By Jill Fraser for Lending Central

“The improvement in economic indicators is consistent with an economic recovery by year end,” says AMP Capital Investors’ chief economist, Shane Oliver.

Oliver’s expectations are:

• While tight credit markets and ongoing deleveraging will most likely result in a slow recovery initially (say around 2% growth next year), the severity of the global recession and the amount of stimulus means a V-shaped recovery (with 5% or so growth next year) cannot be ruled out.
• After strong gains, shares are at risk of a correction and increased volatility in the months ahead as investors start to fret about the strength of the recovery. However, we expect the broad trend to remain up.

Over the last two months fears of a continuing collapse in global economic activity, leading to a re-run of the Great Depression, have been largely unwound and Oliver says the focus has now turned to the timing of the economic recovery and how strong it will be.

Morgan Stanley economist, Gerard Minack agrees with the recovery story (the macro team at Morgan Stanley expects a return to growth over the coming year) but cautions against misguided optimism.

Noting that very few macro indicators in developed economies currently point to growth, he says most are signaling economies that are contracting at a less rapid rate.

“Moreover, because the contraction in the December and March quarters was so extraordinary - double-digit GDP declines (at an annual pace) in several countries - the ‘improvement’ is to rates of decline that would be severe in a normal cycle.”

Looking at the anticipated timing of the recovery Oliver explains that share markets typically bottom about six months before the economic cycle.

“So if economic growth is going to bottom and start turning higher from later this year, as we think it will, then it would be consistent with shares having bottomed during the first half of this year. In other words, it’s likely the lows in March were it for the bear market,” he says.

Alternatively, he says, is if the recovery is going to be another 12 months or so away the risk of a new low in shares is much greater.

“To be sure, economic data relating to current or recent past economic conditions remains very poor – US April retail sales data indicates that US consumers are still cutting back, GDP growth fell at an alarming rate of 10% annualised in the euro-zone in the March quarter and an even worse 15% in Japan, and unemployment is still rising everywhere,” he says.

“However, a range of considerations provide confidence that an upturn in the economic cycle is moving into sight for later this year.”

Both economists can see light at the end of the tunnel as the low for the economic cycle comes into sight but the $64 million question on their lips is; what will the recovery look like?

While Minack believes that the period of economic free-fall has ended he says “it’s not whether there will be a recovery; the key issue is what sort of recovery”.

His view is that it will be slow and tepid.

Oliver says while there is increasing evidence that the recession is abating and there is reason for confidence in a recovery from later this year, there is much uncertainty regarding the strength of any recovery.

“The historical record tends to indicate that the deeper the recession the stronger the recovery,” he says.

“US recessions with a 3% or greater fall in GDP have seen 5% plus rates of growth in the first year of recovery. In Australia, recessions deeper than a 2% slump have been followed by a 6% plus rebound.

“Since this recession will be pretty deep in many countries including the US, if not Australia, history would suggest the possibility of a ‘Deep V’ style recovery.” (A deep but short recession followed by a quick turn around and a steep recovery.)

On balance, says Oliver, a constrained recovery seems most likely, at least for the first year of recovery (i.e., next year). However a V shaped rebound should not be ruled out.