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January 30, 2024
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5 Things Investors Should be Aware of for 2023
Wading through inflation, recession, opportunities, and uncertainties
The pandemic, war in Ukraine, US-China tension, and myriads of other geopolitical events are shaping the trajectory of the market in the year ahead, and it’s something like never before seen.
Prepare to change your strategy as you go and be sure to keep your eyes glued on a few things!
Key Takeaways:
- Inflation will slow down, but will most likely remain above the 2% mark.
- Long-term assets may be affected by inflation.
- A recession is likely to occur, which may bring down corporate earnings along with investors’ profits.
- A volatile market is here to stay, and prudent investors must seek to adjust their strategy to the new normal.
- Deglobalization may be more rampant, which may cause increased production costs. Investors must be careful while investing in sensitive sectors.
- Geopolitical instability will spill into the market. Investors should be aware and prepared for any developments in the geopolitical realm.
- A market valuation reset can be a fresh start for investors that seek steady growth. Until the market value is finished adjusting, investors must be really careful about which basket to put their eggs in.
1. Inflation
Inflation is a situation where there is an increase in price while purchasing value of money decreases. A most commonly heard analogy is where USD100 you have tomorrow may not buy as many groceries as you can with USD100 today.
Currently, the global inflation rate for 2022 compared to the previous year as reported by Statista, is at 7.4%. To put things into perspective, during the 2008 global financial crisis, the global inflation rate was only 6.33%. This has been a worry among many financial experts.
In response to this worrying trend, central banks have been taking the approach of hiking interest rates in the hope that the economy will slow down, thus pushing down inflation back to where it used to be. The question is, will it go back to where it used to be?
Unfortunately, many experts don’t think so. Wei Li, Global Chief Investment Strategist at BlackRock (NYSE:BLK) is of the opinion that there is good and bad news — depending on where you stand.
The good news is that inflation is expected to go down as a response to the many measures that have been done by the central banks. The not-so-good news, however, is that inflation will not go down to the 2% point as hoped for by many, and the market will have to be accustomed to navigating this new landscape.
The same concern has been echoed by a well-known economist, Mohamed El-Erian, whereby Fortune reported that El-Erian describes “sticky inflation” as the situation that the world may face.
Sticky inflation is a concoction of high inflation that doesn’t want to go down and slow economic growth. It’s a pint of bitterness to everyone involved with the market.
Having said that, what would this entail? Well, a lot, but most notably investments in long-term bonds might be taking a hit as a larger chunk of your returns will be ‘severed’ due to inflation.
Now, let’s break it down a bit — if you’re purchasing a bond, the profit that is expected on paper is what you’d call a “nominal return”. Of course, the real value that you’d get is not that, you’ll have to consider inflation out of your nominal value to get your real value (“real return”).
Here’s the formula:
Real Return = Nominal Return — Inflation
Alright, we’ll break it down using a much simpler analogy. But take note that this example is purely fiction, only serving its purpose to clarify the concept.
Say, you have USD 100 and you aim to have USD 102 in a year to buy a collectors’ item, and for whatever reason that is — you can’t seem to find a way of earning USD 2 other than through purchasing a bond. As you’re purchasing the bond, the ‘profit’ that you’re supposed to gain is at USD 2 (nominal return) — Perfect!
A year later, however, you figured out that the collector item price rose to USD 105.6 as the inflation rate was at 3%. Now, you’re USD 3.6 short (real return) off your target compared to a year ago when you were only USD 2 short.
Thus, investors might want to consider all the available factors before considering long-term bonds as their portfolio risk-balancing mechanism.
Of course, many factors can affect the bond market and its profitability, and it’s very much too simplistic to decide based on one or two factors. Thus, it is prudent for you to do your own research before taking any investment actions ahead.
Nonetheless, bond yield might be seeing the potential to rise in 2023, whereby some speculated that core bonds might be an interesting investment of this type. Relatively speaking, a bond may be less risky compared to equity. thus, putting it in the limelight in 2023.
