Although equities have already fallen a lot in absolute terms, we don't think risk asset valuations reflect a “bear case” scenario. With that in mind, we see several key policy risks investors will need to factor into their portfolios in 2023.
Escalation risks for the Russia-Ukraine war.
• The war in Ukraine has disrupted global supply chains, added to a global inflationary shock, and forced a rethink of energy security.
• A nuclear escalation is a remote tail risk, but repeated public US warnings to Russia suggest credible concerns.
• Accidental escalation is a risk too—a stray missile strike on Poland's border in November led to talk of NATO Article 4.
Geopolitical and domestic risks centered on China.
• President Xi’s consolidation of power has raised investor concerns over zero-COVID and reopening, the prioritization of economic growth, and the role of the private sector.
• US-China relations face unresolved disputes over advanced technology export controls, market access, the response to the Russia-Ukraine war, and more.
• Taiwan remains a flashpoint—with implications for chip production and funding, supply chains, national security and trade policy.
Risks of government and central bank policy missteps.
• Disruptions in the UK’s gilt market and pound in 2022 might be a forerunner of financial instability in other markets next year.
• The 2019 Fed balance sheet rundown caused undue tightening of dollar funding conditions. We monitor similar risks for 2023.
• A Republican House and a Democratic Senate are a likely set up for a partisan showdown over the federal budget and debt ceiling in mid-2023, which could affect markets.
Did you know?
• 55% of investors we polled rank geopolitical risk as a top concern, according to the November UBS investor sentiment survey.
• Rather than disengaging from markets and sacrificing long-term returns, we recommend adding hedges and exposure to the more defensive parts of the equity market to reduce portfolio volatility.
• Healthcare stocks tend to be less sensitive to economic fluctuations, offering some defensive characteristics within equities. Safe-haven currencies like the USD and the Swiss franc should offer some resilience, too.
• Watch our Deep Dive videos on defensives and value, the era of security, and safe-haven currencies
We suggest defensive positioning, like healthcare and consumer staple stocks, safe-haven currencies, or capital protection strategies. Selective hedge funds exposure can also help insulate portfolios, while energy exposure can hedge some geopolitical risks.
Main contributors - Jon Gordon, Vincent Heaney
Content is a product of the Chief Investment Office (CIO).
Original report - What risks might derail markets in 2023?, 29 November 2022.