and recovery would represent a V-shape.
As in 1920-21, an important factor contributing to the quick recovery was the (by modern standards wildly inappropriate) policy response, or rather the lack thereof. The Fed's monetary policy response was underwhelming, with a half-percentage-point drop in the discount rate and a three-quarters point drop in the fed funds rate late in the recession. This represents the weakest monetary policy response in the post-World War II era. In terms of fiscal policy, the federal government took no steps to increase spending and overall tightened fiscal policy during the recession and recovery as measured by the high-employment budget surplus, an indicator of the direction of fiscal policy popular among economists.
Once again, a restrained approach to monetary and fiscal policy in the face of recession facilitated the V-shaped recovery that followed. Marring the recovery was the fact that unemployment continued to rise even after the end of the declared recession, peaking in September 1954, possibly due to the Fed's policy shift to interest rate cuts in 1954, which may have slowed the recovery.
What Do Chart Patterns Look Like During an Economic Recovery?
Economic recoveries can last for many years. The shapes of the chart patterns that typically form range from sharp bounces to softer gradual curves. There are many factors that influence economic recoveries, so no two patterns are alike. Traders will often look to common formations such as a double bottom, V-shape, or U-shape when planning how to position themselves during these important inflection points.
What Is a Double-Dip Recession?
A double-dip recession occurs when there is a short-term recovery followed by another recession. Sometimes, active traders will use a V-, W-, or U-shaped chart pattern to mark the reversal in a primary trend. It is worth noting that a double-dip recession is a non-zero probability that can lead to severe losses for those who rely on reversal patterns for trying to time a market or economic reversal.
What Is a Double Bottom Pattern?
A double bottom is a reversal pattern that is used by followers of technical analysis to mark a major shift in the price of a security. More broadly, active traders also use chart patterns such as a double bottom, or V-shape, to mark major shifts in broad market indexes and changes in economic sentiment.
What Is a Reversal Pattern?
A reversal pattern is a chart pattern used by followers of technical analysis to mark the shift in the direction of the predominant trend. Common examples include double top, double bottom, triple top, triple bottom. Broadly speaking, reversal patterns often follow a V-, W-, or U-shape, depending on the conviction of market participants.
The Bottom Line
A V-shaped recovery is a type of economic recession and recovery that resembles a "V" shape in economists' and traders' charting. This type of recovery involves a sharp rise back to a previous peak after a sharp decline in these measurements, and is considered a best-case scenario because of the speed of adjustment and recovery in macroeconomic performance.
Such recoveries are usually powered by a significant shift in economic activity caused by rapid readjustment of consumer demand and spending on business investments.