What Is a W-Shaped Recovery?

A W-shaped recovery refers to an economy that suffers two significant dips which are interrupted by a brief rise before the ultimate recovery takes place. If this series of movements were charted on a graph, the resulting lines going up and down would look like the letter "W". Investors must be aware when a W-shaped recovery is occurring, or else they could be fooled by the false security of the brief economic boost. This type of recovery is only complete after two large downward movements from leading economic indicators.

It is extremely common for economies to go through several periods of strength which are broken up by unfortunate periods of weakness. To indicate the movement of a particular economy, graphs can be used to show the timing of the upward and downward shifts along with their severity. The lines on these graphs may occasionally resemble letters of the alphabet, such as "V", "L", or "U". Particularly tumultuous economic times may result in what is known as a W-shaped recovery.

In a W-shaped recovery, the economic indicators, which can include gross domestic product, employment levels, and market prices, will start at a high point on the chart, indicating a position of strength. That high point is followed by a steep downward drop. A rise back to somewhere at or near the previous high point follows, only to be quickly interrupted by another precipitous fall. Things finally stabilize and recover after that to a position of strength once again. Thus, the graph lines go down, up, down, and up, resembling a "W".

Recognizing a W-shaped recovery is difficult because it can easily resemble another common cycle known as the V-shaped recovery. A V-shaped recovery simply consists of one steep drop and a subsequent rise. Investors may mistake the temporary rise in economic indicators in the middle of the "W" for the permanent one in the "V". If this occurs, the investors who hop on board what they expect to be a long-running bull market, which is signified by rising market prices, will be stung when the second drop of the "W" occurs.

The risk with trying to project a market occurrence such as a W-shaped recovery is that it is impossible to actually diagnose the trend until it is over. For that reason, investors must make sure that the factors that are causing prices to rise are strong enough to maintain that upward momentum. Otherwise, investors might be best served by staying cautious until any economic rebound stabilizes for a long enough period that it can be trusted.