Medium-Term expected returns
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.
Our High Conviction scenario assumes that the global economy will grow close to capacity over the next three years. Growth in the United States (US) is expected to moderate, China should maintain its growth through stimulation, and we anticipate a slow recovery in Europe. Inflation moderated in 2024 but remains sticky and above target in some regions. Central banks (except for the Bank of Japan) should continue to cut rates, but at a more gradual pace in 2025 and into 2026. While lower rates should support economic and earnings growth, the impact will vary across regions and unfold with differing time lags.
The US market (making up 65% of the MSCI All Country World Index) returned more than 20% over two consecutive years. While initial gains were driven by valuation expansion, earnings growth has picked up strongly (primarily driven by the “Magnificent 7” tech giants). Under our High Conviction scenario, we expect earnings growth to continue and broaden to other sectors and regions. Based on price-earnings valuation, the US market is historically expensive, but we assume valuations will remain elevated over the near-term because of the index weights and growth potential of the US tech giants. Emerging markets (EMs), Europe, and Japan are trading closer to historical averages. Over the medium term, global and US equities are rated neutral, while the UK, Europe, Japan, and EMs have moved to an above-neutral rating following the recent sell-off.
US dollar cash remains attractive over the next three years, despite the assumed rate cuts. US bond yields rose sharply and are above our fair value assumptions. Government bonds are rated neutral. Investment grade and high yield bonds are also rated neutral due to attractive yields, despite spreads tighter than our fair value assumptions.
The South African (SA) outlook is improving, and we assume a gradual pick-up in economic growth and stable inflation. The Johannesburg Stock Exchange rallied sharply following the market-positive election outcome but pulled back sharply since October last year. Valuations are reasonable and earnings expectations are picking up. The South African Reserve Bank is assumed to cut rates further in 2025, but high real rates are set to remain in place. We have lowered our exit yield assumption for SA 10-year bonds to 10.75%. SA cash, bonds, and equities are rated above 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’ve 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.
How the market should be acting How the market is acting
In addition to our top-down analysis, we integrate the bottom-up 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 strong fundamentals that contradict broader market signals, we adjust our stance accordingly. This dynamic approach allows us to balance macroeconomic factors with granular insights, ensuring our investment decisions reflect both the broader market environment and underlying asset strength.
The following asset classes have a different short-term signal, to the medium-term fundamental valuation or expected return signals:
- SA government bonds’ medium-term signal remains neutral, but on a short-term basis we are cautious given that the embedded risk premium in SA bonds has now fully priced in an upgrade to BB.
- US treasuries’ medium-term signal is neutral, but we see a short-term buying opportunity after a sharp sell-off in US bonds as the market grapples with pricing in the effects of Trump’s policies.
- SA listed property has a neutral medium-term signal, however on short-term view we are cautious given the exceptionally strong rally in the asset class during 2024.
- European, Japanese, and EM equities are attractive from a valuation perspective and have a medium-term above neutral signal; from a shorter-term perspective it remains marked down to neutral given the lack of earnings growth and the challenging economic landscape.
Our latest asset class views are summarised below.
