Angst grows over double-dipping "W" recovery

By Natsuko Waki - Analysis

LONDON (Reuters) - Investors who have written off 2008 as a year of an economic slowdown and depressing stock market returns, are already gearing up to face a cocktail of new problems next year.

If you imagine a chart of the global economy's future growth -- and hence the stock market's path -- you get to the heart of the investors' big debate right now. Will that chart look like a sharp "V" shaped recovery, a double-dipping "W" or a long "L"-shaped funk?

Six months after the turmoil began, the credit crunch has forced 2-1/4 percentage points of U.S. interest rate cuts and the first joint action by the world's top central banks since September 2001 to calm money markets.

Yet, as the world economy slows, some stock indexes have fallen 20 percent from their peaks, dipping into technical definitions of a bear market; many loan and bond markets remain closed; and insurance premia on credit defaults have soared to record highs.

The crisis, which originated from a crash in the U.S. subprime mortgage market, has to date cost the global banking sector well in excess of $100 billion in debt writedowns -- around a third of the estimated total loss of $300-400 billion.

Financial markets have already built much of this fallout into current prices and, some say, are already positioned for a cyclical upturn in the second half of this year that would resemble a "V"-shaped recovery.

Consensus assumptions are the U.S. economy experiences its low point for growth -- perhaps recession -- in the first half of 2008. The optimism about a sharp bounce stems from expectations that by September another percentage point will be lopped off U.S. interest rates to 2 percent and Washington's $150-billion fiscal stimulus will feed through the economy.

But what if that best-case scenario does not materialize?

"It's very probable we get a cyclical rebound in the second half of this year but after a short snap back we might get a double dip... if consumption doesn't pick up," said Jan Poser, chief economist at Swiss wealth manager Sarasin.

"There is a risk of a W-shape recovery," he said, adding the U.S. policy response may soften the consumer downturn this year but it would be a temporary fix to a likely recurring problem.

For financial markets, it means that stock markets would develop a false sense of a bottoming out before falling back and yields would come down further.

"Usually the cyclical recovery dominates stock markets, which will raise stock indices around the world. Then of course if there is a double dip developing, stock markets may be going down further in the second leg of the downturn," Poser said.

The likely shape of a profit cycle also points to a prolonged period of falling corporate profits, if a profit recession were to materialize.

PROFIT CYCLE

Merrill Lynch reckons that in the past two 10-year profit cycles, it took around 100 months for profits to hit a peak and earnings fell 35 percent on average from peak to trough.