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Citation - First Quarter 2023



Harold Strydom
Investment Strategist and Portfolio Manager
Estimated reading time: 2 minutes 14 seconds

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 (PE) 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.

The outlook for the global economy remains highly uncertain. Economic indicators are mixed, and the full impact of the sharp interest-rate hiking cycle is yet to filter into the real economy. Recent bank failures are indicative of stress in the system and likely to lead to a further tightening of credit conditions. Most recession indicators continue to flash red and the probability of a more severe economic downturn in 2023/24 has increased over the last quarter.

When we construct portfolios, we consider a range of potential economic outcomes, with multiple scenarios feeding into our asset allocation process. Our current High Conviction scenario assumes that global economic growth will be below capacity over the next two years, with weak growth across developed markets. We assume better growth in emerging markets, due to China’s expected rebound.

Projected earnings growth reflects this view, and overall moderate earnings growth is expected for global equity. Valuations (trailing PE ratios) are attractive in most regions, but not the United States (US). Global equity’s rating have slipped to below neutral, along with the US, while Europe is neutral and emerging markets find themselves above neutral. Fixed income is rated neutral overall. Enhanced cash is attractive given the rate hikes. Bonds have rallied but yields remain above our assumed exit yields. Investment grade credit spreads are above long-term fair value assumptions. We believe the investment horizon is crucial, as volatility is expected to persist across markets in the near-term.

South African (SA) capacity growth is impaired by structural issues, and we assume below capacity economic growth for the country. JSE-listed companies’ earnings are well above trend and no earnings growth is projected over three years. However, the JSE is attractive from a valuation perspective. 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 SA’s fiscal and structural challenges.

See the table below for a summary of our Asset Class Valuation Signals based on our three-year High Conviction scenario.

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 return is 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 inflation differentials for modelling purposes.