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Square root recovery

Peter Switzer
13 August 2009

Another big up-day on Wall Street and the question remains around what kind of market recovery will we have. The out and out optimists go for the V-shaped. The cautious optimists say U-shaped. The doubters go for W-shaped and some outside-the-square thinkers are going for square root recovery!

A number of my money colleagues have not heard of this, including the well-read and former top notch economics professor, Dr. John Hewson, of former Federal Opposition fame. He admitted to this on my SWITZER program on Sky News Business Channel this week.

The Soros call

I have to say, one of the scariest things about being a commentator in the internet age is that people can see your big, bad and wrong calls. Happily, I don’t think I’ve got much out there that I’m worried about but I felt for poor old billionaire George Soros recently.

Being an avid watcher of US business TV, I had come across a commentator who had brought up the square root recovery idea but I had a nagging memory of a link between the mathematical sign and Soros. So, it was off to the search engine and the story was revealed.

Forecasts of the past

Back in April, Soros, who only this week said the recession is over, was talking about an inverted square root recovery!

He thought the US economy was heading for a "lasting slowdown" — Japanese-style with low growth and inflation.

Reuters Financial Television reported that he tipped “rescuing US banks could turn them into ‘zombies’ that draw the lifeblood of the economy, prolonging the economic slowdown”.

An inverted square root would see the market go up and then down by more and then head sideways for a long time.

In contrast, the square root recovery would be down — we’ve been there — and then up, which we’re into now, and then sideways.

Shapes and recoveries

The European team at Merrill Lynch wrote a paper called “Alphabet Soup” which looked at the different letter-recovery options.

They made this observation, noted by the Financial Times website: “As long as world financial markets do not suffer a second heart attack, a full “W” looks unlikely. The recovery will have some momentum.”

The Eurozone, the Merrill team say, could fit the square root call pretty well. Because the recession has pushed so many sectors to low production levels, it’s easy to see a biggish bounce back, but the impact of the recession and the market meltdown will hold back a lot of economic enthusiasm of producers, employers, consumers and even investors. We have de-boomed ourselves in effect and that’s why a sideways period is believable.

“Erasing the losses incurred during the recession will not be easy or swift,” the FT journo wrote. “It will probably take until early 2012 for Eurozone GDP to return to its early 2008 peak level.”

Differing views

Before signing off, let me remind you that calling an economy is easier said than done. George Soros is a bright guy who has the tag of being one of the world’s wiliest investors. Let’s revisit what he predicted in April.

"I don't expect the U.S. economy to recover in the third or fourth quarter so I think we are in for a pretty lasting slowdown," Soros said, adding that in 2010 there might be "something" in terms of US growth.

This view was at odds with the consensus of US economists who tipped a 2009 second-half recovery back in November. I know this as I reported it and a few media and economist colleagues scoffed at it.

Soros told Reuters that the recovery will look like an inverted square root sign. "You hit bottom and you automatically rebound some, but then you don't come out of it in a V-shape recovery or anything like that. You settle down—step down."

Sideways movement

Recently Leon Cooperman, chairman and CEO of Omega Advisors told CNBC that he thought the recovery from this point onward will be “square root-shaped.”

“It’s the result of deleveraging—the consumer have to lift their savings rate, corporations have to improve their balance sheets, and government has to get the house in order,” Cooperman told CNBC.

I think there is more upside but there could be some sideways movements like in the early 1970s. Chartist Regina Meani, who I call the Queen of Charts, showed me some charts this week that suggest some sideways action could eventually replace the gravity-defying stuff we’re seeing right now on the stock market.

For advice you can trust, contact Switzer Financial Services.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.


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