What to Watch in 2023
As is our custom, we say goodbye to each year with a glance back and a look ahead. In what follows, we briefly revisit our 2021 year-end calls for 2022 and evaluate how well or poorly we did, and then take a deeper dive into key themes for the world economy and financial markets for 2023. Our aim is to provoke thinking and debate, and we welcome your feedback.
Looking back at 2022
This time last year, we offered five forecasts for 2022.1 We got a couple right and a few dead wrong. Here’s a summary.
The first forecast we nailed was that 2022 would see a surge in demand for electronic vehicles (EVs), with worldwide EV sales topping total automobile output of General Motors. Already in the first half of 2022, global sales of electric vehicles rose to 4.3 million units, nearly double GM’s half-year car production of 2.8 million.2 That’s testimony to the technology that is making EVs viable forms of transportation, as well as the subsidies and tax breaks that make them increasingly affordable.
Our second successful prognosis was the collapse of cryptocurrency prices. We felt the market value of cryptocurrencies would tumble 20% in 20223 as hype about digital money cooled off. In the end, we were too cautious. Based on our calculations, cryptocurrencies lost roughly 60% of their value in the past twelve months.4
Lest we gloat, we got clobbered on two forecasts. We thought US core personal consumption expenditures inflation would drop below 3% by the end of 2022. Inflation proved to be much stickier than we thought and will probably finish the year above 5%. We also thought that declining inflation would push stock markets up 20% this year. Major stock indexes are likely to finish 2022 more than 10% in the red.
Finally, on one 2022 forecast, the jury remains out. We said a year ago that “sustainable assets” (i.e., those managed according to Environmental, Social and Governance [ESG] criteria) would increase from one third to 40% of US assets under management. While it does appear that ESG investing continues to expand, the data we need to validate our view remains unavailable at the time of publication.
Looking ahead to 2023
So much for last year’s picks. What are we willing to stick our necks out for in 2023?
To begin, we will make a slight departure from last year’s approach. While we normally want to have a benchmark to measure our forecasting successes and failures, we also feel it is important to highlight key themes that will occupy investors over the next 12 months (or longer). Our choices for 2023 are therefore more thematic in nature.
But trust us. We will fairly judge what we get right and wrong this time next year. We are not shy about claiming success or admitting failure.
Blockchain goes mainstream
Our first 2023 forecast is that the proponents of blockchain financial technology will seek regulatory frameworks under which they can offer their innovations. That outcome seems increasingly likely given the November 2022 implosion of the FTX exchange.
Regulation of blockchain finance was always probably going to happen. After all, regulation of financial markets is a fact of life. Quasi-libertarian ideals for a parallel set of unregulated and unsupervised currencies, assets and securities have always been fanciful.
Financial regulation is burdensome, and one can openly question whether in some cases it may be excessive, but at the heart of all finance—old and new—reside asymmetries of information and misalignments of incentives that, if left unchecked, impair the functioning of financial markets, and stunt their growth. Regulation enhances trust between the providers and users of financial services. In that regard, proper regulation enables the financial services industry to reach its potential.
Blockchain finance, in all its forms, has begun to recognize that regulation is a step toward its broader adoption, a step that we feel most of the industry will make in 2023.
Balanced bounces back
2022 was a dreadful year for so-called “balanced” portfolios comprised of stocks and bonds. High inflation undermined both asset classes via rising interest rates and soaring risk premiums.
But no investment strategy can be judged, much less discarded, based on one year’s performance. That is particularly true if—as we believe—the 2021-2022 inflation surge proves to be temporary. Already tighter monetary policies are slowing growth and cooling price pressures. Bond yields have tumbled nearly a full percentage point from their cyclical peaks. Expected rates of inflation are receding and ought to decline in the course of 2023 toward the norms of the past two decades.
Bond returns are already improving. But it will likely take longer for stock markets to find their footing. After all, weaker economic growth also implies weaker profits, for which stock market analysts and investors may not yet be fully prepared.
But the key point is this: as inflation falls back toward central bank desired levels, bonds will provide ballast in portfolios, diversifying the risk of a possible profits’ recession. Once equity market valuations more appropriately discount future profits growth, we believe both stocks and bonds will likely offer attractive returns. We think those preconditions will fall into place by mid-2023. “Be balanced” is a key theme for 2023.
A new-new normal
Prior the pandemic, the “new normal” described a world of moderate growth, low inflation and low interest rates. The successful restoration of inflation from its 2022 highs, however, will not result in a restoration of the “new normal.” Rather, a “new-new normal” is likely to emerge.
Some things may look similar. Inflation will likely recede to more desirable levels, drawing interest rates down. But recessions in the United States, the United Kingdom, the European Union, perhaps Japan, and many emerging markets are likely to mark the first half of 2023. Downturns already underway in capital expenditures, housing, construction and many goods-producing industries are foreshadowing that outcome.
