The challenge for 2023 is not different than for any year. It is not about predicting the future market direction but preparing for the changes that may occur in the new year. There will be changes in 2023. Our forecasts today will be wrong. The challenge is adapting quicker than the market to stop downside risk and take advantage of upside opportunities when the forecast errors are realized.
Some of the changes for 2023 are already embedded in the market consensus. Our job is to be prepared for both downside and upside events away from this consensus. The left and right-tail opportunities will be determined by the deviations from consensus. The challenge is to first know the current environment or regime and then handicap the potential for change in the regime.
For example, the consensus is that Fed will likely top out rates at around 5% before the summer with a decline in rates during the second half of the year. This is based on an inflation forecast which shows continued declines and the potential for a recession in the second half of the year. Much of this consensus is already embedded in prices. The challenge is to look for signals that suggest the consensus will not be realized before the market identifies a change.
Forget predictions and focus on the how to prepare and react when the current consensus changes.
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