Yesterday, I wrote of three things that investors should be watching this year. In that piece, I focused on three negative things that could derail the consensus view of a weak first half of the year followed by a strong second half. I focused on what could go wrong not because I am a negative person, but because when you think about risks over a long period, you inevitably think about downside risks.
There is, however, another kind of risk that has to be considered when formulating a long-term view and mapping out a strategy based on that: the risk of opportunity cost should the market achieve significant gains when you are sitting on the sidelines with a big cash position.
That occurred to me as I thought about what to expect from today’s Fed minutes. The release of those notes constitutes an upside risk that could negate the whole year’s projections on just the second trading day of 2023. If, for example, it is clear from the language used by FOMC members that they are actively looking to ease policy as soon as possible rather than waiting for the data, everything changes.
In that case, the market will assume that all is well and that rate hikes will end before the end of June. The big jump would then come in the first half of the year, with a chance of a retracement in the second half. Clearly, if that were to happen, sitting on cash would be exactly the wrong strategy.
That, however, is just one thing that could cause the first half of 2023 to be a lot better than anticipated, and there are others too. In fact, almost everything that constitutes a downside risk could, if things go just a bit differently, result in significant upside.
Take China, for example. Yesterday I laid out the potential for that country to produce a downside shock, but it could turn out to offer big upside, too. If President Xi sees the protests against “zero-Covid” as more about the economic hardship that policy caused than anything, then he may decide to buy back the goodwill of the people by pushing growth at all costs. That would make any aggression towards Taiwan unlikely and would obviously be a big boost to the global as well as domestic U.S. economy.
Elsewhere in the world, if Russia ends their war on Ukraine, for whatever reason, it could reduce overall global tensions and could give markets a boost. Right now, Putin seems set on seeing this through to the bitter end and we look set for a long, painful conflict. That is what is assumed in the base case for the year, but the point of looking for risks, upside or downside, is to consider something that is possible even if it does look unlikely.
Probably the biggest upside risk of all, though, comes from something that I have remarked on before and frequently marveled at: the resilience of U.S. corporations. Time and again, through dips and disasters, whether foreseeable or sudden, or man-made or natural, American corporations have shown the ability to adjust quickly and make significantly better profits than circumstances might suggest they should. The other scenarios here are possible outliers: unlikely turns of events that could happen. But when it comes to corporate profits beating expectations, that has been the case often enough to make it not just possible, but actually quite likely.
As you lay out your strategy for the year, then, don’t forget that “risk” isn’t just about a possible drop in stocks. Anything that negates your predictions constitutes a risk, and investors should always be on the lookout for positives just as much the negatives.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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