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Citation – Second Quarter 2023



Harold Strydom
Investment Strategist and Portfolio Manager
Estimated reading time: 3 minutes 19 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 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 global economy experiences the impact of rising interest rates and tighter lending standards with a delay, that can be lengthy and unpredictable, and at present, economic indicators show a mixed picture. However, unless we believe that “this time is different”, another economic slowdown lies ahead. This will likely impact company earnings negatively.

Given the current market conditions, the global economy is assumed to grow below capacity over the next year, with weak growth across developed markets as tighter monetary policy and lending standards take effect in the United States (US) and Europe, countered by better growth in emerging markets like China and India. A recovery in market conditions will follow this below capacity growth.

In the markets, moderate earnings growth is projected over the next three years according to the GDP-to-profit capture and earnings normalisation methodologies used in our modelling. Particularly in developed markets, earnings are well above trend following the post Covid fiscal-induced boom. Except in the US, which drives global equity, valuations (trailing price-earnings ratios) are fair to attractive in most regions. The valuation signal from global equity, including the US, is now firmly below neutral, while Europe and emerging markets sit above neutral. Enhanced cash is rated above neutral under our assumptions, while bonds are rated neutral overall. Investment grade credit expected returns are attractive, with above average spreads – but we must remember that historically, spreads widen sharply when recessions occur.

In line with the global economy, the South African economy is assumed to grow below capacity over the next year, also with a recovery assumed thereafter. JSE-listed companies’ earnings are well above trend and no earnings growth is projected over the next three years. The JSE, however, is attractive from a valuation perspective. Local interest rates should continue moving in line with the global interest rate cycle, and as such, we assume a very steep yield curve, and high real long-term bond yields in recognition of South Africa’s fiscal and structural challenges. South African 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.

(Please click on the image below to enlarge it)

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.