- Mortgage shocks and re-acceleration of inflation are among the top global risks for markets in 2023.
- The "biggest risks in a typical year ... are often hiding in plain sight," Schwab's chief investment strategist said.
Interest rates flying higher worldwide and China's easing stance on COVID-19 restrictions are among major developments in 2022 that could carry risk into global markets in 2023, according to Charles Schwab.
The broker in "identifying the unexpected" this week outlined its top 5 risks for investors next year, with the list arriving as equity markets head toward steep losses for 2022.
The S&P 500 and the MSCI World Index have each dropped close to 20% this year, a period in which investors traversed through Russia launching a war in Ukraine, a surge in energy prices following that invasion and central banks pushing up borrowing costs to turn down the temperature on hot inflation.
"History shows us that the biggest risks in a typical year aren't usually from out of left field … rather, they are often hiding in plain sight," wrote Jeffrey Kleintop, chief global investment strategist at Charles Schwab, which oversees more than $8 trillion in assets. "Risk appears when there is a very high degree of confidence among market participants in a specific outcome that doesn't pan out."
In no particular order, here are Schwab's top five global risks in 2023:
1. China's reopening
The world's most populous country has abruptly been pulling back on strict COVID-19 testing and quarantine requirements following mass public protests late last month. Pent-up spending by 1.4 billion consumers may present upside risk to earnings estimates for companies with sales exposure to China.
However, "more importantly it could also drive a rebound in global inflation for both commodities and goods. The timing is not ideal," said Kleintop. "Market participants' disappointment at a resurgence in inflation may overwhelm any improvement in the earnings outlook, forcing stocks lower."
2. Mortgage shock
Mortgage rates worldwide have shot higher as the Federal Reserve, the European Central Bank, the Bank of England and other central banks have raised interest rates this year. In the US, the one-year adjustable mortgage rate has more than doubled to 5.6%.
Households without long-term fixed-rate financing face a jump in monthly mortgage payments as interest rates reset higher over the next 12 months. "As the potential global recession lingers, any substantial rise in the unemployment rate may also raise defaults by lowering consumers' ability to repay," Schwab said.
Schwab estimated a "significantly greater risk of mortgage shocks" in the United Kingdom, Norway, and New Zealand - with some risk in Australia, Sweden, and Canada - than in the US, France, Germany, and Italy.
3. Central banks overtighten
The Fed, the ECB and the Bank of England last week downsized their latest rate increases to 50 basis points each. "However, major central banks are making it clear they aren't finished, despite stepping down the aggressive pace of rate hikes," said Kleintop.
Schwab noted that US labor market data are a lagging economic indicator and by the time it deteriorates meaningfully enough for the Fed to change policy, the global economy may have already fallen into a deeper recession than currently anticipated.
Meanwhile, the ECB projects inflation to fall to its 2% target within two or three years but its latest policy statement suggests it's "seeking an insurance policy against inflation in the form of even higher policy rates," the broker said.
"Major central banks overtightening monetary policy by taking rates too high (after leaving them too low for too long), presents a downside risk to the market's expectation of a mild recession extending into early 2023," said Kleintop.
4. European energy crisis
European leaders scrambled to secure enough natural gas to meet heating needs after Russia suspended natural gas flows into the region following sanctions for its invasion of Ukraine.
But adequate reserves, conservation efforts, and a mild start to Europe's winter weather have reduced the risk of an energy crisis, leading to a pullback in European natural gas prices and European stocks leading a global rebound in the fourth quarter.
"That said, Europe's gas supply situation remains fragile, and a cold winter globally could result in increased consumption of gas combined with reduced availability of gas exports from the U.S., prompting shutdowns for Europe's industrial and automotive businesses," Schwab said.
5. Ukraine war broadens
Kleintop said investors appear to be pricing expectations of the intensity of the Ukraine war subsiding and perhaps moving towards a negotiated resolution.
"Yet, the path to end the fighting may require Ukraine reclaiming Crimea after Russia's seizure in 2014. Any move to retake that territory may be Putin's red line, raising the risk of escalation by Russia should Ukraine cross into Crimea after continuing to push through Kherson," he said.
Russia could escalate the war through further large-scale attacks on civilian infrastructure or export restrictions at Black Sea shipping routes.
"But, more significantly, it may take the form of using prohibited nuclear, biological, or chemical weapons to defend what it sees as Russian territory," the strategist said. Russia could preemptively strike arms shipments to Ukraine by members of NATO, or draw others into the conflict with either intentional or unintentional strikes on neighboring countries.