The war in Ukraine has disrupted global supply chains, added to a global inflationary shock, and forced a rethink of energy security. (UBS)

Although equities have already fallen significantly in absolute terms, we don't think risk asset valuations reflect a “bear case” scenario. With that in mind, we spotlight several key policy risks investors will need to consider this year.

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.
  • Accidental escalation is a risk too—a stray missile strike on Poland's border in November led to talk of NATO Article 4.
  • Winter weather has hindered front-line fighting, though a deadly strike on a Russian barracks and Russia-Belarus joint training show risks remain elevated.

Geopolitical and domestic risks centered on China.

  • President Xi’s consolidation of power last year raised investor concerns over mainland China's reopening, 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 in 2023.
  • The 2019 Fed balance sheet rundown caused an undue tightening of USD funding conditions. We will monitor similar risks in 2023.
  • Rebel Republican influence on the US House may set up a partisan showdown over the federal budget and debt ceiling, which may affect markets.

Did you know?

  • 55% of investors we polled ranked geopolitical risk as a top concern in 4Q22, according to a 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, in our view.
  • Watch our Deep Dive videos on defensives and value and the era of security

Investment view

We suggest a defensive positioning, like healthcare and consumer staple stocks, or capital protection strategies. Selective hedge fund exposure could also help insulate portfolios, while energy exposure could 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?, 9 January 2023.