Just because the calendar has changed doesn’t mean the investment environment has changed. The same issues we had leaving 2022 are still there in 2023, presenting investment risks for investors.
Let’s not sugarcoat it: 2022 has been a tough and painful year.
Stocks suffered as S&P500 fell by about 20%, while Nasdaq fell even more, dropping 33%. Due to the financial power of mega-cap technology, the Nasdaq has generally trailed the S&P 500 lower while showing greater upside potential. This was not the case in 2022.
Additionally, cryptocurrencies were hammered and bonds had one of their worst years on record. In fact, many facets of the bond market had their worst year of performance since 1900.
Although we will eventually get out of this mess, what investment risks are still present?
Investment risks: Recession
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A recession is one of the biggest investment risks heading into 2023. Say what you will about the economy, but if the US were to enter a recession, it wouldn’t just affect the tech industry.
Technology is going through its own recession, but once ad spending, consumer spending, and investment decline, the industry will face another wave of trouble. The consumer has been resilient, but he can only hold out for so long.
Make it a global recession rather than just a national recession, given the strength of the US consumer relative to growth. other consumer-based economies — and the situation is even worse for multinational corporations.
Lower sales tend to equate to lower earnings, and lower earnings equate to lower stock prices.
The good news? The stock market is trending down before the economy is at rock bottom, so we may not be that far off from good news for equities, even if there is a recession.
Investment Risks: Inflation
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If inflation cannot be controlled, it will continue to wreak havoc on the economy. Although prices are falling, there is always a risk that we end up in an environment of ultra-high inflation.
Thankfully, that doesn’t seem to be the trajectory we’re on right now.
However, if inflation remains stubbornly high, it will erode consumers’ purchasing power and keep business costs high. Think about the impact of high fuel costs or logistics costs on consumers, then think about the companies that ship millions of products around the world.
Once again, inflation is falling, but it must stay on the ground so that the next risk on our list stays at bay.
Investment Risks: Interest Rates (and the Federal Reserve)
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I want investors to understand one thing: don’t fight the Fed.
Yes, it is possible for stocks to rally when interest rates are high. Additionally, there are other considerations outside of the Fed in determining whether traders and investors should go long, flat, or short.
However, when the Fed is hawkish, risky assets like stocks tend to perform poorly. The riskier the stock, the less it performs. just look Roku (NASDAQ:ROKU) vs. International Business Machinery (NYSE:IBM) or Apple (NASDAQ:AAPL) vs. PepsiCo (NASDAQ:DYNAMISM).
When we look back over the past 10 to 12 years, the Fed has been dovish for most of those years. That is to say; it was accommodating most of the time.
He tried to change his tune in the third quarter of 2018. By the time December rolled around a few months later, the S&P 500 and Nasdaq had fallen 20% and 23%, respectively. It was an annihilation. Considering the S&P 500 suffered a 27.5% peak-to-trough decline in 2022, and it took about ten months to do so, a 20% three-month decline was brutal.
After leaving again dovish at hawkish last year, stocks paid the price. So the risk is quite simple: if the Fed remains aggressively hawkish, stocks are in trouble.
For now, however, the Fed is expected to raise rates slightly from current levels and then maintain those rates for most of 2023. Let’s see if that’s the case.
dollar strength
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Another of our investment risks to watch is the US dollar. This can be tracked via the US Dollar Index (DXY) or the Invesco DB US Dollar Index Bull Fund (@NYSEARCA:UUP), both of which performed quite well in 2022.
While a strong dollar may be good for travelers when going abroad, it is not good for multinational companies with a global footprint.
The profits of these companies overseas are now worth less, which squeezes profits. And as we discussed earlier, lower earnings tend to equate to lower stock prices, as valuations generally fall.
Volatility
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Finally, keep in mind that volatility remains a major risk for investors this year. The S&P 500 has just had a terrible year. Bonds followed suit as yields, currencies and many other asset classes rebounded.
Volatility in and of itself isn’t necessarily bad, but it can cause investors to make bad decisions driven by emotion.
One way to counter this is to maintain a higher than usual cash position and take smaller positions. If you typically allocate 8% to 10% of your portfolio to a single position, consider a 4% to 5% stake.
If you’re someone who goes all-out on index positions – like the SPDR S&P 500 ETF Trust (@NYSEARCA:TO SPY) – so consider mid-sized positions.
Just be aware that high volatility can create sudden and unexpected moves, and investors should find ways to counter these potential dangers.
As of the date of publication, Bret Kenwell had (neither directly nor indirectly) any position in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com Publication guidelines.
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