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Deepak's Memos

What to expect from the markets in 2023


Forecasting is a very difficult business, like selecting lottery tickets. No one could have predicted 2022 as a  year in which there was geopolitical war, worldwide inflation, a massive hike in interest rates worldwide, the US S&P 500 down about 20% and yet, the Indian markets ended up 4%. If anyone got this spot on, they could still be terribly wrong for 2023. That’s why we don’t predict, we react.

(Caveat: we do one single crazy prediction post every year, in Diwali. Read the 2022 edition)

So, what’s going to happen in 2023?

I can almost hear this question, despite all the data that says prediction is a waste of time. But then, much about the markets is an entertainment business, which means it’s great to see people make crazy zany predictions and maybe some of them will win. So we’ll participate mildly in what should purely be entertainment, even if at some point it appears to have deep investing insights.

Ooh, that Volatility

2023 is going to bring volatility back to the table. Why do we think do?

Volatility is like this: Prices will fluctuate. Of course they will. Volatility is about how much they fluctuate. So we’re basically going to weasel out of saying the markets will go up or down, and instead say that they’ll probably go in either direction but faster than earlier. The VIX – the volatility index – is at the lowest since 2021. Which typically is around the level at which things start to get violent again.


The  calculation of the VIX takes into account near term interest rates, which have risen quite a bit in the last few months. An increase in interest rates tends to drop the VIX for the same traded price. Meaning, if interest rates have gone up, then the prices of stock options should have increased, all else being the same.

Option prices have actually dropped or remained the same, roughly speaking. So the VIX has dropped, but in the coming year, markets are likely to see a significant jump in volatility. Which then means people will demand more for options. Typically, VIX increases correspond with strong market falls, but they don’t have to. (Markets can go UP when VIX rises just as well) We just have to remember that volatility ebbs and flows.

The increase in volatility hurts people who sell options with too much leverage. Considering the number of “trading karte ho?” phone calls that I work hard to cut before the second word appears, I believe super-levered option selling is very popular: it has been so even earlier. Option sellers should be wary of too much leverage: in 2011 for example, sudden rises in the VIX forced a number of such shops to shut.

But effectively, what I’m saying is: I don’t know what will happen, but there’s going to be a lot more noise.

The dawn of a new era: Inflation

Inflation is a new thing for the west, and they haven’t had to handle it for decades. Inflation by Country

Source: Trading Economics.

This inflation isn’t anymore from choking of supply ( a Covid problem) – it’s from demand. Very high demand. Rents, salaries, air tickets, everything.

The central bank response: Raise interest rates. Make money costly. This is like saying: if you don’t spend less, I’m going to have you thrown out of a job by bankrupting your employer. As crude as that sounds, that’s the threat of higher interest rates – a recession induced by making money expensive enough that people can’t borrow, and will shut themselves down.

Already, some impact seems to be visible in the US housing prices, with the Case-Shiller National index falling month-on-month for three months in a row. (It’s still up 7% in 2022, but 2023 doesn’t look encouraging) If housing prices fall, it will be because people can’t afford to either buy their first home, as mortgage rates are above 6%, or they can’t upgrade their current house, as they don’t have the cash flow to refinance their existing fixed rate mortgages which are at 3%. But when people can’t buy, they have to rent, and rents remain high a little bit longer until house prices come down. So inflation will linger, since it considers rents and not housing prices.

Using the blunt instrument of interest rates to cause a recession that will tame inflation is not something that’s been easy.

The return of “local” manufacturing and Geopolitical risk

In fact, it’s the return of local buffers and de-optimization of the earlier process.

What’s happened in the last two years:

  • China is the manufacturer for the world. They make everything. Chips to wooden frames to cheap toys to cars. The world has been happy to send their manufacturing there, ignoring all these silly notions of democracy and all that, because it was cheap. When you make one country a platform, everyone eventually has to go there.
  • Covid froze travel and shipping. China slowed down the entry of cargo ships that would otherwise have done a cargo turn fairly quickly, which then slowed down things for everyone, everywhere.
  • That alone destroyed a lot of supply dynamics. If I make a car and some parts aren’t available because they’re made in China, I can’t make that car. (This is why certain higher end BMW cars don’t have a 360-degree camera – they took out what is a standard in a low-end car, because they couldn’t get the parts)
  • And then Russia hit Ukraine and destroyed the supply lines of energy and possibly a lot more things in Europe. With energy fears in Europe and supply fears from China shutting down, the world has started to wake up and say this: we need to build buffers.
  • Building buffers means reducing efficiency. It’s the LOSS of productivity. The older, tested “just in time” approach was where I get a part shipped from the manufacturer at the right time so that it gets to me exactly when I need it in my process. The new thing is: buy more of that part in advance and store it so that this China shipping kind of issue doesn’t halt my entire process.
  • That means more inventory costs, which is what you wanted to reduce earlier. Now you will want this just to avoid not being able to manufacture at will just because some leader in China wants zero Covid.