2. Recession
Recession is bad news for all, and the aftermath is still ingrained in many even after around 14 years of the last major recession the world has seen.
Recession is a state where trade and economic activities are hampered, i.e., a state of economic decline most famously known for its ruthlessness. Many were laid off, put through economic misery, and thrown down the poverty trap.
Interestingly, a research found that during the previous Great Recession in the US, there is an increased amount of working-age adults who lost their lives due to overdose on prescription drugs. Recession is definitely not a beautiful scene, yet many now are foretelling its arrival.
A domino effect — as one can describe, the recession that may come is the product of inflation that has been discussed before. In managing inflation, central banks have been deliberately trying to cause a recession, so that when the market slows down, demands will reduce thus bringing down inflation.
According to BlackRock (NYSE:BLK), there would be a possibility that interest hikes will stop as the damage from recession starts to materialize. If this happens, the price of bonds might increase due to higher demand while inflation is still looming high, thus creating a situation that may be damaging to those that seek to profit from long-term bond yields.
Apart from that, Bloomberg in September this year expected that if a recession is to occur while inflation remains sticky, downturn risk for stocks may also be higher for investors out there.
As recession hits, economic growth will definitely slow down the economy, and corporations as well as consumers are expected to be more frugal with their spending which would most likely result in lower corporate earnings. When corporate earnings shrink, the amount that trickles down would also most probably shrink.
3. Volatility
With everything that is going on — the war, pandemic, unemployment, trade barriers – the macroeconomic scene and the market have seen a volatile environment and as the doldrums are not looking forward to calming down anytime soon, many expect that the turmoil will still make its way through to 2023.
Although it may not seem like it, the world has been going through a moderate period of relative stability where growth and inflation move at a pace that experts and observers can make almost-accurate predictions on what’s coming.
The worst part of this all is, this may no longer be something that the central banks can simply overcome. The cause for the rapid ups and downs in the market this time is constraints on production. Production is an important variable that will determine how the market will go.
Sadly enough, the causes of current disturbances are not internal. We can see how the war in Ukraine, for example, halted the export of wheat and energy, which later caused many bakeries in Germany to shut down or file for bankruptcy due to the rising cost of wheat and energy price.
In the same way that Germany cannot make Ukraine export wheat again, central banks are also unable to make sure production disruptions are controlled. The most central banks can do is by hiking up interest rates to curb demand and inflation.
What would a volatile market means to investors in general, is that their ‘cocktail’ of stocks now is moving at a rapid pace, whereby first — wrong decisions will most likely cost you more, and second — you will have to endure more volatility to get the same profit as you used to get before.
The kind of stocks you buy must also suit your plan. For example, if you seek to incubate your investments for a long period of time, investing in a more volatile market, such as the equity market may be suitable for you, since the price may rise and fall over a short term, but if you do your research right, you may find some stocks are actually soaring over time.
What it means to more advanced traders is that in evaluating the market, one must factor in whether these volatile variables such as inflation, market price, etc. have taken into account the ‘damage’ that the volatility has caused to the market.
Sometimes companies are slow to adjust their reports and earnings in accordance with how the market is actually doing. Thus, it is important for you to take the necessary evaluations before taking in any stocks.
4. Deglobalization
Deglobalization is also a major trend that investors should be cautious of. Given the current state of geopolitics that the world is in right now, major military and economic clashes are something that many experts expect to occur in the year to come.
Due to this, countries are growing more hostile about the prospect of having ‘foreign hands’ meddling within production or services which is of strategic interest to them.
Apart from that, the pandemic has also brought a sudden realization to policymakers on how outsourcing productions to other countries may be catastrophic once unforeseen events halt the supply chain — simply put, they are starting to realize it may not be a good idea to put their fortune at the hands of others.
For example, China’s Zero-COVID policy recently has led to a massive lockdown, halting production and consumption alike, as well as the closure of ports, leading to unrest among global traders that rely on shipments to or from China.
