A 40-year high in inflation, hawkish central banks, Russia’s invasion of Ukraine, tense elections, and the collapse of risk assets are just a few of the events that investors had to deal with in 2022. Some of these dynamics may alter what happens in 2023, while others may be magnified and new ones will appear. The new “new normal” looks a lot different than the past two years, or even the past 20.
Below are some themes that are likely to dominate the investor landscape in 2023.
Recessions Almost Everywhere You Look
The world’s interest rates are rising quickly in an effort to combat inflation, which is reaching multi-decade highs. This is very certain to lead to severe economic contractions, particularly in the US, Europe, and the UK. According to the International Monetary Fund, world growth will decline to 2.7% in 2023, the worst rate since 2001. In 2022, the global GDP is predicted to stay at 3.2%, down from a scorching 6% in 2021 amid the pandemic recovery.
Interest Rates: Higher For Longer
The Federal Reserve increased the federal funds rate six times in 2022—the fastest rate increase on record—from 0% to 0.25% to between 3.75% and 4%.
While the Personal Consumption Expenditures Index’s most recent measurement indicated a 6% annual increase, inflation has slowed in some areas and is still much above the Federal Reserve’s goal rate of roughly 2%.
That indicates that in 2023 we will see more rate increases. The Fed’s terminal rate, or the rate at which hikes will reach their maximum. It is currently higher than 5%. As Fed Chair Powell has said repeatedly, “We still have a ways to go.”
Dollar’s Weight
The strong dollar has been a safe shelter for investors and the bane of many risky assets. As central banks increased interest rates and pressure on bond prices in 2022, investors have held onto the dollar despite a decline in stock prices. The value of the dollar has impacted America’s trading partners as well as American businesses that depend on exports.
Economists say equity investors should hope that this recent decline trend in the dollar value continues. They also added that the dollar may stay strong through at least the first half of 2023 as a result of additional rate increases by central banks and the risk of a recession.
Stagflation
The expectation of stagflation among economists and market observers is growing as rising interest rates gradually reduce persistent high inflation. The economist thinks it is due to weaker GDP. Investors should avoid stagflation, which is marked by persistently high prices in the face of slow growth and rising unemployment.
Japan’s investors are familiar with stagflation as the country had gone through a period known as The Lost Decade, which began in 1991 and lasted three decades. The period was dubbed for the years of slow economic progress in the nation. The last time the American economy experienced stagflation was in the 1970s, when double-digit inflation and an energy shortage plunged the country’s economy into a deep recession and put the stock market into a freefall. The 1970s saw a recovery in the stock market, although overall returns were essentially flat.
Stock Market Expectations
Although investment banks and money managers are now making their own forecasts, it is generally agreed that US equities market returns will be less robust than their current 8-9% yearly average. With rising interest rates, persistently high inflation, and a potential recession as headwinds, Vanguard’s 2023 Economic Outlook anticipates 10-year US equity market returns of between 4.7% and 6.7%.
According to Factset, estimates for the fourth quarter of 2022 and the first half of 2023 have been coming down, and considering the relatively high multiples that currently exist in industries like technology, investors could be in for another nasty surprise.
With short-term bonds, money markets, and even municipal bonds finally offering reasonable returns, investors do have alternatives at last.
Value stocks would likely continue to outperform growth stocks even if a recession occurs in 2023, with staples, financials, healthcare, utilities, and energy sectors leading the pack. They may be responsible for the bulk of the stock market’s returns in 2023 because they are the turtle to growth stocks’ hare.
The good news overall is that coming out of a bear market, the average 12-month gain is 43.4%.
More Geopolitical Uncertainty
The beginning of Russia’s invasion of Ukraine on February 24, 2022, will continue to be a source of worry in 2023 as well. Already, the toll on people and the economy has been catastrophic, and it is impossible to predict how things will turn out. It has also been worrisome that Energy prices have decreased since the spring. However, the rest of the globe has more to worry about than just increasing energy prices as there is no resolution in sight and nuclear threats are coming from the Kremlin.
Energy: A Secular Bull Market
In 2022, energy prices dominated the news and were the main cause of inflation in general. The Russian invasion increased crude oil prices to over $125 per barrel, which caused average gas prices in the US to increase by far over $5 per gallon. Intense price shocks caused power outages, usage restrictions, and other measures as a heat wave spread across Europe, which is highly reliant on natural gas from Russia and Ukraine.
Despite the decline in fossil fuel prices, most commodity analysts believe that this is just the start of a multi-year bull run for commodities. Demand is being fueled by growth-at-all-costs policies in China and India, as well as a global economic recovery. In the midst of the increase, oil corporations like Exxon-Mobil, Occidental, and BP have been making record profits because crude oil prices above $50 per barrel directly affect their bottom lines. It should not be surprising to say that the energy industry had the strongest performance in 2022.
Climate Change
The effects of climate change will be felt all around the world in 2023, regardless of monetary policy or inflation trends. Droughts, wildfires, flooding, hurricanes, and severe freezes plagued 2022 causing tens of billions of dollars in damages, hundreds of thousands of fatalities, and millions of displaced people. Prices for fossil fuels skyrocketed in 2022 as a result of supply shortages and outages for natural gas and crude oil, which were made worse by the conflict in Ukraine. It resulted in less money being invested in climate technologies and renewable energy sources.
At the most recent COP27 summit in Egypt, certain commitments were made, but those were mostly centred on developed economies helping poorer countries pay for damages they suffered as a result of climate change. Effective solutions for climate adaptation and stopping global warming are still pending. This clearly indicates that whatever catastrophes 2023 brings, economies operating will have no control over the planet.