This year gave investors just about all we could take: bear markets across the globe that wiped out $22 trillion in wealth, a 40-year high in inflation, hawkish central banks, Russia’s invasion of Ukraine, tense elections, and the collapse of risk assets, to name a few. As we look ahead to 2023, some of these dynamics may change, while others will be amplified, and new ones will emerge. The new “new normal” looks a lot different than the past two years, or even the past 20.
These are some of the themes that are likely to dominate the investor landscape in 2023.
Recessions Almost Everywhere You Look
The rapid rise in interest rates around the world—with the exception of China and Japan—in order to battle inflation at multi-decade highs, is almost certain to cause steep economic contractions, notably in the U.S., Europe, and the U.K. The International Monetary Fund predicts global growth will slow to 2.7% next year, the weakest pace since 2001. Global GDP is expected to remain about 3.2% in 2022, down from a blistering hot 6% in 2021 amid the pandemic recovery.
Recessions are painful for all economies, but particularly so for developing nations that rely heavily on exports. The strong dollar over the past year has already weakened many of those economies, and the rise in interest rates has swollen borrowing costs for their heavy debt levels.
Many CEOs and economists are predicting a recession in the U.S. beginning in early 2023 and lasting through at least the third quarter of the year. The Conference Board forecasts the recession is already underway in the U.S., and says it will extend through at least the first quarter of 2023. More than half of Investopedia readers, according to our most recent survey, expect a recession next year as well. The depth and duration of a U.S. recession is the great unknown, but if there’s a silver lining, it’s that companies and consumers are better capitalized in 2022 than they were in 2008 and 2000 to deal with the downturn.
If the U.S. economy does go into a recession, or if it’s in one already, it would be a highly unusual one considering unemployment, at 3.7%, is historically low, and the Federal Reserve is aggressively raising interest rates. Given those dynamics, sectors that could be the most impacted include high-growth technology and consumer discretionary. Sectors that may benefit include energy, health care, utilities, and financials, provided the downturn is relatively short.
Interest Rates: Higher for Longer
The Federal Reserve has raised the federal funds rate six times in 2022, from 0% to 0.25%, to between 3.75% and 4%, the fastest pace of rate hikes on record. While inflation has cooled in some areas, with the Personal Consumption Expenditures Index’s latest reading showing a 6% annual increase, it’s still a far cry from the Fed’s target rate of about 2%.
That means more rate hikes are coming in the new year. The Fed’s terminal rate—the rate at which the central bank’s increases will peak—is currently higher than 5%. As Fed Chair Powell has said repeatedly, “We still have a ways to go.”
Higher borrowing costs dissuade businesses and consumers from borrowing and spending. If you’re seeking signs of demand destruction, look no further than the U.S. housing market. New and existing sales, building permits, refinancings, and home prices in most cities have been tumbling all year as the 30-year fixed mortgage rate more than doubled since last January. Interest rate increases have also reversed the gains in the auto market as rates on new and used car loans have also more than doubled. Don’t expect those trends to reverse in 2023 until the Fed is done raising interest rates.
The good news about rising rates is that savers and those living on a fixed income are finally getting a return on their money. Money market accounts, CDs, and short-term government bonds are at last delivering real yields to investors and savers, providing some alpha in the face of inflation and a tenuous stock market. These products have had heavy inflows for the past several months, and that’s a trend that’s also likely to continue.
The strong dollar has been a haven for investors and kryptonite for many risk assets. As central banks raised rates and bond prices and yields have remained under pressure this year, investors have clung to the dollar amid a plunge in stock prices. The dollar’s weight has reduced profit at U.S. companies that rely on exports, and punished America’s trading partners. Their trillions of dollars in debt are priced in dollars, after all.
The dollar has come off of its record highs of late, and equity investors should hope that trend continues. If you’re looking for correlation, you’ll find it in the dollar versus stocks and other risky assets. Equities began their dizzying spiral into a bear market this year just as the dollar was strengthening.
However, more rate hikes by central banks and the likelihood of a recession may mean the dollar will remain strong through at least the first half of 2023.
As rising interest rates slowly erode sticky high inflation, more and more economists and market watchers are expecting stagflation because of slower growth. Stagflation, persistently high prices amid slowing growth and rising unemployment, is no friend to investors. Japanese investors know it well. The Lost Decade, named for the country’s years of stagnant economic growth, began in 1991 but actually lasted three decades. The last time the U.S. economy slogged through a stagflationary period was during the 1970s as double-digit inflation and an energy crisis sent the economy into a deep recession, and the stock market into a tailspin. While stocks recovered at the end of the 1970s, returns were effectively flat for the entire decade.
Stock Market Expectations
Investment banks and money managers are forging their predictions as we speak, but the general consensus is that U.S. equity market returns will be more muted than their 8-9% annual average. Vanguard, in its 2023 Economic Outlook, is targeting 10-year U.S. equity market returns of between 4.7% to 6.7% thanks to the headwinds of rising interest rates, stubbornly high inflation, and a possible recession, all of which historically don’t make for smooth sailing in the stock market.
