The calendar has barely turned to 2023. Unfortunately, not much has changed for investors. Many of the same issues that affected the markets in 2022 are still in place. In fact, we’ll touch on seven of the biggest financial risks facing investors this year. Of course, all eyes will remain on the Federal Reserve. But that’s just one risk – and it may not even be the most significant risk – for investors. You’ll see several of the other usual suspects on this list as well.
This list is based on the risks that we know about today. You could just as easily add a number eight which would be “The Unknown.” That would encompass a risk that the market doesn’t know about today. The big takeaway is that 2023 will be another interesting year for investors but you shouldn’t be too quick to put away the playbook you were using in 2022.
The Federal Reserve and Interest Rates
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The Federal Reserve has made it clear that interest rates will remain higher than investors would like for longer than investors would like. Still, it seems that institutional investors are still expecting a pivot sometime in 2023. Higher interest rates will weigh on corporate earnings and will also make the cost of borrowing significantly higher. That means that many companies will be judicious with their capital spending. And much of this is still being priced into stock prices.
A more intriguing question for investors is what problem the Fed is trying to solve. The conventional wisdom is that it is looking for clear signals that inflation is easing. To do that, the thinking is that investors will need to see higher unemployment and an interruption in the wage-price spiral. However, the Fed may also be attempting to deflate the asset bubble that is the market itself. In that case, investors should pay close attention to corporate earnings.
A Potential 2023 Recession
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Second, there are fears of a potential recession. By at least one metric (two consecutive quarters of negative gross domestic product) the economy is already in a recession. However, some economists suggest that various metrics, such as strong employment numbers, do not point to an economy being in a recession. I’m not going to attempt to convince you that either side is right. The consensus opinion is that the economy will enter a recession sometime in 2023. But the severity of that recession is open to debate.
In the best-case scenario, it will be a shallow recession meaning it will be less severe and may not last for very long. The worst-case scenario is that the recession will be sharp and last longer than investors are factoring in. Part of the answer will come from the direction of inflation and how that impacts the Federal Reserve’s actions. There is growing concern that global monetary tightening may stoke a more severe recession.
Inflation Could Remain Stubbornly High
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The Dec. producer price index (PPI) number is a hint that inflation is likely to remain stubbornly high in 2023. On Jan. 12 investors will get the first read on the Consumer Price Index (CPI). Since the PPI and CPI showed a strong correlation in 2022, consumers may not be getting relief from inflation anytime soon.
And while some metrics have been a case of bad news being good news, that’s not the case with inflation. One part of the Federal Reserve’s “dual mandate” is to keep inflation at its target level. The Fed says that the target level remains at 2%. So in this case, a CPI number that shows inflation at elevated levels will do nothing to discourage the Federal Reserve from staying the course with higher interest rates.
The consensus opinion of economists is that we are years away from that. Still, there is also a genuine sense that inflation could significantly go down this year which could at least make the Federal Reserve less inclined to raise rates further.
Risks of Stagflation
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For investors of a certain age, the current economic conditions may remind them of a different time, specifically the 1970s. That was a time marked by stagflation. Stagflation is a period of slow economic growth combined with high unemployment and high inflation. So far, in the United States, the unemployment rate remains low. This suggests that the U.S. may avoid stagflation. However, a Deutsche Bank survey from Dec. showed that 62% of the bank’s analysts believe that the risk of stagflation emerging in the United States is high or very high. That was up from 33% in Oct. 2021. And the risks of stagflation were even higher in Europe and the United Kingdom.
Escalation of Russia’s War with Ukraine
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For many Americans, Russia’s war with Ukraine has become like background noise. As many investors remember, the market dropped sharply when Russian troops first invaded the country in Feb. For investors, the good news is that the ramifications of the war are likely already priced in. But one of the biggest financial risks facing investors in the coming year is the threat of an escalation, particularly if the war were to move beyond the borders of Ukraine to NATO nations. Such actions would almost certainly draw the United States and other European nations deeper into the conflict.
That may be a boon for defense stocks. But for the broader economy, this would likely bring on a global recession because of the effect it could have on energy prices. Russia has already cut off the flow of natural gas to 12 European Union countries.
U.S. and China Relations Could Weaken
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Potential flashpoints between the United States and China are numerous. To begin with, many U.S. companies are rethinking their supply chains as China continues to enact strict measures to combat another spike in Covid-19 cases. So far China has been unwilling to accept the United States’ offer of dosages of mRNA vaccines.
However, that’s the tip of a very large iceberg. The potential for China to directly confront Taiwan looms large as it would be likely to draw the United States into a direct military conflict. There is also concern over China’s ties with Russia relative to the Ukraine war. Also, don’t forget, any one of these could reignite the trade war that the Trump administration began with China.
Although there is evidence that companies are rethinking their dependence on China, any significant movement will take years to enact. That makes the two countries’ relationship one of the biggest financial risks facing investors in 2023.
Commodity Prices Could Spike
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When looking at the biggest financial risks facing investors many of these risks are linked to others. That’s the case with commodity prices. The war in Ukraine has affected two of the world’s largest agricultural exporters. This has affected the global grain and fertilizer markets. While the effect in the United States so far is reflected “only” in higher prices, there is greater concern about famine and food insecurity in developing countries.
Add to this the fact that climate change models suggest that extreme weather events will become more common. In 2022 those events took the form of severe droughts and heatwaves in many countries including the United States. And as the holiday winter storm that swept across the U.S. proved, it doesn’t take much to create an environment that could cause a spike in commodity prices.
On the date of publication, Chris Markoch did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.