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.
Our current High Conviction scenario assumes that the global economy will grow close to capacity over the next three years. Headline inflation has moderated closer to target in most regions and this opens the door for central banks to start cutting interest rates, which should be supportive of growth. However, the effect of falling interest rates will, similar to rising interest rates, impact regions differently, and with variable lags. Overall, monetary policy is assumed to remain more restrictive than the previous cycle, with higher real interest rates.
Equity markets have done exceptionally well, and valuation expansion has been the biggest driver. Earnings growth has picked up this year and, under our High Conviction scenario, this is expected to continue over the next three years. From a price-earnings valuation perspective the United States (US) market and parts of emerging markets (EM) are expensive, while Europe and China are trading closer to fair value. Over the medium-term, global equity has a neutral rating, along with Europe and EMs, while US equity has a below neutral rating.
US cash is attractive under our assumptions. US government bonds and investment-grade credit are rated neutral, with yields and spreads close to our fair value assumptions. High yield bonds are less attractive, with tight spreads.
There is still too much uncertainty around the effectiveness of the Government of National Unity to make meaningful changes to our South African (SA) assumptions. We continue to assume the SA economy will grow below capacity over the next year, with a recovery thereafter. The JSE is attractive from a valuation perspective, but the earnings growth outlook uncertain. Interest rates are expected to continue moving in line with the global interest rate cycle and cuts are assumed. We assume a very steep yield curve, and high real long-term bond yields in recognition of SA’s challenging fiscal position. SA cash and bonds are rated above neutral, but SA equities are rated neutral.
The table below offers a summary of our Medium-Term Asset Class Valuation Signals based on our three-year High Conviction scenario. It is important to note that medium-term valuation-based signals are typically not good short-term market timing tools.
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