At State Street Global Advisors, our Global Market Outlook encapsulates our views on investment and economic prospects for 2023. However, we recognize that the future is always uncertain and believe that consideration should also be given to alternative scenarios that have a reasonable, if low, probability of occurring. We call these scenarios Grey Swans.
Unexpected events in the last few years, from the Covid-19 pandemic to war in Ukraine to double-digit inflation, illustrate why thinking about Grey Swans can help inform the risk-aware approaches we apply across our portfolios. We have identified a group of Grey Swans to watch in 2023. To learn more about our thinking underlying each of these scenarios, please download the complete article “Six Grey Swans That Could Unsettle Markets in 2023” by Lori Heinel and Gaurav Mallik.
In what is probably our darkest Grey Swan, we identify a scenario in which major central banks reassert a hawkish approach to monetary policy. Multiple rate hikes get delivered on top of already high rate levels, with a Bank of Japan exit from its yield curve control policy then contributing to global bond yields jolting higher. At the same time, China’s reopening from Covid restrictions sees the country’s leadership adopt an aggressive price competitive approach to bolstering growth. Unemployment finally rises in earnest, likely stoking retrenchment in consumer and business spending. Amid weakening global demand and improved supply, oil prices tumble to send a deflationary impulse through the economy.
The impact would be considerable. For investors, portfolio positions in Treasuries would be rewarded while equities, credit, commodity, and real estate markets suffer losses. Against the backdrop of central banks reverting to quantitative easing policies to support economic activity, opportunities should emerge for investors to pick up long duration assets at relatively more attractive entry points.
Figure 1: Deflationary Bust: Impact on Investment Assets
Fear of a liquidity event keeps many investors awake at night. Even the US Treasury market is not immune to such concerns, despite its renowned depth. In this Grey Swan, diminished market liquidity would amplify the risk of a rupture under circumstances where a more hawkish Federal Reserve exacerbates heightened market volatility in pursuit of quashing inflation.
A rupture in the US Treasury market, a linchpin for all other interest rates, would not only severely disrupt mortgage markets, corporate funding, vast numbers of derivatives contracts, but would also undermine other major asset classes from stocks to commodities, real estate and beyond. A jump in bond-equity correlations might see investors scrambling for second-line hedges such as gold, broad commodities, or selected alternatives.
Figure 2: Deterioration in Treasury Market Liquidity
In this Grey Swan, the housing market correction takes a more ominous turn, with high prices adjusting sharply lower to help clear a market suffering from record low affordability and freefalling demand. An increase in unemployment could set the scene for rising defaults, leading to foreclosures that adds more supply to the market; home prices decline by 15-20%. However, because the housing supply had lagged household formation for years, buyers should soon emerge to put a floor under prices.
For investors, this correction would differ from the global financial crisis; banks are much better capitalized to endure the impact. Housing-related sectors would take a hit, from construction to materials sectors, with a negative wealth effect dampening spending as homeowners turn cautious; consumer staples should thus fare better than consumer discretionary stocks.
Could something as simple as an extended cold winter be the trigger for the euro slumping to a record low? A depletion of natural gas reserves and an eye on the 2023/24 winter would likely drive energy prices (and overall inflation) higher, raising fears of increased European Central Bank policy rates. A retreat to more nationalistic positions on energy, immigration and fiscal policies could create political divisions within the European Union.
A breakup of the eurozone seems highly unlikely in this Grey Swan scenario, but the fear of a single country exit in an environment of recession, rising political tensions, and high debt levels, could drag the euro toward its previous record low of $0.84. The combination of slower growth and potentially higher ECB rates then results in renewed divergence between core and peripheral debt yields as investors adopt a safety first approach. Allocations away from euro area equities could see UK shares preferred as investors adjust Europe exposures.
While the war in Ukraine, OPEC+ cuts in production, and a pandemic reopening surge in demand took crude oil prices above the $100 per barrel mark for half of 2022, prices ended the year closer to their starting point.1 In a world where sanctions on Russia already restrict supply and the threat of tensions bubbling over in other oil-producing regions is ever present, a catalyst that could make sharply higher oil prices more tangible in 2023 is a larger-than-anticipated economic response to China’s scrapping of Covid-related policies. This could stoke oil demand from Chinese industry and also have a positive impact on other emerging markets that have intertwined economic relationships with the world’s second-largest economy.
Another spike in energy prices would deliver another stagflationary impulse, particularly in Europe. For investors, the impact might warrant continued use of commodities as a portfolio hedge, as well as investment in oil-related stocks, from Big Oil to energy sub-sectors.
Figure 3: World Liquid Fuels Production and Consumption Balance
In what was a truly volatile 2022 for US equities, the broad technology sector had a difficult year. Performance dispersion within the sector was high, with leadership particularly narrow. The semiconductor industry proved one of the worst performers — down over 30% for the year as it posted its worst performance relative to the S&P 500 Index in over a decade.2 But what if the drivers for the market’s pessimistic assessment shifted? The semiconductor sector could swivel from market laggard to market leader.
The trigger for a reversal in fortunes lies in a significant US policy pivot that further tempers dollar strength and delivers a positive growth surprise. Given that the semiconductor industry garners more than 80% of its revenue from overseas markets, this would be impactful. An economic growth surprise on more dovish Fed actions could drive increased productivity/capital expenditures and, more importantly, revive sentiment for the highly cyclical semiconductor industry.