Adding more salt to the wound, the war in Ukraine has also worsened the fear among countries on relying too much of their supply requirements externally, whereby many countries are currently feeling the losses from Ukraine’s wheat supply.
Germany, for example, is at a crossroads between going against the Russian occupation of Ukraine while at the same time being heavily reliant on energy imports from Russia.
As a response to this, many are looking forward to bringing back production to their own country.
The US Defense Advanced Research Project Agency (DARPA) has launched an initiative to open a contract for a project called Next-Generation Microelectronics Manufacturing (NGMM), a project which seeks to create an ecosystem that allows the process of manufacturing important electronic components like microchips in the US.
This project aims to minimize the country’s exposure to the risk of supply chain disruption if such electronics are to be manufactured and developed elsewhere.
“For U.S. armed forces, supply chain disruptions threaten the ability to maintain technological superiority in an increasingly competitive environment.”
5. Geopolitical scene
The war in Ukraine raised tensions between the eastern and western blocs, with Russia and China seeking to reconsider US’ dominance in the market and global order.
If that is not enough, other major conflicts are also brewing such as the US-Iran tension, the South Korea-North Korea conflict (which may require US intervention), and the China-Taiwan conflict (which also may lead to US intervention).
As of now, the fuel of discontent is flowing, awaiting for sparks to turn it into a wildfire. Investors seeking to invest in the US market must make themselves familiar with global conflicts that are related either directly or not directly to the US, which is easier said than done, considering the fact that the US is almost somewhat always involved in global conflicts.
Despite that, the most important geopolitical relationship that investors must keep themselves updated on is the US-China relationship. This is due to the fact that China is one of the largest trade partners to the US, recording a whopping $559.2 billion (two-way) goods traded in the year 2020.
Tech firms such as Apple (NASDAQ:AAPL), Dell Computer (NASDAQ:DELL), and Texas Instruments (NASDAQ:TXN) are also considering China as an important part of their business, with Apple (NASDAQ:AAPL) acknowledging that China recorded the third largest global sales in 2019.
What geopolitical rifts such as trade wars between the US and China would mean to the market is there would be a great disturbance to corporate revenue, thus affecting investors.
For example, when the news got out that US President Joe Biden will impose bans on the export of certain high-tech chips to China, tech firms like Intel (NASDAQ:INTC), saw their stocks tanked by 8% when the market opened.
Why did Biden decide to call off the chip exports to China? For geopolitical reasons, some call it a move to ‘choke’ China’s technological development, especially in terms of surveillance and military techs. This is said to give the US a bit more advantage in the race.
Thus, what an unstable geopolitical scene would entail is that the market would be much more vulnerable to any events that may occur. This is where investors must be prudent to keep themselves abreast of the current news and any possible cataclysmic events like a trade war or even an actual war that may affect the stocks that they are putting their money on.
Of course, conflicts can be bad for the market at large, but wherever there’s a loser, there will always be some winners. Lockheed Martin (NYSE:LMT), one of the biggest weapon manufacturers in the US, recorded a jump on their opening price of $458.53, just five days after Russia launched its attack on Russia, whereas, on the day of the attack itself, the stock’s closing price was only at $395.71.
In 2023, investors will have to shift their strategy from focusing on seeking long-term profit into a method where long-term profit-seeking is still viable, but only when paired with keen eyes on the possibilities that external factors may meddle with said investments. In simpler words, be agile for unexpected circumstances.
Bonus Point: Market valuation reset
There is a silver lining to each crisis. Despite the unfavorable sight of stock prices falling, many are considering this a revaluation of the market, whereby yields per stock are expected to actually increase.
What this essentially means is nearly close to what is called ‘buying the dip’, but not in the way that it used to be. Before this, buying the dip works for companies with promising performance or price growth projections.
In this situation, the whole market is dipping, and the focus that investors should give is to see when will the equity market valuation reach its ‘stability’, a point where the market is ready to grow again with whatever it got. This will then give investors a good point to jump in and sow their prospects of growth.
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