The 2023 Recession Explained (Investing During Inflation, High Interest Rates and Market Crashes)

This video is sponsored by Seeking Alpha. You can get 12 months of Seeking Alpha premium for just $99 via the link in the description. There's no doubt 2022 has been a very difficult year for the average investor. Year to date, the S&P 500 is down about 16%. Cryptocurrencies have been absolutely decimated, and the property market is tapering off.

Despite all these asset classes being totally different, all these price movements have been the result of the same two things—two very big macroeconomic factors that you would have heard about a lot in the news over the past 12 months: inflation and interest rates. During the lockdown periods of 2020 and 2021, the Federal Reserve printed roughly 4 trillion US dollars as relief for businesses and citizens. While it was genuine relief in the short term, it did have an unfortunate side effect of bringing inflation up to 40-year highs.

But inflation, left alone, only gets worse. So over the past 12 months, the Federal Reserve has had to raise interest rates, which controls demand for goods and services by restricting people's ability to borrow and have free cash to buy stuff. By restricting that demand, it causes prices to stop inflating, as now supply and demand are back in line. So that's the back story.

Long story short, at the end of 2022, we now have inflation at a very high 7.7 percent, although it is slowing down a little bit now, and we also have interest rates climbing now up to 3.75 to 4. So with that foundation laid, I wanted to discuss how we should be thinking about investing in 2023. What are the factors that we need to consider? There are three or four things I wanted to discuss with you guys. So with that said, let's get started.

Okay, the first factor that we really need to address before anything else—it sounds like a bit of a cop-out, but it really isn't. The first factor you need to think about before investing in 2023 is whether you're actually in a financial position to invest in 2023. Because while investing is great and all, in the short term anything goes; your portfolio might go up or it might go down.

To be a really good investor, you need to be in the market for a long time—like 5, 10, 20 years. That's how people make a load of money in the market; they don't just flip-flop, they make great investments and they hold on to them. What this means is you need to make sure any money you put aside for investing isn't actually necessary in your day-to-day life. You know, if you need that money to pay rent, or pay bills, or pay for anything, just forget it.

The other consideration is this: when interest rates go up, as they are now, companies earn less money and they start to cut costs. So if you haven't noticed, right now all the biggest companies in the world are doing layoffs. You also need to ask yourself, "Do I have an emergency fund, and is my income truly secure over the next year or two?"

Because while recessions are typically a great entry point for new investors, they certainly aren't kind to workers. So you really need to assess your own financial situation or get help from an advisor to answer these questions first.

Then from there, the second factor to consider is interest rates. As we said before, interest rates are going up. Yes, there are currently signs that inflation is coming down and the Federal Reserve may slow the rate of interest rate hikes, but generally in 2023, it looks as though we're going to be dealing with a high-interest rate environment—certainly a lot higher than what we've seen over the past few years.

So what does that mean for investors? Well, it actually means quite a bit. Because in the stock market, high interest rates make it harder for businesses to grow. You know, servicing debt becomes more expensive; opening new stores becomes more expensive. This is also coupled with citizens having less discretionary income to spend on goods and services that make up the revenue of these companies we're looking to invest in.

In real estate investing, higher interest rates mean higher mortgage repayments if you have variable rate debts. So suddenly returns drop for investors as more of the rental income goes towards paying interest. Then in terms of the housing market, generally, it's logical that as rates rise, more and more homeowners will be pushed to breaking point and more homes will come onto the market, which increases the supply and puts pressure on prices.

So there are a lot of issues for property nerds as well. But the one asset class that actually does get more enticing as interest rates rise is government bonds. As rates get higher and higher, the coupons on new government bonds also rise. But of course, remember, if rates keep rising after you buy a bond, then the value of your bond will go down as the newly issued bonds with even higher coupons come out.

So that's definitely the second consideration you need to make regarding your investing in 2023: you need to be aware of the effective interest rates on your investments.

So will interest rates keep going up in 2023? It's a logical question. Well, unfortunately, who knows? Because remember, it's all dependent on that inflation rate getting back down to 2 to 3 percent. Jerome Powell and the Fed have said they will keep monetary policy very restrictive until that happens. But how long that takes and how many interest rate hikes are required—that's anyone's guess.

