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Citation - Fourth Quarter 2023



Harold Strydom
Investment Strategist and Portfolio Manager
Estimated reading time: 2 minutes 16 seconds read

Scenario modelling has formed part of Citadel’s investment philosophy for two decades, and it enables us to better understand potential market outcomes and construct stronger portfolios. The Citadel Asset Management team has a core or “High Conviction” scenario based on a three-year view, which is expressed as macro-economic and market assumptions, including economic growth, inflation, interest rates, price-earnings multiples, and credit spreads, to list a few. Based on these assumptions, our asset valuation models produce expected returns for various asset classes. This section is used to summarise our High Conviction view and the resulting asset signals.

Our High Conviction scenario continues to assume below capacity global growth over the next year, with a recovery thereafter. Economic indicators still paint a mixed picture, with traditional recession indicators flashing red. The sharp rise in interest rates and tightening of lending standards have not yet fully impacted economic growth, and as such, any policy easing is also expected to have a lagged impact.

Inflationary pressures continue to ease, and we assume rate cuts later this year. Monetary policy is, however, assumed to remain more restrictive than the previous cycle, with positive real rates. Bond yields are lower and trade close to the assumed fair value.

Earnings remain above trend in developed markets, caused by the post-Covid fiscal-induced boom. However, in conjunction with below-capacity GDP growth assumptions, our earnings models project only moderate growth over the next three years. Following the strong equity market rally into year-end, US valuations are even more stretched, but Europe and emerging markets (EM) remain attractive, with the latter driven by the derating in the Chinese stock market. Global and US equities are rated below neutral, whereas European and EM equities are rated above neutral from a valuation perspective.

Cash is attractive under our moderate rate-cut assumptions. Government bonds and investment-grade credit shifted to neutral after the sharp fourth quarter rally. High yield bonds are less attractive, particularly considering the risk of spreads widening in a weak growth environment.

The South African economy is assumed to grow below capacity over the next year, with a recovery thereafter. The JSE is attractive from a valuation perspective, but the earnings outlook is weak. Local interest rates are assumed to continue moving in line with the global interest rate cycle. We assume a very steep yield curve, and high real long-term bond yields in recognition of South Africa’s challenging fiscal position. Local cash, bonds and equities have an above neutral rating.

The table below offers a summary of our Medium-Term Asset Class Valuation Signals based on our three-year High Conviction scenario. It is important to note that valuation-based signals are typically not good short-term market timing tools.

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Source: Citadel. The outlook shown reflects the signals from Citadel Asset Management’s asset valuation models and is based on each asset class’s three year expected return. The model’s expected returns are compared to what investors historically expected from these asset classes. As an example a Neutral Outlook will be roughly 1% real return for Cash, 3% for Bonds, 4% for Gold and 6% for Equity and Property. Noted that no currency views are taken and currencies are assumed to change in line with interest rate differentials for modelling purposes.