A W-shaped recovery is when an economy experiences two significant dips, interrupted by a brief rise, before the final recovery takes place. Investors need to be aware of this type of recovery as it can be easily confused with a V-shaped rally, leading to false security and potential losses.
A W-shaped recovery refers to an economy that suffers two significant dips that are interrupted by a brief rise before the final recovery takes place. If this series of moves were to be plotted on a chart, the resulting lines going up and down would look like the letter “W.” Investors need to be aware of when a W-shaped rally is taking place, or else they could be misled by the false security of the brief economic boost. This type of recovery is only complete after two large downward moves in leading economic indicators.
It is extremely common for economies to go through several periods of strength that are divided into unfortunate periods of weakness. To indicate the movement of a particular economy, charts can be used to show the timing of the up and down changes along with their severity. The lines on these charts can occasionally resemble letters of the alphabet, such as “V,” “L,” or “U.” Particularly tumultuous economic times can lead to what is known as a W-shaped recovery.
In a W-shaped recovery, economic indicators, which may include gross domestic product, employment levels, and market prices, will start high on the chart, indicating a position of strength. That high point is followed by a sharp drop back down. An ascent to somewhere at or near the previous high point follows, only to be quickly interrupted by another precipitous drop. Things finally level off and pick up after that to a position of strength once again. Therefore, the lines on the graph go down, up, down, and up, resembling a “W.”
Recognizing a W-shaped rally is difficult because it can easily resemble another common cycle known as a V-shaped rally. A V-shaped rally simply consists of a sharp drop and subsequent rise. Investors may confuse the temporary rise in economic indicators in the middle of the “W” with the permanent rise in the “V”. If this occurs, investors who jump on what they expect to be a long lasting bull market, resulting in rising market prices, will be hit when the second dip of the “W” occurs.
The risk of trying to project a market turnout, such as a W-shaped rally, is that it is impossible to diagnose the trend until it is over. For that reason, investors need to make sure that the factors that are causing prices to rise are strong enough to maintain that upward momentum. If not, investors might be better served by being cautious until any economic rebound stabilizes over a long enough period that it can be trusted.
Smart Asset.
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