Will the Stock Market Crash in 2023? 7 Risk Factors

Continued inflation, geopolitical turmoil and banking jitters mean risk factors abound in 2023.

Through the first quarter of 2023, the S&P 500 is up about 7%. Considering the S&P was down 19.4% for 2022, the stock market is experiencing a robust rebound in the first three months of the year.

Even so, economists and market mavens point to multiple pain points for the U.S. economy that could send stock prices back to 2022 levels over the rest of the year.

“Interest rates on long-term bonds have fallen lower than those of short-term bonds, creating an inverted yield curve that usually portends an upcoming economic slowdown,” said Andrew Slimmon, head of the Applied Equity Advisors team for Morgan Stanley Investment Management, in a recent research note. “Could a weaker second half of the year follow a surprisingly strong first half? It is possible. If there is a risk to the stock market, it could be in the second half of the year.”

Slimmon is hardly alone in that sentiment. Other market experts see problems ahead if the Federal Reserve continues on its inflation-fighting course, with no sign of the Fed easing off on interest rate hikes.

“The market is now bracing for the prospect that the Fed could raise rates even higher than previously anticipated,” notes Jurrien Timmer, director of global macro in Fidelity’s Global Asset Allocation Division. “Talk is emerging of a 6% terminal rate at the peak or ending rate for this rate-hike cycle, as the Fed attempts to slay the inflation dragon.”

Simultaneously, as the market is adjusting its expectations for the Fed, Timmer sees that earnings have “unmistakably inflected” and are declining. “Based on how earnings estimates have been progressing, 2023 is increasingly looking like it could be a -10% earnings year,” he adds.

Inflation

In February 2023, the annual U.S. inflation rate stood at 6%, with economists expecting it to bump back up over 7% when the March inflation figures come out on April 12.

Those continue to be alarming numbers, and they’re a big reason why inflation has been enemy No. 1 for investors, shoppers and the Federal Reserve in 2023.

In late March, the Fed boosted its target rate by 25 basis points, to a range of 4.75% to 5%. In a March 22 statement, the Federal Open Market Committee said that while the U.S. banking system is “sound and resilient,” recent developments “are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation. The extent of these effects is uncertain.”

Thus, the Fed “remains highly attentive to inflation risks.”

If inflation rebounds or if the Federal Reserve is forced to continue to aggressively raise interest rates to keep it in check, that could be a negative scenario for stock prices.

Interest Rates

It’s no secret that the higher interest rates rise, the more expensive it is for companies to borrow money to invest in growth.

With the Fed hiking its benchmark rate and still saying it has work to do to get inflation firmly trending back in the right direction, lending and credit will continue to tighten.

Historically, higher rates lead companies to pull back on spending (and especially on hiring). Consumers, too, will keep a sharp eye on their household budgets with prudence in mind.

Those factors could lead to a weaker stock market – especially if the Fed raises rates again in 2023.

Disappointing Earnings

S&P 500 companies continue to see a decline in key financials, with earnings expected to slide in 2023.

According to FactSet Research Systems, the estimated S&P 500 first-quarter earnings decline is -6.6%, with 79 S&P 500 companies issuing negative earnings-per-share guidance and only 27 reporting positive EPS guidance.

Consequently, the status quo going forward is shaky for the stock market, as investors prepare for the Fed to impose even more interest rate hikes in 2023. If earnings growth continues to fall short of expectations, the stock market’s reaction could be severe.

Geopolitical Event

The biggest geopolitical event of 2023 continues to be Russia’s invasion of Ukraine, which has rattled global financial markets and remains a massive wild card for investors. That war continues unabated, with no end to the fighting in sight.

In a worst-case scenario, what some have called a proxy war between the U.S. and Russia could devolve into a global nuclear war. But even a full Russian victory in Ukraine or annexation of Ukrainian territory could be enough to trigger a stock market sell-off.

In addition to the Ukraine conflict, escalating tensions between China and Taiwan could put U.S. supply chains at significant risk. Additionally, saber-rattling between Serbia and Kosovo in 2022 has carried over into 2023, upsetting an already fragile Balkans region, with the prospect of a military conflict rising.

This all goes to show that geopolitics are complicated – and often unpredictable. This lends itself to downside shocks, as few surprise geopolitical developments are unabashedly positive.

Banking Crash

The collapse of Silicon Valley Bank on March 10, followed by the crash of Signature Bank a couple of days later, stoked fears of larger banking instability at home and abroad.

The Fed and the Federal Deposit Insurance Corp. stepped in to stabilize the situation, but not before a crisis of confidence engulfed the U.S. regional banking market.

“Headline risk is centered around how well capitalized these banks are and the liquidity profile of their businesses,” states Melanie Coffin, equities investment strategist at Lord Abbett.

Banks with low capital and long-duration assets, but short-lived deposits, may need to raise capital, raise expensive funding or sell to a bigger bank, Coffin notes.

“Looking ahead, there may be an increase in regulatory scrutiny over small and midsize banks and a more proactive regulatory involvement,” she says. “We also expect to see a shift toward deposits becoming more concentrated in the largest U.S. banks.”

If more banks edge toward insolvency, as occurred in 2007 and 2008, the impact on the stock market could be substantially negative for the rest of 2023.

Oil Shock

There have been several oil shocks in decades past that negatively affected the stock market to varying degrees. The Saudi oil embargo in 1973 created temporary U.S. shortages.

Iran’s Islamic Revolution in 1979 and the first Gulf War in 1990-1991 each caused oil prices to double. Oil prices as high as $140 per barrel even contributed to the economic crisis in 2008. Oil shocks have been some of the most common catalysts for U.S. economic recessions over the past 50 years.

At about $80 a barrel as of April 3, the price of crude oil has stayed fairly stable on a year-to-date basis, but it remains down nearly 22% over the past year. Higher interest rates and fears of a looming recession underscore the volatile nature of the global energy markets heading into the second quarter of 2023.

Supply Chain Disruption

The basic law of supply and demand suggests supply disruptions lead to higher prices and inflation. As the last two years have demonstrated, many U.S. companies are at the mercy of their international suppliers, creating significant risks in the market.

While the supply chain scenario has moderately improved in early 2023, there’s still a long way to go, experts say.

“Disruptions to supply chain operations are set to stay in 2023, whether they are existing or new geopolitical conflicts, inflationary pressures and the recessionary environment, climate change weather events, or other issues yet to emerge,” KPMG notes in a recent research report. “They can all impact access to goods and how they flow to their final destination, create port holdups, reduce container and ocean freight availability, and surge prices, among other concerns.”