Over the past few months as economic stability has begun to return, forecasters have turned their attention from the downturn to the overall economic cycle. In other words, they have moved from forecasting how far economies would drop to both the drop and the subsequent recovery. Economists have begun using letters to describe their forecasts, and as a result discussing the most common scenarios has begun to feel a bit like a Sesame Street episode. The letters most often used are V, U, L and W and I'll describe each scenario below.

 The V shape describes most recessions, with the left side of the V or "\" representing the downturn, and the right side, or "/" representing the recovery. The recovery mirrors the downturn, with both occurring relatively quickly. Part of the rationale for a V-shaped recovery comes from economic research which demonstrated that in most economic cycles, the sharper the downturn, the sharper the recovery.

There is some logic to this, as most recessions are at least partly the result of supply outweighing demand. As producers pare back production, excess supply decreases until production begins to ramp up again and it is this ramping up that contributes to the recovery. Note that the level of demand here doesn't change so much as producers get ahead of themselves. In most downturns, the idea that the general level of demand doesn't change makes sense, but not necessarily in this downturn.

The U.S. consumer borrowed over the last several years in order to keep increasing demand, but with the credit taps now having been shut off, it's difficult to see how the level of consumer demand won't drop at least for the next few years. Another driver of economic recovery - exports - is also likely to be lackluster given the global nature of the downturn.

So if the two primary contributors to recoveries in past downturns are likely to be weak, what will the recovery look like? The most pessimistic forecasters - and anecdotally it seems to us that there are fewer forecasters in this camp with each passing week - look for an L-shaped recovery.

In this scenario, the sharp downturn is followed by years during which the economy operates at a much lower level - similar to what occurred in Japan in the 1990's. Government debt would continue to grow, and interest rates would likely spike as well as investors demanded higher rates for what would be an increasingly risky investment. The good news is that the likelihood of this scenario is low and it continues to diminish as economic stability returns.

So if we're not looking at a V-shaped or L-shaped recovery, what are the other possibilities? Some forecasters look to a U shaped recovery - the downturn is sharper than that found in a V-shaped cycle, and recovery is slow to return as well as the economy scuds along the bottom. However, when recovery does come it is quite sharp. While we can't argue with the sharpness of the downturn, the primary impediment to a sharp recovery is the level of U.S. debt. The two most likely ways to decrease the debt levels are via inflation or higher taxes, neither of which tends to be associated with sharp recoveries.

The final letter most often mentioned in describing a plausible economic cycle is W. In this scenario, the economy recovers only to fall back into recession before finally entering true recovery. An unexpected economic shock during the initial recovery could cause this, as could the inability of stimulus to ignite demand. One of the primary concerns about the stimulus was that it was spread out over multiple years, but this could prove to be a plus in combating the latter scenario.

So which scenario strikes us as most likely? Something between a U and a V - in which, after the sharp drop we've seen, the economy bottoms and takes some time to consolidate before growing at a modest rate - seems plausible. But a W shaped recovery can't be ruled out either, both because of the organic economic challenges we face and because the extent of government involvement in the economy raises the potential negative impact of policy missteps.

Given our outlook, we remain positioned fairly defensively, overweighting fixed income and underweighting stocks. Stocks don't appear particularly inexpensive now, so we'll likely maintain the underweight unless the market drops appreciably, in which case we'll look to increase the stock allocations. Although the overall outlook might not appear particularly positive, economic conditions are far more stable than they were just a few months back so we have come a long way in a few short months.