[GREETING] Thank you for joining me today. Over the next half hour or so, I’ll offer AB’s assessment of the global economic and capital markets landscape. I’ll also offer our insights on the opportunities and risks we see globally. If we start with the 30,000-foot view, we’ve seen continued positive momentum so far in 2017. But today, we’ll look at the various stories within the story, because once you scratch the surface, you start to see issues that could change the direction or the force in economies and markets— both globally and locally. Over the past six or so years, we’ve gone from the Great Beta Trade, to After the Beta Trade, then the Trump Bump, which started to unwind in March of this year, even as markets, in general, continued to do well. But there are questions as to when fiscal policy may step in, and if and when further monetary tightening may reach a point of changing the current course of the markets. And while the global growth theme is one of broad improvement—both developed and emerging— possible stress points are always just under the surface. The issue for investors now is where to find growth, but without going too far out on a limb. It’s been a long time since we’ve had a notable correction, so it’s important for investors to determine how to participate and also defend. With that in mind, let’s take a look at how markets did in the third quarter. 0
The third quarter produced solid to strongly positive performance generally across the board. In equities, there was a continuation of strength that’s been going on for some time. Across the board, equity returns are in double-digits year to date, with emerging market returns strongest. And the major fixed income indices are all positive, with a rather strong showing by munis. Also, alternatives have generally done better than 2016, notably long-short equity. But there’s an extremely important story within the story, and we all need to examine the big picture so that we can get back to the basics of steady and safe long-term investing—that ability to both participate and defend. 1
For many years, we’ve talked about 4 pillars that have been major drivers of the global economy: Moderate, below trend, but improving global growth Low global inflation but not deflationary As a result of those two conditions, we got the third and fourth pillars: Highly accommodative, well below trend rates – particularly in the developed world; and Large amounts of nontraditional monetary support in the form of QE and the like. For many years, these have been the structural backdrop that underpins our perspective on economic and market movements—as balance to the “noise” of short-term shifts. But once again, things appear to be changing, so this backdrop is important to keep in mind to invest with objectivity and insight. The first pillar—global growth. After quite a number of years of saying “below trend global growth,” we can update that and remove “below trend”, because global growth has now reached trend-level growth. Now, it’s moderate and improving global growth. But usually, if you have synchronized, improving global growth, you’d expect there to be inflationary pressures. Essentially, economic growth is supposed to drive consumption and more hiring; then more hiring drives more wage gains, and more wage gains are inflationary. So, improving growth should eventually lead to inflationary pressures. But we’re not yet seeing that corresponding rise in inflation. As a result, monetary policy has to navigate this interesting world where growth would say you should tighten monetary policy, but low and sluggish inflation would say you can stand pat. Central banks are testing the coexistence of these two pillars, and they seem to be OK with potentially structurally low inflation while still allowing for a tightening of policy. But they do think more inflation pressure will happen over time, because you can’t continue to take down available labor force candidates and not get some kind of pressure over time. 2
Let’s look at what’s driving global growth today and its return to the long-term trend. Global growth rose to 3.2% in the second quarter, the best showing since the first half of 2011. And survey data in the composites of the Purchasing Managers Indexes (PMIs) suggest that this strong performance continued through the third quarter. There’s a strong correlation between manufacturing PMIs and GDP, as the left-hand chart shows. The continued climb of the global manufacturing PMI reflects the synchronized global growth picture—the back-to-trend growth that we’ve now got. And the middle chart shows that’s true for both the developed market and emerging market pictures. And it’s broad within developed markets by country and region as well—with upward trends in manufacturing output for the US, euro area and Japan 3
And with economic growth, as we mentioned a moment ago, you’d expect that developed market jobs will grow. And they have. The left-hand chart shows that unemployment is now well below-trend in the developed world. But wages haven’t yet climbed with that job growth. The middle chart shows that wage gains have continued to be pretty benign. Consequently, with no wage pressures pushing through, overall CPI inflation—specifically core inflation—continues to run below trend. 4
While developed markets have this improving growth and moderate inflation story, so do emerging markets—but with a twist. The left-hand chart shows that EM market growth is picking up, but headline inflation is now lower, which is fairly benign relative to its history. Along with that, the middle chart indicates that general country balance sheet metrics have improved following the Taper Tantrum. So you’ve got EM countries with pretty good growth that’s getting better, low inflation and improved balance sheets. Lastly, the right-hand chart shows the inflation-adjusted real rates for both EM and DM and how much more attractive EM real rates—especially when you look at the differential between them, which is slightly larger than EM because some DM real rates are currently negative. The net result of this combination allows EM countries to generally stay accommodative in policy and even cut rates, which some of them are doing. 5
So broadly, on a relative basis, for both the developed and emerging markets, growth is good and getting better; inflation is moderate and below trend, probably structurally so. But in the developed markets, that’s generally translating into neutral to tightening policy; while in EM, it’s translating into neutral to easing policy. Now, some of that has to do with the developed market countries also using a great deal of QE, which is something that was largely absent from emerging markets, except maybe China with its ongoing fiscal policy stimulus. So on our map: In Canada, strong growth has warranted tighter policy rates, but we expect them to proceed cautiously. US has announced its reduction in the balance sheet, which should, more or less, cut the level of the Fed’s balance sheet in half by sometime in 2020 [thereby taking most of their “excess” reserves close to zero]. The ECB will mostly likely (in October) start talking about beginning tapering, and run down their program through 2018, at which time they may start taking their rates up. Even the Bank of England has talked about possibly raising rates—in part, because they have to keep up with the rest of the DM. With so many of their developed neighbors on the world stage tightening, the BOE’s policy by comparison, becomes more stimulative as others tighten, so they might have to move directionally that way, too. Only Japan seems likely to stay with its QQE YCC [quantitative and qualitative easing / yield curve control] policy of targeting the 10-year rate at zero. But if they’re successful in continuing to generate a level of inflation and growth, even they could have a form of QE, because the amount of bonds they would have to buy to keep the yield up around zero would be less. So that would be more of an indirect QE reduction, if they just simply had to buy less bonds. Meanwhile, on the other side, emerging markets are getting neutral to easing policy. And probably the two most notable “easing” discussions are around Russia and Brazil. Largely, those are becoming stabilizing economies, and stable or declining inflation, that allows for rather aggressive easing of policy in both countries. Russia – undershooting on inflation targets allows them to do more cutting Brazil – everyone has been expecting the Selic rate [Sistema Especial de Liquidação e Custodia—i.e., Brazil’s overnight rate] to ease for some time. Overall, what this means for the world in light of those four pillars, is that the global economy is growing pretty well, with continuing improvements expected. Inflation remains benign, with the developed world using that opportunity to start taking down some of their stimulus measures, particularly by reducing the amount of QE—with the Fed taking down its total amount, while the ECB starts tapering the amount they will buy. And in the emerging market world, they’re using that combination of economic growth with subdued inflation to keep policy relaxed or, in some cases, cutting rates, to benefit their economies. 6
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