The ASX share market and global stock market have been through a rollercoaster in 2022. What does 2023 have in store?
I believe looking at the performance of the US share market – which covers a wide range of global companies – is a good proxy for how investors are feeling about the situation.
One of my preferred ways to evaluate the performance of the US share market is to look at the exchange-traded fund (ETF) iShares S&P 500 ETF (ASX: IVV).
For the year to date, it's down by more than 13%, though by mid-June it was down by more than 20%.
While a 13% drop isn't as much as the declines of plenty of individual ASX shares this year, such as Xero Limited (ASX: XRO), it still represents a negative turnaround from the returns we've seen in the last couple of years and indeed the past decade.
Given how high interest rates are – and they're still going higher, at least in the US – could 2023 see another crash for the ASX share market?
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Why 2023 may be another tough year
The interest rate can have a very big impact on the valuations of assets — the higher it goes, the more it's supposed to hurt valuations, in theory. The US Federal Reserve is probably the world's most important central bank, and has been dealing with very high inflation in the US, which has had an impact on the global stock market.
While US inflation may start to settle down in 2023, Federal Reserve boss Jerome Powell has indicated that it could still take some effort to get inflation back to a stable level. This could see the US interest rate go above 5% and stay relatively high for longer than expected.
With the iShares S&P 500 ETF up 9% since the low in June 2022, and the S&P/ASX 200 Index (ASX: XJO) up around 11% since mid-June, the market may already be thinking the worst is over. In time, this could end up being a premature conclusion.
It could take some time for the full effect of these interest rate rises to flow through the Australian and US economies. The central banks want to take the heat out of the economy, but the higher costs to consumers and households could lead to a downturn, hurting the overall earnings of companies within the ASX share market.
Seeing as normal businesses are typically valued by their profitability, a downturn could hurt investor sentiment and put us back into a bear market.
Of course, there is also something completely unpredictable that could cause problems for the global stock market as well.
The case for uncertainty to improve in 2023
I think the share market is largely forward-looking. When the future seems dramatically uncertain, we see large sell-offs. This happened earlier this year when it was uncertain how high inflation would go. Yet, despite interest rates rising even higher, the ASX share market has risen.
For example, at the start of the COVID-19 pandemic, the bottom of the plunge for many businesses on the global stock market was in March 2020, even though there were a growing number of cases, deaths, and lockdowns in the subsequent months.
There are signs that the worst of inflation is over, which could bring forward the peak interest rate. The US Federal Reserve 'only' increased its interest rate by 50 basis points last week rather than 75 basis points. Collectively, the market may be comfortable enough with what's going to happen next.
It's normal for the stock market to go up and down, but with central banks slowing down the rate increases, we may have moved past the worst of things, even if there is a bit of volatility.
Foolish takeaway
I think we may have seen the low point for the share market when it comes to this period of rapidly rising interest rates. So, I'm not expecting the share market to fall further than we saw in June.
But, it's certainly possible that the ASX share market could drop 10% or 15% at some point over 2023, particularly if it starts from a comparatively higher level. If an asset goes up 10% and then drops 10%, it's roughly back to where it started.
