Will Policy Shifts Ignite Global Growth?

As stimulus sparks fly across global economies, the question on everyone’s mind is whether these changes will ignite a new phase of growth. Where there’s smoke there’s often fire, and recent moves by central banks and governments suggest that efforts to reinvigorate markets are heating up. Let’s explore how these policy shifts could shape the path forward for global growth.

The Forces of Change

Global equities posted gains during the third quarter, bouncing back from a sharp sell-off in early August. Markets remained sensitive to any signs of deterioration in economic data and closely monitored the tone of central bank commentary on monetary policy.

Japanese equities experienced notable volatility due to an unwinding of the carry trade, which was seemingly triggered by a rate hike from the Bank of Japan and concerns over weaker-than-expected U.S. labor market data. However, several key developments helped markets rebound by the end of the quarter, including the U.S. Federal Reserve’s (Fed’s) much-anticipated interest-rate cut and China’s announcement of a new round of stimulus measures.

The global disinflation narrative drove a rotation out of growth and momentum into small-cap and rate-sensitive areas of the market.

From a style perspective, growth equities, which had significantly outperformed during the first half of the year, underperformed value equities during the third quarter. The global disinflation narrative throughout the quarter drove a rotation out of growth and momentum into small-cap and rate-sensitive areas of the market.

Despite these shifts, fundamentals remain strong and earnings growth estimates for the third quarter indicate continued resilience, with expectations for further breadth in the market.

Now let’s look at a few key developments by region.

United States and Europe: Fed Rate Cut Marks a New Phase in Economic Expansion

The Fed reduced the federal funds rate by 50 basis points in September, an acknowledgement that the post-COVID rate of inflation had subsided to the point that monetary policy could be recalibrated. Other global central banks have and will follow suit.

In addition to declining inflation, stable employment and wage growth should boost demand, so we believe most of the world’s developed economies will remain in an expansionary phase.

That said, consumer spending patterns have shifted significantly since COVID-19, moving away from goods and toward services. While the pandemic saw a surge in demand for goods, the weak industrial production we are now seeing reflects the aftereffects of that boom—an unusual trend during a period of economic expansion. As this shift in spending continues, demand for both consumer goods and industrial products is likely to decelerate through 2025.

However, this slowdown isn’t uniform across the industrial sector. Beyond goods production, there is strong growth in nonresidential, private fixed investment, particularly in infrastructure and equipment, signaling continued expansion. Additionally, robust services purchasing manages’ indices (PMIs) highlight the resilience of consumers and their increased willingness to spend on services.

It’s worth noting that goods-producing firms are more heavily represented in public equity markets than firms that focus on consumer services.

Japan: Economic and Political Winds Shift

Japanese wage growth has increased in real terms for two consecutive months, boosting the country’s reflating domestic economy.

While the Bank of Japan is gradually moving toward monetary policy normalization, its main focus is likely to remain on ending deflation. As the Fed and other central banks ease policy, we expect the gap between Japanese and global yields to narrow, leading to a gradual, though uneven, appreciation of the yen.

We remain optimistic that Japan’s ongoing structural reforms could benefit its equity market.

We remain optimistic that Japan’s ongoing structural reforms could benefit its equity market. The Liberal Democratic Party (LDP) recently elected Shigeru Ishiba as its leader, positioning him to become the next prime minister. A former defense minister with decades of experience in the House of Representatives, Ishiba plans to continue his predecessor’s policy agenda. Compared to other candidates, he is slightly more hawkish, believing that the Bank of Japan should independently decide when to normalize policy. Overall, however, we expect any impact on markets to be limited, assuming no major policy changes.

China: Market Sentiment Shifts as New Stimulus Unveiled

The Fed’s recent rate cuts have opened the door for the People’s Bank of China (PBoC) to introduce its own stimulus measures to support the struggling Chinese economy. After criticism that previous monetary easing was insufficient, the September policy adjustments were more substantial, aiming to lower costs for homeowners. However, the possibility of large-scale fiscal stimulus remains uncertain, and its effect on consumer sentiment and spending is still unclear.

Our team continues to analyze the near-term impacts of these measures. China continues to face significant structural challenges, including an aging population, high youth unemployment, and elevated debt levels. The economy is also in a prolonged cyclical downturn, exacerbated by historically low consumer confidence and a property market decline. While it is uncertain whether this stimulus can alleviate some of the cyclical deflationary pressures, the boost in market sentiment is notable.

We believe non-U.S. and emerging markets equities could be the potential beneficiaries of falling interest rates and the likely weakening of the U.S. dollar.

The Chinese market has been underperforming for years, and valuations reflect a widespread pessimism toward Chinese equities—justifiably so, given the sluggish growth. However, if recent and future policy measures succeed in stimulating growth, the potential for corporate earnings to rise in the short to intermediate term could be dramatically underappreciated.

While we believe the market will ultimately be discerning in differentiating between winners and losers, these recent developments warrant our reassessing of investment positions. This includes reconsidering the underweight stance that we and many global investors currently have and reevaluating the composition of allocations to Chinese assets. We expect greater clarity to emerge in the fourth quarter.

Looking Ahead

Looking ahead to late 2024 and early 2025, we believe non-U.S. and emerging markets equities could be the potential beneficiaries of falling interest rates and the likely weakening of the U.S. dollar.

Ken McAtamney, partner, is a portfolio manager on William Blair’s global equity team.