Q3 Recap

Growth accelerated in Q3, with inflation quiescent in most countries; perpetuating the “Goldilocks” conditions that have generally favored risk assets since early 2009. Global equity markets continued their gallop in Q3, with the MSCI ACWI and the S&P 500 reaching all-time highs. Among developed markets, the MSCI Eurozone index outperformed the MSCI ACWI by 28 bps; Japan trailed by 44 bps whilst Emerging Markets (EM) bested the global benchmark by roughly 300bps. With the US dollar having fallen 8% year to date, a significant portion of the relative performance advantage for international equity markets came through currency gains. (See TABLE 1).

Among sectors, IT, energy and materials outperformed the global equity index whilst consumer staples and health care underperformed in all three major regions. Financials outperformed in the U.S. and the Eurozone, but trailed in Japan and EM. Industrials also outperformed in the Eurozone and Japan but lagged in the U.S. and EM. Consumer discretionary, utilities and telecom services trailed the broad market and were a mixed bag across the three major regions.

In the U.S., growth rebounded sharply after a seasonally weak Q1. First-half GDP growth came in at 2.2% (above trend, which is estimated at 1.8%), and the manufacturing ISM reached 57.7 in September. The two big hurricanes will probably knock around 0.5 points off Q3 growth but the lesson from previous disasters is that this will be more than made up over the following three quarters. Rebounding capex, and consumption aided by a probable acceleration in wages, should keep GDP growth strong. With Q2 GDP growth 2.3% YoY and the manufacturing PMI at 57.4, Europe’s growth surpassed the U.S., reflecting its greater degree of cyclicality, with the German IFO growth index plumbing new heights and manufacturing wages growing by 2.9%YoY.

Japan has been buoyed by the external sector (with exports rising 18%YOY and industrial production 5%), but has thus far still been plagued by weak household spending and core inflation. Despite potential uncertainty with the impending election later this month, we expect a continuation of earnings-supportive Abenomics (monetary accommodation as well plus structural market reforms). Finally, China’s PMI has oscillated around 50 all year, as the authorities tried to stabilize growth ahead of October’s Party Congress. But money supply and credit growth have been slowing all year, and this is now showing through in downside surprises in fixed asset investment and retail sales data. Especially if the Congress moves towards structural reform and short-term pain, growth may slow further.

Going forward, we expect growth to remain strong for the balance of 2017 and much of 2018. Accordingly, the Citi Economic Surprise Indices (see CHART 1 on the next page), show strong upward surprises in all major markets except for China, which since early this year has been undergoing a notable deceleration of money and credit growth.