How Do Investors Prepare for Black Swan Events In 2023?

A black swan event is an unlikely and unpredictable event with significant consequences. These events can have a major impact on financial markets and can negatively alter an investor's portfolio. Therefore, it is vital for investors to understand the potential for black swan events and to have a plan in place to mitigate their potential negative impact.

One well-known example of a black swan event is the financial crisis of 2008, which was caused by the housing market's collapse and resulted in a global economic recession. The mortgage crash had a substantial impact on financial markets, with many investors losing a sizeable 

portion of their portfolios.

Another example of a black swan event is the COVID-19 pandemic, which drove the equity markets toward bear market territory (a drop of more than 20%) within a month. 

The pandemic disrupted supply chains and led to economic uncertainty and worldwide lockdowns, resulting in lower consumer spending. 

The triple whammy of rising interest rates, red-hot inflation, and supply chain issues will likely impact financial markets in 2023. So let's see what black swan events can impact your investment portfolios in 2023. 

The last time global economies entered a period of sustained recession was back in 2008. Then, during the financial crisis, the S&P 500 fell over 56% from record levels wiping out massive investor wealth in the near term. 

In 2022, rising commodity prices compelled the U.S. Federal Reserve to hike interest rates at the fastest pace ever. The central bank is willing to risk the possibility of a recession to keep inflation in check. 

As interest rates increase, the cost of debt rises for corporates resulting in lower profit margins. In addition, an uptick in bond yields will also lower household discretionary spending, indirectly impacting companies' top line. 

Noted investment bank Goldman Sachs estimates there is a 35% probability that the U.S. economy enters a recession in the next 12 months, much lower than the median of 65% among forecasters on Wall Street.

Global growth in 2022 has slowed due to fiscal and monetary tightening policies, COVID-19 restrictions in China, a decline in property prices, inflation, and the Russia-Ukraine war.

According to Goldman Sachs, global growth is forecast at 1.8% in 2023, and the U.S. could narrowly avoid a recession if core PCE inflation falls to 3% in Q4 of 2023 from 5%.

It expects interest rates to rise by another 125 basis points and peak at 5-5.25% next year, while unemployment rates might increase by 0.5%.

So, how can core inflation fall with such a minor employment hit? Goldman Sachs believes supply chain disruptions will normalize in 2023, reducing prices across the board. However, it emphasized that long-term inflation expectations remain well-anchored relative to the 1970s.

The banking giant also explains that incoming activity data is nowhere close to recessionary. For example, GDP reports indicate annualized growth of 2.6% in Q3, while nonfarm payrolls rose by 261,000 in October, and jobless claims stood at 225,000 in the last week.

According to Rich Weiss, the chief investment officer at American Century Investment Management, the obsession with policy hikes of the Federal Reserve have blinded investors from economic realities.

The tech-heavy Nasdaq Index is up 10% from 52-week lows despite weak economic data from housing and manufacturing and several earnings downgrades.

There is a good chance for the acceleration in bond yields to result in deteriorating fundamentals for corporates part of developed markets, including the U.S. and Europe.  

Historically, the economy is in shambles by the time central banks pivot and start lowering interest rates, resulting in a sustained broader market sell-off. It will be interesting to see if the S&P 500 declines by another 20% in 2023, after falling by 22% year-to-date. 

The triple threat of red-hot inflation, earnings contraction, and a restrictive monetary policy will continue to act as headwinds for equity investors in 2023.

Since the 1970s, the stock market has fallen by 24% on average after a pivot towards a more accommodative monetary policy.

The success of cryptocurrencies is directly linked to the adoption of these digital assets at the global level. For example, during the bull run of 2021, several publicly listed companies, including Tesla, The Block, MicroStrategy, and PayPal, held Bitcoin on their balance sheets. Further, El Salvador was the first country to accept Bitcoin as legal tender.

Bitcoin prices rose from $5,100 in March 2020 to an all-time high of $68,000 in November 2021. But the ongoing bear market has dragged BTC prices lower to $16,700 currently. In 2022, challenging macro-conditions, coupled with big-ticket bankruptcies in the crypto space, have driven digital asset prices significantly lower year to date.

However, the $32 billion collapse of FTX, once the second-largest global crypto exchange, has shattered crypto stakeholders' confidence. The former CEO of FTX, Sam Bankman-Fried, was arrested in the Bahamas last week and has been charged with wire fraud, money laundering, and securities fraud by regulators in the U.S.

These events are likely to reshape crypto in the coming years. First, the FTX disaster is bound to spur regulators into action. Second, crypto investors don't enjoy the same protection compared to those with funds with a licensed bank or broker.

A report from CNBC states governments in the U.S. and European Union is taking steps to bring crypto market players under regulation and clean up the market.

The Web3 space right now can be compared to the internet of the early 90s, which was clunky, slow, and unintuitive. But the crypto winter is likely to pave the way for innovative uses of blockchain technologies rather than speculative uses right now.

Finally, there are over 22,000 cryptocurrencies in circulation, but just a handful of them will succeed over the long term. As a result, we expect consolidation and acquisitions to accelerate in the upcoming months.

In case interest rates moderate in the next 12 months, it's possible for gold prices to gain pace and end 2023 at all-time highs. Typically, the stock market and gold prices have an inverse relationship. So, gold prices should also accelerate if the market continues to remain vulnerable. 

In an interview with CNBC, Juerg Kiener, managing director, and chief investment officer of Swiss Asia Capital, said gold prices could move higher and range between $2,500 and $4,000 in 2023. According to Kiener, the uptick in gold prices will be well over 20%. 

He emphasized that economies will likely slow the pace of interest hikes in Q1 of 2023 due to recessionary risks, making gold instantly more attractive. Gold is also an asset held by every central bank globally. Data from World Gold Council indicates central banks purchased 400 tonnes of gold in Q3 of 2022, almost 70% higher than the previous record of 241 tonnes purchased during Q3 of 2018. 

According to Keiner, "Since [the] 2000s, the average return [on] gold in any currency is somewhere between 8% and 10% a year. You haven't achieved that in the bond market. You have not achieved that in the equity market." 

Historically, gold has been viewed as a hedge against inflation and a store of value. 

Most financial experts expected the U.S. dollar to weaken in 2022. However, the USD gained significant momentum this year, touching multi-year peaks in the process. Furthermore, the supply chain disruptions in Europe, as well as the monetary tightening policies of the U.S., ensured the USD/EUR trading pair hit parity in 2022, reaching an exchange rate of 1:1. 

Currency swings are difficult to predict and are a crucial catalyst for company forecasts. For example, Microsoft expects a strong dollar to negatively impact its bottom line by almost $600 

million in 2022. 

To offset a rising dollar, entities need to use various hedging tools ranging from forward contracts to currency swaps, allowing participants to lower risks related to foreign exchange. 

It will be interesting to see if the U.S. dollar gains pace or moves lower in 2023. 

Black swan events can be challenging to predict, but there are steps investors can take to mitigate the overall impact on portfolios. 

Method 1: Diversify Investments

One approach is diversifying investments across different asset classes, such as stocks, bonds, precious metals, and real estate. As a result, you can lower your risk profile and reduce the potential impact of a black swan event on a portfolio.

Method 2: Apply a long-term investment horizon

Another approach is to have a long-term investment horizon. While black swan events can significantly impact financial markets in the short term, markets tend to bounce back and recover over time. 

Method 3: For experienced investors - use financial instruments

More sophisticated investors can also consider using financial instruments, such as options or futures, to hedge against black swan events. These instruments can be used to protect against potential losses and can help to reduce the impact of a black swan event on a portfolio.