But the new-new normal will exist beyond a brief period of recession. Aging societies, falling labor-force participation rates, and the growth of informal employment in the gig and hybrid-work sectors will be become durable hallmarks of the new-new normal. Skills shortages will continue to push up real wages for some workers. Worker shortages will spawn innovation and investment in labor-saving technologies. We believe those trends will extend well beyond 2023—they will become decade-long stories.
Other trends will emerge next year. For example, large gaps between median household income and housing affordability are likely to postpone the ability of younger generations to get on the housing ladder. Technological advances in communications and remote working, together with shifting attitudes about leisure and environmental awareness, will further erode conventional approaches to work, commuting and living. Pandemic changes in workplace attitudes and lifestyles are not reverting to the status quo ante.
But perhaps the biggest challenge of the new-new normal resides in the paucity of productivity. There is perhaps no greater irony of our age than the observation that we live in an era of staggering innovation and yet wretched productivity growth. According to the US Bureau of Labor Statistics, in years from 2007-2019, the United States experienced the weakest period of nonfarm productivity growth since the 1970s, and the second-worst such period since the end of World War II.5 Given an aging population and stunted labor-force participation, restoring productivity growth has become the single greatest economic challenge this decade for the United States (and for most developed countries).
China searches for a new way
Our fourth theme for 2023 regards China. In China, too, there is no return to the old new normal. In the four decades since 1980, burgeoning trade and investment engagements with the rest of the world drove China’s rapid ascent, but are unlikely to be as successful in the future. Beset by domestic indebtedness, confronted by a global populist backlash against its exports and skepticism about its geopolitical ambitions, and burdened with a rapidly aging population, China must find new ways to balance the competing demands of markets, geopolitics, demographics and debt, as it vies with the United States as the world’s largest national economy.
Having solidified his political leadership in 2022, President Xi Jinping must now navigate China in new directions. Like all middle-income countries that came before it, China’s route to sustainable increases in living standards resides in innovation and productivity. In 2023, we should therefore expect China’s government to double down on investing in the industries of the future: renewable energy, artificial intelligence, and advances in computing technology (particularly given US export restrictions on China for advanced computer chips).
But even China cannot prosper if it does not address inefficiency, above all the enormous misallocation of resources made over the past two decades into housing, urban development, and infrastructure. We should also therefore expect China to embark on significant asset and debt restructuring efforts in 2023 and the years beyond.
Putting energy into energy
Our final theme to watch in 2023 is energy transformation. In key respects, of course, the energy transformation is well underway, as countries, industries and individuals worldwide shift away from carbon sources of energy toward renewables.
But other factors—above all geopolitics—compound the need for all actors to put more energy into energy. Russia’s invasion of Ukraine and the sanctions much of the world has put on Russia are forcing dramatic changes in energy supply and distribution. The United Kingdom has now signed an agreement for the delivery of US natural gas, while Germany has made similar arrangements with Qatar. Liquified natural gas terminal shortages across Europe must be addressed, and oil and gas distribution networks need to be reconfigured.
In the United States, the Inflation Reduction Act represents a significant shift in US environmental policy, embracing subsidies to encourage a switch from oil, natural gas and coal to solar and wind. As laudable as that transition is, it does not sit easily alongside international trade agreements that discourage subsidies that protect domestic industries. Expect squabbling and disagreement, and perhaps even rising trade tensions, between the United States, Europe, Japan and perhaps China in this arena during 2023.
Finally, despite the headlong rush into renewables, it is worth noting that tight supply/demand conditions characterize global energy markets. The erosion of Russia’s crude oil and natural gas energy exports is one reason, as is OPEC production restraint. Chronic underinvestment in key producing countries such as Venezuela is another factor limiting world output of crude oil. If geopolitics or some other shock deals a blow to Iranian or other key producer capacity, 2023 could easily see a significant spike in energy prices just as the global economy dips into recession.
2023 has the potential to begin the pivot toward what the next few decades might look like. Look for us to dig deeper into the themes from this piece in future newsletters. May you all have a wonderful holiday season!
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1. See “Turning the Page: How 2022 Might Be a New Chapter for Capital Markets, by Stephen Dover, on LinkedIn. December 22, 2021.
2. Source: GM Q2-2022 Corporate Update, EVvolumes.com report on Global EV sales for H1-2022.
3. See “Turning the Page: How 2022 Might Be a New Chapter for Capital Markets, by Stephen Dover, on LinkedIn. December 22, 2021. Total market capitalization of the cryptocurrency market as measured by the Maha-CoinGecko Digital Asset Index that aggregates price and total circulating supply across all cryptocurrency exchanges.
4. Crypto Market Capitalization, Coin Gecko as of November 30, 2022.
5. Source: US Bureau of Labor Statistics.