And it’s not just China. The Ukraine war means wheat supply to the world is impacted. The US wants to deny China semiconductor access to slow down any AI capabilities that China has, and China has a lot. Taiwan won’t provide chips to Russia. The US and Europe have sequestered Russia’s foreign reserves.

This means a business in any country can suddenly get impacted if they depend too much on importing from another country. This drives countries to push de-globalization, even if it increases costs. This will eventually mean the return of tariffs – massive duties on finished good imports, to allow local manufacturers to thrive. India’s doing it already (there’s a minimum 10% duty on anything imported) and China does it by simply banning imports. Eventually, localized manufacturing will thrive.

The investing impact: you’re going to need balance sheets to be able to set up local plants, to buy local companies instead of exporting, and to invest in capacity expansions just to manage higher buffers. In a rising interest rate market, this is going to need profitable businesses too. Because if you don’t make a profit, people won’t lend to you; and equity is naturally far more expensive. The concepts of “asset light” and “don’t worry about profit” will likely be less attractive.

The AI will take your job

It’s real, folks. ChatGPT has already demonstrated how smart it can get. It will eventually replace the concept of content as we know it. You won’t be able to tell if an article – even this one – was written by AI. Unless there’s an unintentional smelling pistake.

AI will not be only in the written form. It’s already in Art, making pictures, some of which are incredibly cool. It’s going to be used to make music. Just feed it all the stuff we like, classify it in different ways, and soon, you’ll just be able to ask an AI tool to give you some rock, and it’ll make something for you. It’ll probably be a better trader too, figuring out markets better than humans can. It’s already being used to write code even if enough of it is wrong.

In the earlier era, automation and machinery reduced the need for workers. Need to lift heavy things? Get a forklift. Need to dig a trench, get a JCB. This is considered bad because it replaces real jobs. (And that’s also why NREGA doesn’t allow machines to be used for the 100 days of guaranteed employment by the government) However, now, the scene is that AI will replace the jobs that are done by white collared people, who are “creative”. Content, art, music, video. This stuff was supposed to be something that people were born with or spent their entire lives learning. If great music can be generated by an algorithm that can learn the same thing at mega-speed, everything will change for the musicians. If great stock market investing is a learnt process, then AI can finish the PhD in the school of hard knocks faster than any of us, and without the rising heartbeat that we humans have.

There’s hope, though. Workers didn’t lose jobs, they just transitioned. The fork lifts needed operators. The machines needed people to run them. AI too, will need people to drive them; maybe not to do the actual work, but to do something else – monitor, adjust, direct or stop. For example, too much music is a waste, but AI will generate way too much, and then you’ll need the humans to curate it. Art too, will need curation, and the number of curators will increase substantially. The business will exist, but not at the same level you imagine today – it will be in a different thing. The only thing I know is that when you have something simple, humanity will find a way to complicate it so much that you will need trained people to use it meaningfully.

AI will change our lives, and possibly, 2023 is the start of that process. We all must find our peace with it and indeed, harness it for our own betterment.

These are not predictions…

That’s by design. These are grand theories of existence. Every year, I grow older. Every year, I sit and think about how the last few years have changed my perception for the rest of my life. And this is just a little bit from those thoughts. The thoughts will change, but increasingly, I feel life is to be lived in the present, as it happens.

I’ll leave you with lyrics from Time, by Pink floyd:
And you run, and you run to catch up with the sun but it’s sinking
Racing around to come up behind you again
The sun is the same in a relative way but you’re older
Shorter of breath and one day closer to death
Every year is getting shorter, never seem to find the time
Plans that either come to naught or half a page of scribbled lines
Hanging on in quiet desperation is the English way
The time is gone, the song is over, thought I’d something more to say

I wish you all a very Happy 2023!

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