Opinion: 5 reasons why 2023 will be a tough year for global markets

Those who issue warnings are rarely popular. When Kassandra told her fellow Trojans to beware of the Greeks and their Trojan horses, she wasn't doing herself any favors. But, as financial markets face unprecedented volatility, it is important to take a hard look at economic realities.

Analysts agree that the market faces serious headwinds. The International Monetary Fund predicts that a third of the world economy will be in recession by 2023. Energy demand is buoyant, supply is in short supply, prices are skyrocketing, and emerging economies are shaky out of the pandemic.

There are five fundamental and interrelated issues that will spell trouble for asset markets in 2023. It is recognized that in an environment of uncertainty, investors do not have clear choices. Every decision has trade-offs.

net energy deficit

Without major changes in the geopolitical and economic landscape, fossil fuel shortages are likely to persist well into next winter.

Russia's oil supplies have been decimated by sanctions related to the Ukraine war, while Europe's energy architecture has been irreparably damaged by an explosion that destroyed part of the Nord Stream 1 gas pipeline. This is irreversible because building new infrastructure takes time and money, and ESG requirements make it difficult for energy companies to justify large-scale fossil fuel projects.

At the same time, once China emerges from the economic slowdown caused by the new crown epidemic, already strong demand will only increase further. Record growth in renewable energy and electric vehicles played a role. But there are limitations. Renewable energy requires hard-to-obtain elements such as lithium, cobalt, chromium and aluminum. Nuclear power will ease the pressure, but new plants take years to come online and gaining public support may be difficult.

manufacturing return

Supply chain shocks from the pandemic and Russia's invasion of Ukraine have sparked a desire in major economies to reshoring production. While this may drive domestic growth in the long run, reshoring requires investment, time and a mature workforce.

In the short to medium term, the repatriation of jobs from low-cost offshore locations will fuel inflation in high-income countries as it drives up wages for skilled professionals and lowers corporate profit margins.

Transition to a commodity-driven economy

The same disruptions that sparked the reshoring trend also drove countries to seek safer and greener supply chains for raw materials within their borders or those of their allies.

In recent years, mining of key rare earths has been outsourced to countries with plentiful cheap labor and lax tax regulations. As these processes move to high-tax and high-wage jurisdictions, the sourcing of raw materials will need to be re-engineered. In some countries, this will lead to increased investment in exploration. That could lead to a shift in trade alliances in countries that cannot source commodities domestically.

We can expect such an alliance to reflect a geopolitical shift from a unipolar to a multipolar world order (more on this below). For example, many countries in the Asia-Pacific region will be more likely to prioritize China's agenda over the US's, with implications for US access to goods now coming from Asia.

persistent inflation

Given these pressures, inflation is unlikely to slow anytime soon. This poses a huge challenge to central banks and their favorite tool for controlling prices: interest rates. The power of higher borrowing costs will be limited now that we have entered an era of secular inflation where the disintegration of globalization has created an imbalance between supply and demand.

12-month percent change in the Consumer Price Index (CPI), 2002-2022 Source: U.S. Bureau of Labor Statistics

Past inflationary cycles have all ended when prices rose to unsustainable levels, triggering a collapse in demand (demand destruction). The process is uncomplicated when it comes to discretionary purchases, but problematic when it comes to necessities like energy and food. As consumers and businesses have no choice but to pay higher costs, there is limited room to ease upward pressure, especially as many countries subsidize consumer purchases of these necessities.

Acceleration of decentralization of key institutions and systems

This fundamental shift is driven by two factors. First, broken supply chains, tightening monetary policy, and conflict triggered a recalibration of the geopolitical world order. Second, global trust in institutions has eroded due to chaos in the COVID-19 response, economic distress, and widespread misinformation.

The first point is key: Countries that once viewed the United States as a leader of opinion and enforcer of order are questioning this alignment and filling the void with regional ties.

At the same time, distrust of institutions is soaring. A Pew Research Center survey found that Americans are increasingly suspicious of banks, Congress, big business and the health care system — and even each other. Escalating protests in countries including the Netherlands, France, Germany and Canada show that this is a global phenomenon.

This discontent has also fueled the rise of far-right populist candidates, most recently Georgia Meloni, who was elected prime minister of Italy.

Likewise, it has fueled growing interest in other ways of accessing services. During the epidemic, home education surged. Then there's Web3, which aims to provide an alternative to legacy systems . Take the Bitcoin community’s Beef Initiative, which aims to connect consumers with local farmers.

Historically, periods of extreme centralization have been followed by waves of decentralization. Consider the fragmentation of the Roman Empire into local fiefdoms, the successive revolutions of the 18th and early 19th centuries, and the rise of antitrust laws in the West in the 20th century. All can see the overall structure split into parts. Then, the slow process of centralization started again.

Today's transformation is being accelerated by revolutionary technologies. While this process is not new, it is disruptive to markets and society. After all, the prosperity of the market depends on the ability to calculate the result. This is increasingly difficult to do when the fundamentals of consumer behavior are undergoing a phase shift.

Taken together, all of these trends suggest that only prudent investors are heading into the future during this period. So fasten your seat belts and get ready for this journey.