Global stocks advanced in the third quarter, but investor sentiment wobbled amid puzzling signals on macroeconomic growth and monetary policy. Political uncertainty and a cloudier outlook point to more volatility, which should compel investors to intensify their focus on stock fundamentals.

Developed market stocks were led by Japan, while Chinese stocks advanced despite the weaker trend in emerging markets. The MSCI World Index increased by 1.5% in the quarter and was up 18.5% for the first nine months of the year, in local currency terms. But the real drama unfolded beneath the headline numbers. In September, style return patterns took an abrupt turn, with value stocks outperforming growth in a rising market for the first time since late 2016, particularly in US and European large-caps. While growth stocks still slightly outperformed value stocks over the entire quarter, the move showed just how sharply sentiment can shift, and why style diversification is important.

Style Shift: Short-Term or Sustainable?

What can explain the sudden appeal of value in September? The rotation could have been triggered by many things, including relative valuations and technical factors. But macroeconomic expectations certainly played a big part, in our view. Bearish sentiment appeared to peak in August and gave way to small doses of good economic news. Global manufacturing showed signs of life, as the PMI for August increased after 15 straight months of decline.

Bond yields reflected some of this optimism. The 10-year US Treasury yield bottomed out at 1.43% in early September, then clawed its way back to 1.90% by mid-month, before falling back to 1.68% at quarter-end. US and global economic surprise indicators improved. The possibility that growth expectations may have become too pessimistic helped fuel returns for stocks that are more sensitive to the economic cycle, which are typically among the most attractively valued cohort in the market.