2023 ended with an 'everything up' rally … but there's a fly in the ointment

While investors might see the broad market rally that capped off 2023 as a cause for celebration, one investing leader is taking a more tempered and conservative view.

“The rally we saw was about two months long, including November and December,” Craig Basinger, chief market strategist at Purpose Investments, told Wealth Professional. “I think what surprised everybody was the magnitude of that bounce. It was an ‘everything up’ rally.”

A two-month Santa Claus rally

That broad-based rally – which saw both bonds and stocks rocket significantly alongside a fall in credit spreads – came after three painful months for investors. Markets declined over the course of August, September, and October, with global equities falling a bit over 10% from their end-of-July high.

That three-month-long fall in the markets, Basinger says, came after a significant upward move in bond yields, which saw the 10-year US Treasury yield moving above 4%. Compounding that pressure were some heavy US government debt issuances that came after debt ceiling dances.

But after that bond issuance activity cooled and softer economic data came in – including continued improvements in headline inflation and central bankers backing away from their hawkish rate stances – the market rally started to gain traction and, eventually, carried on into the end of 2023.

“The US was clearly the star last year … Japan and Europe were not that far behind,” he says. “Canada lagged, but I'd point out Canada also didn't get nearly as much of a beating in 2022. … If you didn’t believe in Santa Claus before, you should certainly believe in him now.”

While a run-up in the markets would typically be a welcome end to any investor’s year, he says the revival in North American equities was purely from multiple expansion. A look at earnings estimates, he says, reveals no change at all for the S&P 500, while earnings projections for the Canadian equity market as reflected in the TSX have declined.

“It’s quite possible that some of the market advance we had at the tail end of last year might have stolen some of the performance for 2024,” Basinger says.

Companies need earnings – but it won’t be easy

From Basinger’s perspective, there’s a real risk of the North American stock market falling back from its recent rally. To “backfill” that advance, he says there needs to be more positive momentum on the earnings front – and the prospects of that happening aren’t exactly encouraging.

“The US is forecasting 12% earnings growth in the next year. We're just not convinced that's going to happen,” Basinger says. “Interest costs are starting to add up on the corporate balance sheet, [and] we still see wage pressure.

“We’re seeing slowing inflation, which sounds like good news, and it is,” he adds. “But it’s not so good for corporate earnings, because it’s inflation that had helped companies drive sales growth.”

Proponents of central banks might claim the slowdown in inflation as evidence that the aggressive rate hikes since 2022 have had their intended impact. But with the one-two punch of rising prices and higher debt carrying costs weighing on households, Basinger says the resilience of Canadian consumers is also starting to wane.

While he sees some improvement in global trade compared to the doldrums of the past year and a half, there have also been signs of recession across the world. He pointed to the third-quarter deterioration in Canada, with GDP shrinking unexpectedly by 1.1% in Q3; during the same period abroad, GDP in Japan contracted 2.9% on an annual basis, while Germany’s economic engine stumbled as it fell slightly by 0.1%.

“Our base case is we’ll probably get some sort of recessionary activity in 2024. … There’s enough warning signs that it’ll be the most talked-about recession ever,” Basinger says. “We're already actually seeing the slowdown. It's just hasn't come back to America nearly as much.”