1 Brent crude oil
2 Source: Bloomberg Finance LP as of December 31, 2022
State Street Global Advisors Worldwide Entities Abu Dhabi: State Street Global Advisors Limited, ADGM branch is regulated by the Financial Services Regulatory Authority (FSRA). This document is intended for Professional Clients or Market Counterparties only as defined by the FSRA and no other person should act upon it. State Street Global Advisors Limited, ADGM Branch, Al Khatem Tower, Suite 42801, Level 28, ADGM Square, Al Maryah Island, P.O Box 76404, Abu Dhabi, United Arab Emirates. Regulated by the ADGM Financial Services Regulatory Authority. T: +971 2 245 9000.
Australia: State Street Global Advisors, Australia, Limited (ABN 42 003 914 225) is the holder of an Australian Financial Services License (AFSL Number 238276). Registered office: Level 14, 420 George Street, Sydney, NSW 2000, Australia. T: +612 9240-7600. F: +612 9240-7611.
Belgium: State Street Global Advisors Belgium, Chaussée de La Hulpe 185, 1170 Brussels, Belgium. T: +32 2 663 2036. State Street Global Advisors Belgium is a branch office of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2.
Canada: State Street Global Advisors, Ltd., 1981 McGill College Avenue, Suite 500, Montreal, Qc, H3A 3A8, T: +514 282 2400 and 30 Adelaide Street East Suite 800, Toronto, Ontario M5C 3G6. T: +647 775 5900.
France: State Street Global Advisors Europe Limited, France Branch (“State Street Global Advisors France”) is a branch of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. State Street Global Advisors France is registered in France with company number RCS Nanterre 899 183 289, and its office is located at Coeur Défense — Tour A — La Défense 4, 33e étage, 100, Esplanade du Général de Gaulle, 92 931 Paris La Défense Cedex, France. T: +33 1 44 45 40 00. F: +33 1 44 45 41 92.
Germany: State Street Global Advisors Europe Limited, Branch in Germany, Brienner Strasse 59, D-80333 Munich, Germany (“State Street Global Advisors Germany”). T: +49 (0)89 55878 400. State Street Global Advisors Germany is a branch of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2.
Hong Kong: State Street Global Advisors Asia Limited, 68/F, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. T: +852 2103-0288. F: +852 2103-0200.
Ireland: State Street Global Advisors Europe Limited is regulated by the Central Bank of Ireland. Registered office address 78 Sir John Rogerson’s Quay, Dublin 2. Registered Number: 49934. T: +353 (0)1 776 3000. F: +353 (0)1 776 3300.
Italy: State Street Global Advisors Europe Limited, Italy Branch (“State Street Global Advisors Italy”) is a branch of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. State Street Global Advisors Italy is registered in Italy with company number 11871450968 — REA: 2628603 and VAT number 11871450968, and its office is located at Via Ferrante Aporti, 10 - 20125 Milan, Italy. T: +39 02 32066 100. F: +39 02 32066 155.
Japan: State Street Global Advisors (Japan) Co., Ltd., Toranomon Hills Mori Tower 25F 1-23-1 Toranomon, Minato-ku, Tokyo 105-6325 Japan. T: +81-3-4530-7380. Financial Instruments Business Operator, Kanto Local Financial Bureau (Kinsho #345), Membership: Japan Investment Advisers Association, The Investment Trust Association, Japan, Japan Securities Dealers’ Association.
Netherlands: State Street Global Advisors Netherlands, Apollo Building 7th floor, Herikerbergweg 29, 1101 CN Amsterdam, Netherlands. T: +31 20 7181 000. State Street Global Advisors Netherlands is a branch office of State Street Global Advisors Europe Limited, registered in Ireland with company number 49934, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2.
Singapore: State Street Global Advisors Singapore Limited, 168, Robinson Road, #33-01 Capital Tower, Singapore 068912 (Company Reg. No: 200002719D, regulated by the Monetary Authority of Singapore). T: +65 6826-7555. F: +65 6826-7501.
Switzerland: State Street Global Advisors AG, Beethovenstr. 19, CH-8027 Zurich. Registered with the Register of Commerce Zurich CHE-105.078.458. T: +41 (0)44 245 70 00. F: +41 (0)44 245 70 16.
United Kingdom: State Street Global Advisors Limited. Authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 2509928. VAT No. 5776591 81. Registered office: 20 Churchill Place, Canary Wharf, London, E14 5HJ. T: 020 3395 6000. F: 020 3395 6350.
United States: State Street Global Advisors, 1 Iron Street, Boston, MA 02210-1641. T: +1 617 786 3000.
The information provided does not constitute investment advice as such term is defined under the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor’s or potential investor’s particular investment objectives, strategies, tax status, risk appetite or investment horizon. If you require investment advice you should consult your tax and financial or other professional advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.
The views expressed in this material are the views of State Street Global Advisors through the period ended 31 December 2023 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
Investing involves risk including the risk of loss of principal.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.
Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Investing in high yield fixed income securities, otherwise known as “junk bonds”, is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These Lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.
There are risks associated with investing in Real Assets and the Real Assets sector, including real estate, precious metals and natural resources. Investments can be significantly affected by events relating to these industries.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
© 2023 State Street Corporation.
All Rights Reserved.
Exp. Date: 01/31/2024