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The Harder the Fall, the Bigger the Bounce

Historical data show the worse the economic decline, the stronger the recovery.

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There has been a lot of talk about a very slow economic recovery, with many of these discussions highlighting the severity of this recession as the key cause for a tepid turnaround. In reality the historical pattern has been just the reverse: the worse the economic decline, the stronger the economic recovery.

In a recent article, Fidelity economist Dirk Hofschire shows the pattern of economic recovery six months and 12 months after an economic bottom. The harder it falls, the bigger it bounces seems to be the appropriate motto. The data show economic growth after mild recessions (1990-91, 2001) in the 2.3% to 2.6% range in the following year and after severe recessions (1953-54, 1957-58, 1973-75, 1981-82) in the 7%-8% range.

The reason for the strong bounces is often inventory driven. As demand falls, businesses cut back harder on production (which is what is measured in GDP) than the actual shrinkage in sales volume. That's because as sales shrink, firms need to hold less inventory either because too much inventory was built in the first place, because management predicts sales will stay low for a while, or out of just plain fear. Once sales bounce, not only does production have to rise to meet sales on a one-for-one basis, but inventory stocks must be rebuilt. The same type of bounce effect can occur in employment with firms cutting back on employees more sharply than necessary at the beginning of a recession and then having to add back people faster than many expect in a recovery.

Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.