Overview

Global economic activity remained resilient through the third quarter even after considerable monetary tightening by global central banks over the past 18 months:

• Despite speculation earlier this year that a US recession was imminent, strong labor demand provided a buffer to household incomes and supported private consumption, boosting the economy. The most likely economic scenario is one of modest US growth in the back half of 2023 and into 2024, with a lower risk of recession in the near term.
  
• The risks of a European recession are significant. Europe's post-COVID recovery has already faded, with Q2 GDP growth just barely positive in the Eurozone, UK, and Switzerland. Available hard data for Q3 is mixed, while soft data is dreadful.
  

• Weak growth is likely to continue in China, barring significant measures by the government to jumpstart the economy. Consumption spending and industrial activity remain anemic, while the real estate sector continues to struggle. In contrast to Europe and China, Japan is a relative bright spot, with economic growth underpinned by solid consumption and business spending and a more supportive central bank.

Executive Summary

Economic Outlook

• Global economic activity remained resilient through the third quarter of 2023 despite considerable monetary tightening by global central banks over the past 18 months, which prompted speculation earlier this year that a US recession was imminent.
  
• Strong labor demand in the US has provided a buffer to household incomes and supported private consumption, while fiscal stimulus continues to boost the economy. The most likely economic scenario is one of modest US growth in the back half of 2023 and into 2024, with a lower risk of recession in the near term.
  
• Europe's post-COVID recovery has already faded, with Q2 GDP growth just barely positive in the Eurozone, UK, and Switzerland. The risks of a European recession are significant. Available hard data for Q3 is mixed, while soft data is dreadful.
  
• In contrast to Europe and China, Japan is a relative bright spot, helped by a relatively more supportive central bank. The Japanese economy remains underpinned by solid consumption and business spending.
  
• Weak growth is likely to continue in China, barring significant measures by the government to jumpstart the economy. Consumption spending and industrial activity remain anemic, while the real estate sector continues to struggle.
  
• Central banks are making progress in their fight against inflation. US headline inflation remains driven by geopolitics and OPEC+ supply cuts, but core inflation has declined from its peak. Eurozone core has moderated slightly from its recent high.
  
• Although their hiking cycles appear to be ending, the US Federal Reserve and European Central Bank are likely to keep monetary policy tight until they have more confidence that they can reach their inflation goals. The Bank of Japan has kept interest rates low as other central banks raised rates and is just beginning to allow more flexibility in its yield curve control program.
  
• While the People's Bank of China has continued to cut interest rates marginally in Q3, it continues to hold back from a "bazooka" stimulus to restart the economy.

Market Outlook

• Global equity markets delivered mixed performance for much of the third quarter, with US stocks pulling back modestly despite better-than-expected corporate quarterly results.
  
• The dominance of a narrow field of mega-cap stocks moderated this quarter following exceptional performance in H1. Flat-ish to negative returns for this group, as well as most other global asset classes, defined Q3.
  
• Our view has shifted to a more balanced one, as the incoming hard economic data in the US lessens the possibility of a near-term recession occurring.
  
• The third quarter also likely marked the trough in the earnings cycle as growth expectations for future quarters turn positive and move past the negativity of Q2.
  
• However, we are cognizant that the high valuations of US equities already price in an optimistic scenario, so it's difficult to see much further upside.
  
• While sector composition often explains much of the difference in valuation between the US and the rest of the world, US stocks are expensive even after accounting for composition effects.
  
• Within equities, we prefer US and Japan over Europe, as Europe will likely experience more challenges in its fight with stagflation.
  
• On a cross-asset basis, the equity risk premium of the S&P 500 has recently dipped below the risk premium for high yield bonds, making the former relatively less attractive on valuations.
  
• Fixed income assets are attractive, especially the higher rates found in lower duration assets. Although declining inflation and economic weakness potentially on the horizon are supports, persistent risks include inflation remaining sticky and central banks keeping rates higher.
  
• While commercial real estate was calm in Q3, underlying problems linger and the sector is likely to remain an overhang on banks.
  
• Following a strong quarter for commodities, energy is expected to remain supported by supply-side issues, while industrial metals have a muted outlook on soft recovery-related demand-side factors.