Stay prepared for the unexpected in 2023

It is said that a good story should have a beginning, a middle and an end. But economic reality is far more complex, narratives that began in 2022 remain unresolved at the outset of 2023 and there are sure to be more unpredictable plot-twists yet to come.

We have just experienced a year of incredible unpredictability: in January 2022, you would have been hard-pressed to find anyone predicting double-digit inflation by the end of the year. Back in January, tensions were mounting on Ukraine’s eastern border, the economy was tentatively anticipating a continuation of the post-Covid recovery and the best advice for 2022 was to prepare for the unexpected. And, without wanting to sound like a broken record, the wisest approach to 2023 is: prepare for the unexpected. That is because, while 2022 was certainly eventful, the inflection points that precipitated those events remain unresolved. 

China’s commitment to a Covid-zero strategy seemed prudent in 2020, but it left the world’s most populous nation painted into a corner by the start of 2022, its economy hamstrung by the inability to open-up its borders. Continuing Chinese lockdowns were seen as one of the biggest threats this time last year, yet their impact has been more limited than many feared. But if that situation was a source of uncertainty, China’s sudden reversal of strategy – forced by internal pressure, rather than external economic factors – appears to be an even bigger gamble. Increased infection rates are liable to impact Chinese industrial output and the imminent Lunar New Year, during which hundreds of millions of people will travel to celebrate with their families, could see a further surge in cases. Furthermore, opaque reporting of the impact of abandoning the Covid-zero policy is leading to caution and distrust; multiple countries have rushed to put in place restrictions on travellers arriving from China, in an ominous echo of the early days of the pandemic. 

For many in Europe, the shock that came to define 2022 was Russia’s illegal invasion of Ukraine. Looking back to predictions made last January, opinion was split over whether a full-scale invasion was really on the cards. The massing of Russian troops on Ukraine’s border seemed like a pretty unambiguous signal, yet some reasoned that an invasion was too great an economic risk for Russia. Others pointed out that the spring thaw would make manoeuvring heavy weapons impossible within weeks. These predictions were accurate, but the outcomes unexpected nonetheless: the spring thaw came, but Russia invaded anyway. As a consequence, the conflict, which was expected to be short and decisive, has become a long, brutal war of attrition. It has led to shifts in global alliances as the belligerents attempt to shore-up their economies. The invasion is another source of unpredictability that remains unresolved as we enter 2023. Its economic impact has reached far beyond Russia’s borders in the form of pressure on energy prices, the knock-on effects of which you will already be familiar with.

However, oil prices have dropped from a high-point well above $100 in the summer of 2022, falling below $80 at times during December. Inflation is still hundreds of percentage points above central banks’ monetary stability targets but falling energy costs could help bring the situation under control. Meanwhile, pressure from consumers is setting a natural limit on price rises: manufacturers and retailers have had two years of blaming pandemic-related supply chain issues for price rises, but this excuse no-longer washes with many consumers who recognise that mitigation efforts during the Covid-19 pandemic have created overcapacity and greater resilience in supply chains.

There was one prediction frequently made in 2022 that was deferred over and over again: while we are undoubtedly experiencing an economic slump, the much-anticipated global recession is yet to materialise. In 2023, there are signs that it may be avoided altogether. In the US, a competitive labour market is putting upward pressure on wages, which could encourage greater consumption and reduce the risk of recession. Europe’s dependence on Russian gas puts it in a weaker position, but recession is far from inevitable and there is growing expectation that any recession is likely to be brief.

In part, this is down to the problem of defining what really constitutes a recession. On the face of it, this seems like a needless semantic quibble, but it gets to the heart of how investors should build their investment strategy in 2023: not based on arbitrary measures such as the “two consecutive quarters of negative growth” definition of a recession, but in anticipation of how economic reality is likely to impact the areas in which they’re investing.

I have only discussed the biggest known, unresolved sources of volatility, but the main takeaway is that even when events occur exactly when they have been predicted to occur, their impacts can still be uncertain and their long-term consequences unresolved. Energy prices, supply chain disruption, inflation, war, climate emergency and public health will, of course, have different and difficult to predict impacts on each part of the economy. As ever, keeping a diverse range of investments is a proven method of protecting against these variables. And investors taking a long-term view may want to explore sustainability and ESG-focused investments, which could become the safe-haven investments of the future.

Are energy, supply chains, inflation and recession worth focusing on? They are. But don’t forget that expectations of long-term inflation and recession have been in the positionings market for some time now. And in the face of falling growth, whether it formally qualifies as a recession or not, there is the long-standing advice to engage in defensive, non-cyclical sectors. However, it may be worth not just buying into non-cyclical sectors but acting anti-cyclically in the first place. Investors with sufficient risk appetite and risk-bearing capacity may explore short-term opportunities via leveraged products in order to adequately benefit from price fluctuations in an environment of continued volatility. The outcome of either approach will depend upon whether the current downturn is followed by a sharp rebound, or long and slow path to recovery.