5 Things Investors Can Expect Navigating the Markets in 2023

Kavan Choksi, a successful investor, business management and wealth consultant

The past year has delivered plenty of geopolitical shocks that impacted the investment landscape, including the War in Ukraine, political upheaval in the UK, and protests in China over the country’s zero-Covid policy. Even amid this uncertainty, many of the predicted economic assumptions leading into the year held up. The pandemic-related worker shortage resulted in continued strength in the employment market, coupled with continued supply chain woes. These factors, fueled by a historically low-interest rate environment, ignited inflation. The magnitude of inflation – which reached decades-high rates – may have been difficult to predict, but it certainly did not come as a total surprise.

And while we can’t predict future geopolitical shocks and the precise direction of the economy over the next year, we can assume certain economic realities and forecast a few factors that investors should consider as we enter 2023. Below you’ll find a list of five things investors can expect navigating the markets in 2023.

1. Eroding revenues amid recession

Corporations entered 2022 from a position of strength. The reopening of the economy after the pandemic helped fuel strong revenues and margins. This resulted in one of the fastest economic turnarounds in recent history. As central banks sought to control inflation, the probability of a recession grew. The Fed recently pegged that probability at 50% for the US economy, while the Bank of England has signaled its belief that the UK is most likely on the path to recession.

A recession broadly results in lower corporate earnings. Higher rates have already led to slower growth, and corporate earnings began to decline in earnest in the third quarter. That trend will likely continue into 2023. For investors, it will be important to parse out how well companies manage pricing, control costs and maintain margins in the lower revenue environment. Where companies find growth opportunities will also be important, as borrowing costs will likely remain unattractive. Corporate activity may involve more consolidations, spinoffs, or creative M&A structures rather than leveraged buyouts. Such an environment lends itself to more seasoned, disciplined management teams, so investors should consider the experience and effectiveness of a company’s managers when evaluating how carefully investor capital will be shepherded through a shrinking economy.

2. Signals of inflation and reinflation boosting volatility

The balancing act of rate hikes that central banks are undertaking is unenviable. The real and perceived messages of a rate raise have large economic consequences. Too hawkish of a stance can plunge the economy into a deeper recession than required, while too soft of a stance will allow inflation to fester, creating a long-term economic drag or a possible reignition of higher inflation rates. As these decisions on rates are made, the economy dynamically responds, making decisions more difficult later in the rate hiking cycle.

Central banks have signaled a slowing of rate increases, and inflation is predicted to ease as the rate hikes tamp down growth, but reinflation remains a risk. Supply chains, particularly for oil, remain volatile, and demand isn’t guaranteed to respond to higher rates, particularly as the world is still recovering from the pandemic. The job market remains surprisingly resilient, creating wage inflation risks.

Because of this economic tension, the focus will be on indicators of inflation. It may decline sharply, it may persist through 2023, or we may even see a period of stagflation. Until inflation is well-controlled, it will likely drive higher volatility.

3. Lower household wealth pressuring markets

The effect of inflation is already being felt by households, and consumer confidence is in decline. Interest rates are still increasing for now, and while households can often temporarily delay borrowing for a home or for other large purchases, higher borrowing costs will eventually take a toll on household wealth. Add in potential layoffs, and the typical household is set to bear a high price of a slower economy. 

This may translate into lower amounts set aside for savings and investing, and possible redemptions from retirement accounts. These technical factors may play a role in equity and debt prices outside of corporate fundamentals. Depending on the depth of a possible recession, investors may want to keep an eye on household wealth and net flows into equity and debt markets in 2023.

4. A rebounding China

China’s stringent Covid policies have led to costly lockdowns and recently resulted in widespread protests. Economic growth has deteriorated, and increased unemployment has added to the civil unrest; however, Covid cases are on the rise in China, and vaccinations for its elderly population have lagged. At some point, the government will need to ease Covid restrictions, and it has signaled a willingness to do so, citing the lower fatality rates of recent variants. Opening too quickly will increase the risk of large-scale outbreaks, which may further damage the stalled economy and disrupt global supply chains. Waiting too long may increase protests, which may fuel Covid outbreaks anyway. This uncertainty has rattled markets in the short term. Whether large disease outbreaks delay a rebound or not, eventually China’s economy will move past its zero-Covid policy. Investors will be watching the country in 2023 to see when it resumes its role in creating both global supply and demand, and if such an economic rebound ignites more inflation.

5. An emphasis on value equity

In an environment of slowing growth or economic contraction, investors may wish to seek more downside protection with some hedge against inflation. This is generally when value investing outpaces growth equity. For the ten-year period, the Russell 1000 Growth Index has outperformed the Russell 1000 Value Index, but that trend changed over the last year, as the Russell 1000 Value Index has held up far better than its growth counterpart. Whether the trend continues is speculative, but investors will likely continue to seek the relative safety of value stocks, particularly as interest rates continue to rise. Relative returns for value stocks have generally tracked the level of interest rates. And when revenues come under pressure, the market tends to reward predictable, well-established companies that provide a high degree of revenue visibility and generous dividends. 

The Takeaway

There is plenty of uncertainty, both economically and geopolitically, for investors to chew on as we plan for 2023. While caution is warranted, keep in mind the relative economic strength that ushered us into 2022. The economic cycle is shifting, a certainty given the shift in rate policy, but there remains a large degree of strength in important economic areas, such as margins, low default rates, and low unemployment. While we may not achieve the level of growth we have attained over the last few years, it is possible for investors to reach their financial goals by staying disciplined, avoiding overreacting to short-term noise, and maintaining a long-term view.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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