That said, a lot of damage was done in 2022, bringing valuations down to more reasonable levels. The forward P/E ratio for the S&P 500 was about 18 as of Dec. 2nd, down from its 2021 high of 23. But 18 is still historically higher than past bear markets. Bear markets typically last about 300 days, and the average drawdown is 36%. This current bear market is now nine months old, and the trough reached back in October was 25%. Historically speaking, it could fall further and last several months longer, especially if a recession is coming.
Estimates for fourth-quarter 2022 earnings and the first half of 2023 have been coming down, according to Factset, and given relatively high multiples that still exist in sectors such as tech, investors might be in for another rude awakening. With short-term bonds, money markets, and even municipal bonds finally offering reasonable returns, investors do have alternatives at last.
If 2023 brings a recession, value stocks will probably keep outperforming growth, with staples, financials, health care, utilities, and energy leading the way. They are the tortoise to the growth stock’s hare, and they may carry the load of the stock market’s returns in 2023.
The good news overall is that coming out of a bear market, the average 12-month gain is 43.4%.
More Geopolitical Uncertainty
Russia’s invasion of Ukraine, which began on Feb. 24, 2022, will still be a hot spot of uncertainty in the new year. The human and economic toll has been devastating already, and the end game couldn’t be more unclear. From an economic standpoint, energy prices have subsided since this spring, right after the invasion, and are actually trading lower than they were before it began. But with no resolution in sight and nuclear threats coming from the Kremlin, the rest of the world has more than higher energy prices to fear.
U.S.-China relations remain tense, as usual, and China is wrestling with a Zero-Covid policy that’s sparked political unrest and economic disruptions across the country. Given China’s key role as the planet’s second-largest economy, its relations with the U.S. and how the nation navigates wave after wave of Covid cases make 2023 a critical year for the economic powerhouse and everyone who does business with it.
Other global hotspots include Taiwan, and its relationship with China, as well as long-simmering tension between India and Pakistan.
Energy - A Secular Bull Market
Energy prices dominated headlines in 2022 and were the principal driver of overall inflation. Russia’s invasion drove crude oil prices north of $125 a barrel, which pushed average gas prices up well over $5 per gallon in the U.S. Europe, which relies heavily on natural gas from Russia and Ukraine, experienced intense price shocks that led to power outages, usage limits, and other measures as a heat wave swept the continent.
While prices for fossil fuels have abated, most commodity-watchers say this is only the beginning of a multi-year bull market for commodities. The growth-at-all-costs agendas in China and India are fueling demand, as did an economic recovery in developed countries. Oil companies like Exxon-Mobil, Occidental, and BP have been enjoying record profits amid the surge, as prices anywhere above $50 per barrel for crude oil go right to their bottom lines. It should come as no surprise that energy was the best-performing sector in 2022, by a lot.
No matter what happens with monetary policy or inflation in 2023, the impact of climate change will be felt across the globe. This year was beset by droughts, wildfires, flooding, hurricanes, and deep freezes that killed hundreds of thousands of people, displaced millions, and cost tens of billions of dollars in damages. Supply shortages and outages for natural gas and crude oil, compounded by war in Ukraine, sent fossil fuel prices soaring in 2022, which meant that less money flowed into renewable solutions and climate technology.
Some promises were made at the recent COP27 summit in Egypt, but those were mostly centered around developed economies helping poorer countries pay for damages they suffered as a result of climate change. Climate adaptation and the reversal of global warming have yet to be addressed in meaningful ways. That means the planet and all the economies operating within it are at the mercy of whatever disasters may be lurking in 2023.
The Inflation Reduction Act of 2022—really a climate bill disguised as an inflation-fighting tool—pledged more than $300 billion in new spending toward fossil fuel alternatives, but they will take a long time to develop, which gives the commodity bulls even more room to run in 2023.
Will the Crypto Winter Continue?
2022 has been an abject disaster for cryptocurrency investors. A bear market in all risk assets put crypto assets into a deep freeze and sent Bitcoin, the most widely held of all, down 70% from its highs. Bankruptcies and exchange-runs at crypto brokers such as FTX, BlockFi, and Celsius Networks evaporated billions of dollars in customer accounts and breached a massive hole in investor trust in the overall crypto market.
Regulators have been circling around crypto brokers for a few years, but the recent collapse of several exchanges may prompt the SEC and the CFTC to hasten their attempts to put guardrails on the industry in 2023. European regulators have already announced their intention to do so.
It’s hard to say what impact that might have on crypto prices, but those have been much more subject to terrible headlines that seem to be increasing in frequency lately. That said, money managers such as Fidelity are still moving forward with plans to provide custody services to clients for digital assets. If Fidelity and others can help restore trust in the industry, investors may warm back up to the volatile asset class.