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Familiar to many, the headline phrase warning of the looming winter is from the famous fantasy series, Game of Thrones. In the ‘GoT’ world, the seasons can be very long, and winter can last for years. However, the main message of winter's arrival is that everyone should prepare for a period of darkness and cold.

The mood in the economy and markets is very similar right now. Worse times are ahead. In economic literature, "bad times" usually refer to a recession or, in the worst case, a deeper depression. Bad times have also often meant below-average investment returns. What should investors consider now?

Three risks gnawing away at the market

The most topical risk - inflation - has been a major headache since last year. Nightmares of the inflation boogeyman are tormenting central bankers, who have the inflation blunders of the 1970s and 80s in the back of their minds. Fear has driven central banks into a rigorous monetary tightening. Rising prices for energy, goods and services are also increasing the burden on household budgets. Tighter monetary policy is also holding back economic growth through higher financing costs.

Another deep concern is the energy crisis, which is particularly acute in Europe. Record-high natural gas prices have driven energy prices sky-high. As we head into winter, households are struggling to cope with huge energy bills. Many energy companies are already stretched, and various rescue packages have started to appear in different countries. It goes without saying that the Russian invasion and the subsequent war in Ukraine is the main culprit behind the energy crisis. Will the war end in months or years, or not at all? It is still difficult to say.

The third market concern is the increased risk of recession. Global economic growth this year is expected to halve from last year's record strong growth of over 6%. Next year, growth could already fall below the critical 2.5% level often seen as the threshold for recession. Europe is already heading for recession. The question is no longer if there will be a recession, but when. But let's not forget that historically, the only time a global recession has occurred was when the US went into a downturn. But it is most likely that the recession will not hit America until next year.

Good news – there’s some of that also

Although risks and gloomy news are constantly flashing across the screens, there are some potentially positive drivers on the horizon for markets.

In the US, the peak of inflation has probably passed. It is therefore worth reminding that it is the US, in particular, that has experienced more persistent inflation, driven by strong demand. If economic growth stalls, it will raise unemployment and dampen wage pressures. In the view of the US central bank, the Fed, this is probably the path that will lead to a decline in inflation. As more signs of a slowing economy and receding inflation emerge, the Fed is likely to pause its rate hikes.

The energy crisis is a big question mark, but a possible Russian proposal for a ceasefire could bring at least temporary relief to a difficult situation. Getting out of the war and high energy prices, however, is likely to be a rocky road. In the worst case, the war will continue, and high energy prices will remain a long-term problem. In the coming years, the green transition may also create more permanent inflation brought on by energy pricing.

Recessions come and go, but not necessarily at the same time in different geographical areas. Fortunately, there are no major systemic risks at the moment. China's over-indebted real estate sector is the single biggest risk if it causes a Chinese recession. Western economies are in relatively good shape so far. Households continue to have plenty of savings, unemployment is low, and the corporate sector is doing well on average. In other words, any potential recessions will be mild and short-lived.

However, future downturns have not been fully priced into the markets. The period when the economy sinks into recession is often a difficult one for stock markets. Although, after a fall early in the year, valuation levels have already sunk very low in many markets this year. This may well soften the market decline when the next earnings downturn hits.

Light at the end of the tunnel?

Of course, there is nothing yet that sheds any light on future recessions, since no recession has started yet in Europe, the US or Asia (probably). Of course, recessions can also be avoided. This remains to be seen.

The first glimmer of hope for investors is likely to be a monetary policy reversal by central banks. The hawkish stance could suddenly turn dovish. A slowdown in inflation could be the driving force, and the turnaround could, at best, take place in the coming months. If it does, markets are likely to react very positively.

We already got a glimpse of this during the stock market rally in the summer months, when investors expected the central banks to change course already by the end of the summer. When it did not happen, the market went into a new decline.

Although winter is coming, it’s not necessarily all doom and gloom. Winter can also bring good news.

As I said earlier, the freezing winter may not only cool the global economy but also the central banks' eagerness to tighten the screws. History reminds us that stock markets often bounce back in the midst of economic sluggishness. This time, the turnaround in inflation and the accompanying change in monetary policy may put an end to the ongoing downtrend in equities.

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