Global Growth Should Strengthen Next Year, Lifting Equities

Key Points

• Equities have been rising, although we believe stronger economic growth is needed to promote an increase in corporate earnings and stock prices.
• Investors have reasons for concerns, but we think the long-term positives outweigh the negatives.

Markets were mixed last week, but the S&P 500 Index was up 0.2%, posting its fifth consecutive weekly gain.¹ Last week’s highlight was Wednesday’s Federal Reserve meeting. The central bank left rates unchanged, but indicated the possibility of an increase in December. Corporate earnings were also in the news, with several companies posting positive results. The health care sector made a notable turnaround to become the best performing last week while utilities lagged.¹

Weekly Top Themes

1. Third quarter gross domestic product growth was mixed, but critical areas showed strength. Real GDP growth rose 1.5%, in line with expectations.² Inventory accumulation detracted most from growth, while trade was largely neutral.² Importantly, domestic demand was positive, with consumer spending up 3.2% and residential investment up more than 6%.²
2. Holiday spending should be strong. A recent Gallup survey showed spending intentions at their highest level since 2007. Consumers do not appear to be worrying about issues such as slowing Chinese growth, widening credit spreads and bond market liquidity that keep Wall Street analysts up at night.
3. The budget deal should contribute to economic growth and stability. The twoyear deal to raise the debt ceiling and increase federal spending marks the end of a multi-year period of budget austerity. We expect the increase in spending should contribute 0.1% to 0.2% to U.S. growth over the next year.
4. The possibility of a December rate increase appears to be growing. In the statement that accompanied the Fed’s meeting, the central bank shifted the theme of its message from maintaining low rates to possibly raising them. The Fed also explicitly mentioned the "next meeting" in December as a time of possible action. Equities dipped and then recovered following the news,¹ which we think is a good sign that investors are prepared for higher rates.
5. Outside of the energy sector, earnings growth is accelerating. With two-thirds of companies reporting results, third quarter earnings are on pace for a slight decline of around 1%.³ Excluding energy, that number would rise to a positive 7%.³ The health care, consumer discretionary and technology sectors have been showing particular strength.³

The Positives Mostly Outweigh the Negatives

The macro outlook remains uncertain, but we think the long-term prospects for global economic growth remain reasonably good. Central banks remain focused on promoting growth, and most parts of the U.S. economy are doing well (particularly the consumer sector). Decoupling will likely persist, with the United States continuing to exhibit stronger growth compared to most of the rest of the world.

Over the past month, global equities have rallied strongly, largely due to signs of stabilization in China and signals from central banks around the world that policy will remain broadly accommodative. Looking ahead, we think these trends should continue to provide tailwinds for equity prices, but we acknowledge that global economic growth must strengthen for both corporate earnings and equity prices to improve. We expect global corporate profit levels to advance, but possibly not until next year when the negative effects of the rising U.S. dollar and falling oil prices have faded.

On balance, our view toward equities remains cautiously optimistic. We’ll close with a look at seven positive factors and seven areas of concern:⁴

Positive Factors	Areas of Concern
Monetary policy should remain accommodative	Corporate earnings are heading in the wrong direction
Corporate America is healthy	Equity markets are not as inexpensive as they used to be
Risks from Washington, DC have been reduced	Upward wage pressures are rising
Signs of stability in China are emerging	Global growth remains under pressure
The U.S. housing market continues to grow	The Federal Reserve may be behind the curve
M&A activity is still happening	Investor sentiment remains depressed
Companies are engaging in stock buybacks and dividend increases	M&A activity could be hindered by regulatory pressures

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