Not all recessions are the same. Here’s what could happen to the economy and markets

Economists, CEOs, Wall Street and Main Street are sounding the recession alarm bell.

Most agree a recession could start to take shape in the United States over the next few months. The question is what shape that recession will take.

Recessions and recoveries come in shapes and sizes as varied as the alphabet. Perhaps that’s why economists have come to name different kinds of economic downturns after letters.

But predicting which letter will match the situation isn’t quite as easy as ABC. This looming recession is particularly complicated.

“Whether it’s Covid in Asia or what’s going on in Ukraine or what’s going on with energy, it’s one thing after another,” said Nick Tell, CEO of investment bank Armory Group.

The component of this potential downturn that’s unlike others is “the psychological impact on the workforce from Covid and the enormous amount of subsidies that were introduced into the economy,” said Tell. The resulting labor shortage is something that hasn’t been seen outside of a wartime recession.

“When you look at job openings relative to the number of unemployed individuals we’re certainly in uncharted territory here,” agreed David Lebovitz a global market strategist at J.P. Morgan Asset Management. “I’ve never really seen it like this in my lifetime.”

But “components of what’s going on are reminiscent of past recessions,” said Tell.

So if we’re bound for a recession, what form will it take?

U-shaped

“I think we’re going to have a U-shaped recovery, which is one we haven’t seen in a long time,” said Tell.

A U-shaped recession signals a steep decline, with a bit of a long struggle at the bottom before recovery. These are painful recessions that last a year or two and are caused by a number of coinciding factors. The stagflation, oil crisis and stop-and-go Fed response between 1973-75 caused a drawn-out U-shaped recovery.

Simon Johnson, the former chief economist at the International Monetary Fund, compared this type of recession to being stuck in a bathtub. “You go in. You stay in. The sides are slippery. You know, maybe there’s some bumpy stuff in the bottom, but you don’t come out of the bathtub for a long time,” he said.

The economy will need to slow down for a while before the workforce and unemployment return to a normal level, said Tell. When that finally does happen, things will revert back to normal, but it might take a few years.

V-shaped

A V-shape recession is just what it sounds like: A sharp decline with a clear bottom and then a sharp incline. This type of quick and complete recovery is considered a best-case scenario when it comes to recession. Sometimes the fall into recession is steeper than the climb back up towards recovery, like a Nike swoosh.

These usually represent a recovery from recession based on one-time shocks, like the two-month-long 2020 Covid recession.

Lebovitz is hopeful that if there is a recession, it will be V-Shaped and only last a few quarters. One of the things that we always look for and try to gauge is some sort of imbalance,” he said. “There was an imbalance in equity valuations during the tech bubble, and an imbalance in housing in the run up to the financial crisis of 2008. Looking at the economy today, we don’t see any significant imbalances that would lead to a serious downturn in the economy.” The next recession, said Lebovitz, will be relatively mild.

Lebovitz recommends that investors stay the course over the next 12 to 18 months. “We don’t suggest selling when you’re already down 20%,” he said. Still, investors should take this as an opportunity to rebalance their portfolios and to make sure that their broader house is in order.

W-Shaped

The dreaded double-dip recession. This occurs when an economy moves beyond a recession into recovery and then falls right back into another recession. A W-shaped recovery is particularly painful to investors who jump back into what they believe to be a recovered market before plummeting to another bottom.

In 1980, the economy had a short six-month recession and recovery followed by a 16-month downturn that stretched all the way from mid-1981 to late-1982. If the Federal Reserve isn’t aggressive enough in raising interest rates, some analysts say, this could happen again.

L-Shaped

An L-Shaped or “hockey stick” recession is what economists want to avoid at all costs. It means a plunge in growth for a very long time, and we often creep out of ‘R’ word territory into ‘D’ word territory: Depression. It usually means large numbers of workers remain unemployed for significant periods of time and that capital goods are sitting idle.

The Great Depression in the 1930s had an ‘L’ shape, and some economists argue that the Great Recession of the late 2000s was the same, it took six years after the crisis for GDP to return to 2007 levels. Some called it a “barbecue recovery”: low and slow.

K-Shaped

A K-shaped recovery is what happens when separate communities recover from economic downturns at varying rates. Some sectors of society may experience renewed growth while others continue to lag behind.

These changes are usually defined by industrial, wealth and geographic differences and are exacerbated by increased rates of income and wealth inequality.

While the 2020 recession recovery can be described as V-shaped, many point out that it was actually two-pronged. Low-income Black and Hispanic families saw the fastest depletion of their savings during the pandemic, for example.

Many who worked in white-collar jobs recovered quickly from the 2020 recession as the government handed out stimulus payments and stocks and home prices appreciated. Those without savings and who worked service jobs continued to suffer. Employees receiving the lowest wages were the most likely to lose their jobs in nearly every sector of the economy between 2020 and 2021, according to data from the Bureau of Labor Statistics.

“The lowest average wage establishments and the lowest earning workers have borne the brunt of the recession induced by the Coronavirus pandemic,” wrote economists at the BLS. “The lowest wage establishments and the lowest wage workers both saw the steepest initial declines in employment at the start of the recession and experienced the slowest subsequent recovery in employment.”