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Citation Third Quarter 2023



Investment Strategist and Portfolio Manager
Estimated reading time: 2 minutes 13 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.

The effect of rising interest rates and tighter lending standards has impacted the real economy with “long and variable lags”. While economic indicators continue to paint a mixed picture, various recession indicators continue to flash red.

Within the High Conviction scenario, the global economy is assumed to grow below capacity over the next year, after which a recovery is assumed. Headline inflationary pressures have eased, but certain core measures remain sticky and the labour market remains tight. Monetary policy is assumed to remain constrictive for some time, but rate cuts are assumed within our three-year horizon.

With company earnings still above trend, particularly in developed markets, due to the post-Covid fiscal-induced boom, and with below capacity GDP growth expected, our earnings models project moderate growth over the next three years. Valuations in most regions are attractive; however, this is not the case in the US. After the recent sell-off in equities, global equities moved to a neutral rating, US equity remains below neutral, while European and emerging market equities are rated above neutral.

With higher interest rates, cash is attractive. After the recent sharp sell-off in bonds, yields have risen to attractive levels and government bonds and investment grade credit are rated above neutral overall. High yield spreads, however, are not attractive, especially with a risk that spreads widen in a weak growth environment.

The South African economy is assumed to grow below capacity over the next year, with a recovery thereafter. JSE-listed companies’ earnings are still above trend and only moderate earnings growth is projected over the next three years. The JSE is attractive from a valuation perspective. 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 deteriorating fiscal position. SA 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 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.