How recession fears are shaping investor behaviour and emotions

This latest game changer is just that: the latest. It is an important reminder that humans are built for change. We do what we’ve always done when new opportunities and challenges emerge: we adapt. Why am I writing about this? Because investor psychology is fragile coming into 2023. Fears about interest rates, inflation and a possible recession are preventing investors from seeing this period of time for what it is: a good buying opportunity. 

When people ask me, “How do you have the confidence to buy right now? How do you know things will get better?” I say it’s because we’re always moving forward. The markets reflect the companies that are involved in innovation, taking us to the next level—the next big thing. This time is no different. Interest rates and inflation should eventually fall, and the markets should reach new highs.

What many Canadian investors are doing is letting emotion drive their decision-making. My job as an advisor is to have the knowledge to take emotion out of the equation and give investors the goods. In this case, the goods are…

Bad news is being interpreted as bad news again

A few months ago, I wrote about how bad economic news could be perceived as good for the markets. At that point, the central banks were looking to significantly increase interest rates in order to slow inflation by slowing the economy. Investors, through the markets, rewarded not-great economic data because it meant the U.S. Federal Reserve and the Bank of Canada (BoC) would limit rate hikes.

This year started with investors viewing bad news as bad news, and reacting negatively to it. Why the shift? There’s a new fear gripping investors. We’ve transitioned from an environment where the number one cause for investor worry was the one-two punch of higher interest rates and higher inflation, to a point where we have seen the bulk of the interest rate increases. We now know those rate hikes are working. That means we don’t want to see bad economic data anymore because that could lead to the realization of investors’ current top fear: recession. A Leger poll from January 2023 found that 69% of Canadians think Canada is in a recession, compared to 51% a year ago. A Bank of Canada survey in April 2023 found that “most Canadians see a recession as the most likely scenario for the economy in the next 12 months.”

We’ve adapted to the higher interest rates and inflation, and we want a soft landing for the economy. So, when economic data comes out this year, good news will be viewed as good news. If we see gross domestic product (GDP) growth, we’ll say, “Look, GDP is still positive even though we’ve raised interest rates seven or eight times.” Canadians continue to spend money, even though it costs more to borrow now with higher interest rates. We want to see the markets doing well and that they can withstand the pressure of higher rates.

The Goldilocks ideal

Canadian investors want the markets to be just right—not too hot and not too cold. That’s why, when the U.S. jobs report for January 2023 blew past analysts’ predictions (517,000 new jobs were created, versus the 187,000 that were expected), there was a sell-off. Albeit a slight one. No one wants to see central banks return to aggressively raising interest rates. If we had 200,000 new jobs, the markets would have yawned.

How living in the past is costing investors

Even though current economic conditions are allowing investors to view bad news as bad news and good news as good news, this doesn’t mean Canadians are making the right investing decisions.

In January 2023, I had a lot of investors upset because their mindset was still living in the month of December 2022—a horrible month for the markets. Meanwhile, returns from the second and third weeks of January 2023 were fantastic. We got back a lot of the losses of 2022. That year was the fourth-worst year since 1945 for major stock indices in the United States. Instead of searching for deals, some Canadian investors let the fear of a potential recession hold them back.

Why a recession doesn’t matter

While it’s possible we are heading into a recession, if we do, I think it will be mild. And I don’t think investors should worry about it.

“Recession” is a label; it’s a word that describes two consecutive quarters of negative GDP growth. What we know for sure is that the world’s economic growth is slowing. No doubt about that. Many companies, especially those in the tech space, are laying off workers. Growth rates are coming down, and they will probably flatline eventually. Canadians need to get comfortable investing in a world where growth is slowing.

The markets will reveal the future

The markets look ahead six to 12 months and offer the most accurate window into what’s likely to come. When the market dropped like a stone in October 2022, it fell because it envisioned a slowdown six months later. And, here we are.

When we get to the point when our governments could say we’re in a recession, the markets will be way higher. The markets saw this coming, factored it in and are looking toward better days. Anyone who tries to time the market based on what they read and see in the media will likely be too late.

Where to invest in 2023?

Investors should be as greedy as can be. Six, 12, 18 months from now, you could potentially be rewarded with better returns. There is a very good chance 2023 will be a positive year. How positive? Some analysts are calling for a 15% return. I’m anticipating yields between 8% and 10%. My recommendation: Put your money to work and buy large-cap names that could provide long-term growth.

Allan Small is the Senior Investment Advisor at the Allan Small Financial Group with iA Private Wealth (allansmall.com) and host of The Allan Small Financial Show. He is also the author of How To Profit When Investors Are Scared. He can be reached at [email protected].

Read more from Allan Small:

• 2022’s year in review: The financial highs, lows and what’s in store for 2023
• Does TINA still apply for the stock market? Are GICs and bonds a new option for Canadian investors?
• How to stay invested and pick up good quality companies—on the cheap
• What fast-rising interest, inflation and bond rates mean for investors

About Allan Small, FMA, FCSI

Allan Small is the Senior Investment Advisor at the Allan Small Financial Group with iA Private Wealth and host of The Allan Small Financial Show. He is also the author of How To Profit When Investors Are Scared. He can be reached at [email protected].

Linkedin Twitter Facebook Website