So that's definitely the second consideration. And the third factor we actually need to think about—this one sounds like a contradiction, but I promise it's not. The third consideration is focusing on each individual investment on its merit and not acting based on the macro. So what do I mean here? Yes, it's important to understand what's happening with inflation and interest rates, but because these things are very unknowable or unpredictable, you should always go back to analyzing each individual investment purely based on its fundamentals.

It's like what Peter Lynch said back in this iconic presentation: "Stocks are not lottery tickets." There's a company behind every stock. If the company does well, the stock does well; it's not that complicated. People get too carried away and first of all, they try and predict the stock market. That is a total waste of time. No one can predict the stock market. They try to predict interest rates; if any interest rates right three times in a row, they'd be a billionaire, considering there's not that many billionaires on the planet.

Logic, syllogism in the study—these, when I was at Boston College—they can't be that many people who can break interest rates because there'd be lots of billionaires, and no one can predict the economy, right? A lot of people in this room were around in 1981 and '82 when we had a 20% prime rate, with double-digit inflation and double-digit unemployment. I don't remember anybody telling me in 1981 about it. I didn't read; I studied all this stuff—I don't remember any big time. I got the worst recession since the Depression.

So what I'm trying to tell you is it'd be very useful to know what the stock market is going to do. It'd be terrific to know that the Dow Jones average a year from now would be X, that we're going to have a full-scale recession, or interest rates are going to be 12%. That's useful stuff. You never know it, though; you just don't get to learn it.

So I've always said if you spend 14 minutes a year on economics, you've wasted 12 minutes; and I really believe that. I love that talk by Peter Lynch. It's honestly just a 45-minute investing masterclass. I'll leave it linked in the description if you wanted to check it out. Most of you guys have probably seen it already, but yes, we do need to judge each individual business based on its fundamentals.

Do we understand it? Is there a competitive advantage backed up by the numbers, AKA uninterrupted growth in revenue, earnings per share, free cash flow, equity? Now, is the management doing a good job? Do they keep debts low? Is the return on invested capital high? And then finally, what's the valuation on this business, and are we able to purchase the shares at a discount to intrinsic value?

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So with that said, the third consideration is to focus on the actual underlying business and not the macro. And then from there, the last consideration, which always goes undiscussed, that I have a feeling will be very important in 2023 is temperament. You know, the basic gist of the stock market is to buy low and sell high, right? Well, most people actually do the opposite—they buy high and they sell low. It sounds dumb, right? But it's because of this: when the stock market dips suddenly and the news turns gloomy, people panic, and they often sell at a loss.

This happens all the time, and it's actually how market crashes occur. You know, one wave of selling then scares the next wave of people into selling, which scares the next wave of people into selling, and all of a sudden the stock market crashes horribly. But if you want to be a really successful long-term investor, you need to stay in control of your emotions and not act on them.

Because I'll be honest with you guys: 2023 could be another really tough year for investors. Now, of course, I don't know that, but with inflation and interest rates the way they are, and you know, layoffs happening left, right, and center, it could be another really tough year in the market. You know, maybe not; maybe inflation cools and the Fed lowers rates and we get back on track.

But you know what I'm saying is that you really need to go in prepared for all scenarios, and this gets back to focusing on the long term and only investing money that you don't actually need.

You know, those will be very critical components to investing well in 2023. You have to keep your emotions in check, seize your opportunities, and stay focused on where you'll be in a decade, not where you'll be in six months from now. The stock market could be very volatile next year, and you need to be prepared for that.

I mean, volatility overall is great for long-term value investments; don't get me wrong, I love watching stock prices fly around in the short term. But you do need to train yourself to have the emotional control to not panic, no matter what happens. It's easier said than done, definitely, believe me on that.

It's easier said than done, particularly if you're new to investing. But overall, guys, there you have it—there are four considerations for investing in 2023. Thank you very much for tuning into the video. Leave a like on it if you did enjoy, subscribe to the channel if you'd like to see more. Another quick plug: Seeking Alpha premium, you can check it out down in the description below or in the pinned comment.

But guys, that will do us for today. Thank you very much for watching. I'll see you guys in the next one.