As our follow up to our annual predictions piece, we're pleased to share a new take from Wavelength: 5 Wild Card Predictions for 2023 from our CIO, Andrew Dassori.
Having a base case is useful when investing, particularly if it’s different from what markets are pricing, but as we saw last year, a paradigm shift beyond any forecaster’s core predictions can end up driving asset prices. Accordingly, we believe that considering risks that fall outside of the box is equally important, and seeking to prepare portfolios where possible for these types of scenarios can be a true difference maker.
Consistent with this concept and after thinking through a host of prospective risks with the global economy in transition, we have identified the following five potential wild cards that could have a meaningful impact on financial markets – and in some cases the world as we know it – in 2023.
Wild Card #1: The sharpest financial tightening in decades takes a disorderly turn.
Over the course of last year’s historically broad and rapid rise in rates, markets suffered meaningful losses but continued to function in a relatively orderly fashion. Stressful events – like the UK’s gilt market crisis and Russia’s failure to make dollar and Euro-denominated debt payments – were fairly well-contained and did not spread significant contagion. With a tighter economic backdrop, however, policies behind Japan’s yield curve control, European energy dependence, and other fundamental imbalances may prove to be unsustainable. This new dynamic could push markets to the brink with liquidity drying up as the impact of overwhelmingly restrictive policies flows through to underlying economies.
Wild Card #2: Shockwaves from higher rates reach private markets to force widescale repricing.
The year of the down round may have a far-reaching impact across private markets where many companies have yet to face the reality of meaningfully higher capital costs. We have already identified private credit as a potential canary in the coal mine here, and when these companies seek the infusions of capital they need to operate, it may further expose critical issues with how they’ve been valued that cut deeply through the private investment landscape.
Wild Card #3: New geopolitical threats emerge under the cover of the war in Ukraine.
At a time when nations across the globe have their eyes on the conflict between Russia and Ukraine, other geopolitical actors may see an opportunity to further their interests with less scrutiny from the international community. Amidst sanctions and domestic unrest, Iran is now backed into a corner with enough enriched uranium to build several nuclear weapons. And under increasingly consolidated power, China may look to expand its sphere of influence across Asia, the Middle East, or emerging economies as it plays the long game to disrupt the existing world order. While these tensions are well-known, the most impactful threats often come seemingly out of nowhere, and the void left by distracted global leaders increases the likelihood of this happening.
Wild Card #4: Artificial Intelligence is weaponized to spread misinformation at scale.
As highlighted in our Ten Predictions for 2023, we expect the technology behind ChatGPT to lead to groundbreaking applications for AI in our daily lives. This exciting development may unlock new levels of productivity, but it also carries the critical risk of being used unethically to manipulate the people it is meant to serve. As creating mass volumes of content becomes easier and determining its legitimacy becomes harder, bad actors may use an onslaught of computer-generated propaganda to control their populations and sow seeds of dissent elsewhere in the world.
Wild Card #5: Wrangling over the debt ceiling drives US growth lower.
While anything is possible, the risk of a US government default remains at a distance due to the cash management measures being implemented in the wake of January’s debt ceiling breach. Even as these efforts are exhausted and the ex-date approaches, the Treasury will still have options like issuing premium bonds which, while suboptimal, could ultimately help the keep the government from running out of money. With that being said, a prolonged negotiation leading to reduced government spending would put further downward pressure on growth at a time when the economy is already fragile. Looking back to the last contentious debt ceiling showdown in 2011, the price of Treasuries actually rose alongside their default risk in a dynamic where near-term concerns over nonpayment were outweighed by the risk that this disruption would drive growth lower over the long-term.
Andrew Dassori is the Chief Investment Officer of Wavelength Capital Management, a forward-thinking systematic investment firm based in Connecticut. He has written extensively about artificial intelligence, machine learning, and the use of technology in investing. He was previously a portfolio manager at Credit Suisse Asset Management and graduated with a BSc from the London School of Economics.
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