Scenario modelling has formed part of Citadel’s investment philosophy for over 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 macroeconomic 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.
High conviction scenario: medium-term expected returns
Our High conviction scenario assumes the global economy will grow close to capacity over the next three years. Rate cuts and loose fiscal policy are expected to help the United States (US) maintain growth near capacity, support recovery in Europe, and prevent a sharp slowdown in China. Inflation is closer to target in most areas, though core inflation (excluding volatile items like food and energy) remains sticky and US tariffs pose upside risk. The US labour market is softening, with past job growth figures revised down. The US Federal Reserve and Bank of England are expected to cut rates further, while the European Central Bank remains on hold, and the Bank of Japan may need to hike rates. Lower rates should support company growth and earnings, though the impact will vary across regions and unfold at different speeds.
Equity earnings growth is expected to be strong in the US and select emerging markets (EMs) over the next three years, while more moderate growth is likely in other developed markets. US valuations are assumed to remain elevated as conditions for the secular (long-term) bull market persist, while emerging and European markets trade closer to long-term averages. Over the medium-term global equities are rated neutral.
Cash remains attractive despite projected rate cuts. US bonds are now trading at yields below our fair value assumptions. Government bonds are rated neutral, while credit is below neutral due to tight spreads. Market consensus is that we are likely in a secular US dollar bear market, and the potential impact of a weaker dollar on fixed income returns and company earnings should be factored in.
The South African (SA) outlook remains unchanged, with structural growth constraints persisting. The Johannesburg Stock Exchange has been driven by resources, with earnings surprising to the upside. Valuations are now less attractive. The South African Reserve Bank is expected to cut rates twice more over the next year, with real rates remaining relatively high. SA 10-year bond yields are trading below our fair value assumption. Ratings for SA assets remain unchanged: cash above neutral, and bonds and equities neutral over the medium term.
The chart below shows the three-year expected return versus the historical standard deviation of each asset class, based on our High conviction scenario.
Near-term asset class views
Our investment process is anchored by a High conviction macroeconomic scenario and the corresponding expected returns for asset classes. This foundation helps us form expectations about how markets should behave. However, we are keenly aware that short-term market behaviour frequently deviates from these expectations. We have long recognised that medium-term, valuation-based signals are often poor guidance for short-term asset performance.
To address this, we’ve developed a range of tools and indicators to enhance our short-term analysis. These include a close examination of market dynamics, cross-asset correlations, and currency and commodity trends, and several other technical factors. These insights help us adapt our views and make more informed short-term decisions.
The diagram below gives a visual representation of how these two parts of the process play into each other.
In addition to our top-down (looking at the broader market) analysis, we integrate the bottom-up (company) insights provided by our analysts. Their detailed research on individual companies and sectors plays a crucial role in shaping our overall views. When bottom-up analysis reveals fundamentals that diverge from market signals – positive or negative – we take this into account in refining our positioning. This dynamic approach allows us to balance macroeconomic factors with granular insights, ensuring our investment decisions reflect both the broader market environment and underlying characteristics of individual assets.
Our latest asset class views are summarised below. The orange circles represent the short-term views from the team, with an indication of risks leaning towards the up or downside. Where the High conviction scenario medium-term signals are different from the short-term views, it is indicated in blue. To determine the signal as Neutral or Above and Below, the model compares expected returns to what investors have historically required from these asset classes. For example, a Neutral Outlook implies a real expected return range of 1% to 3% for SA Cash, 2.5% to 5.5% for SA Bonds, and 4.5% to 9.5% for SA Equity. No currency views are taken; currencies are assumed to move in line with short-term interest rate differentials for modelling purposes.
