Earlier this year, markets were most concerned with inflation and would rally on tepid economic data. That's no longer the case.Mark Blinch/Reuters
Sign up for the Globe Advisor weekly newsletter for professional financial advisors. For more from Globe Advisor, visit our homepage.
The market selloff earlier this month makes it official – weak economic news is back to being bad news for investors.
Earlier this year, the key word was inflation and weak economic news meant that higher interest rates were having the intended effect of taming inflation and keeping the economy from overheating. Markets would rally on tepid economic data.
Meanwhile, strong economic news meant that inflation was staying stubbornly high and hinted that interest rates could rise again. Markets would dip when economic news was stronger than anticipated.
Now, that has flipped, and the dreaded R-word – recession – is gaining traction.
A weak U.S. manufacturing report followed by a weaker-than-expected U.S. jobs report sent markets spiralling earlier this month, with the tech-heavy Nasdaq in correction territory. Investors worried the U.S. Federal Reserve Board has been waiting too long to cut interest rates, putting a soft landing in jeopardy.
When bond yields were falling and inflation was improving earlier this year, the stock market reacted positively, says Craig Basinger, chief market strategist at Purpose Investments Inc. in Toronto.
But that good news has turned into bad news as the market responds to the economy “slowing down a lot faster than people expected – which, all of a sudden, isn’t good news,” he says.
Markets are a “social environment” made up of individuals, he says. While markets can handle bits of bad news and continue to rise, “when those bad news pieces start to pile up and get bigger and bigger, then it starts to weigh down the sentiment. And I think that’s what we’ve been wrestling with for the last little while,” Mr. Basinger says.
Douglas Porter, chief economist with BMO Financial Group in Toronto, says investors got a “real-time lesson” in how the market has changed the way it views economic data. “It’s okay if the economy slows; it’s not okay if it tips into a downturn. There’s a fine line, and we got too close to that line for comfort.”
While there has been recession “chatter” for the past few years, it faded into the background over the past six to eight months, before coming “back to the forefront,” Mr. Porter adds.
For investors, though, he doesn’t see the need for a “dramatic reassessment” of portfolios.
When the economy is slowing, it’s a good environment to be “tactical” with investments, Mr. Basinger says. Purpose Investments is now overweight on bonds, carrying bonds of longer duration as well as more cash.
It’s also reducing the concentration of some U.S. stocks that have risen significantly and adding international and emerging markets equities.
“You can make some pretty good moves to insulate portfolios better for this kind of environment,” Mr. Basinger says.
He’s not overly worried about a recession, though. “We have just gone from a period during which nobody was talking about recession, and we might be getting closer to something that people worry a little bit more about.”
The potential is for this to “turn into some sort of correction in the market, which wouldn’t be abnormal for this time of year,” Mr. Basinger adds.
Often, a recession can come on quickly due to an external shock – for example, in the early 1990s when Iraq invaded Kuwait and oil prices spiked, Mr. Porter says. Technically, Canada’s last recession was during the pandemic lockdowns in 2020, but it didn’t last long. The previous recession was during the 2008-09 global financial crisis.
Mr. Porter expects there will be “a very active debate” ahead of the Fed’s Sept. 18 meeting as to whether there will be an interest rate cut, and if it might be 25 or 50 basis points.
“The first rate cut is … always a watershed event,” he says.
The next big economic number for investors is the U.S. employment report in early September, Mr. Porter says, noting that, in the meantime, markets may be more sensitive than usual to other economic data, such as retail sales and inflation figures.
Mr. Basinger concurs, adding the U.S. consumer is key: “If the labour market remains decent, then the U.S. consumer can sort of muddle through this. But if the labour market starts to soften far more, that’s probably going to get the recession talk growing louder and louder.”
For more from Globe Advisor, visit our homepage.