A trader works on the floor of the New York Stock Exchange (NYSE) in New York, August 29, 2022.
Brendan McDermid | Reuters
After a tumultuous year for the financial markets, Standard charter outlined a number of potential surprises for 2023 that he says are “undervalued” by the market.
Eric Robertson, the bank’s chief research officer and chief strategist, said outsized market moves are likely to continue into next year, even as risks diminish and sentiment improves. He warned investors to prepare for “another year of rattling nerves and rattling brains.”
The biggest surprise of all, according to Robertson, would be a return to “more supportive economic and financial market conditions,” with consensus pointing to a global recession and further asset class turmoil next year.
As such, he named eight potential market surprises that have a “non-zero probability” of occurring in 2023, which lie “materially outside the market consensus” or the bank’s own baseline views, but are “undervalued by the markets”.
Fall in oil prices
Oil prices surged in the first half of 2022 due to ongoing supply bottlenecks and Russia’s invasion of Ukraine, and remained volatile throughout the year. They fell 35% between June 14 and November 28, as OPEC+ production cuts and hopes of an economic recovery in China prevented the slide from accelerating further.
However, Robertson suggested that a deeper-than-expected global recession, including a delayed Chinese recovery following an unexpected rise in Covid-19 cases, could lead to a “significant collapse in oil demand” in even previously resilient economies in 2023. .
If a resolution to the Russian-Ukrainian conflict occurs, it would remove “war-related risk premiums” — the extra rate of return investors can expect to take on more risk — from oil, causing prices to shed around 50% of their value in the first half of 2023, according to Robertson’s list of “potential surprises”.
“With rapidly falling oil prices, Russia is unable to fund its military activities beyond the first quarter of 2023 and agrees to a ceasefire. Although peace negotiations drag on, the end of the war makes completely disappear the risk premium that had supported energy prices,” Robertson speculated.
“Military conflict risk had helped keep front-end contract prices high relative to forward contracts, but lower risk premia and the end of the war see the oil curve invert in Q1-2023.”
In this potential scenario, the collapse in oil prices would take international benchmark Brent from its current level of around $79 a barrel to just $40 a barrel, its lowest point since the peak of the pandemic.
The Fed cuts by 200 basis points
The central bank’s main story in 2022 was the US Federal Reserve’s underestimation of price inflation and Chairman Jerome Powell’s mea culpa that inflation was not, in fact, “transient.”
The Fed then raised its short-term borrowing rate from a target range of 0.25%-0.5% at the start of the year to 3.75%-4% in November, with a further hike expected during of its December meeting. The market expects a possible peak of around 5%.
Robertson said a potential risk for next year is that the Federal Open Market Committee is now underestimating the economic damage inflicted by the massive interest rate hikes of 2023.
If the US economy fell into a deep recession in the first half of the year, the central bank could be forced to cut rates by up to 200 basis points, according to Robertson’s list of “potential surprises”.
“The narrative in 2023 is rapidly changing as the cracks in the foundation spread from the most indebted sectors of the economy to the most stable,” he added.
“The FOMC’s message also quickly shifts from the need to maintain tight monetary conditions for an extended period to the need to provide liquidity to avoid a major hard landing.”
Tech stocks fall even further
Growth-oriented tech stocks have suffered a hammer blow during 2022 as the sharp rise in interest rates has raised the cost of capital.
But Standard Chartered says the sector could have even more fall in 2023.
The Nasdaq 100 closed Monday down more than 29% year-to-date, although a 15% rally between Oct. 13 and Dec. 1 amid easing inflation helped cushion annual losses.
On his list of potential surprises for 2023, Robertson said the index could drop another 50% to 6,000.
“The tech sector globally continues to suffer in 2023, weighed down by falling demand for hardware, software and semiconductors,” he speculated.
“Furthermore, rising funding costs and shrinking liquidity are leading to a collapse in private corporate funding, leading to further significant valuation declines in the sector, as well as a wave of job losses.”
Next-generation technology companies could then see an increase in bankruptcies in 2023, reducing the market capitalization share of these companies on the market. S&P500 from 29.5% at its peak to 20% at the end of the year, according to Robertson.
“The tech sector’s dominance in the S&P 500 is also dragging down the broader equity index,” he suggested, adding, “The tech sector is leading a global stock meltdown.”
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