(Bloomberg) — US stocks have started exiting bubble territory and returns from here will be muted, according to Citigroup Inc. strategists, as risks from monetary tightening and collapse in technology stocks mount.
“With the US exiting bubble territory, this calls for caution on US equity risk,” strategists including Dirk Willer wrote in a note. They expect “subpar” returns from here and recommend favoring cheaper, so-called value stocks over growth shares.
The strategists said that the US stock market entered bubble territory in October 2020, and that most of the froth has been concentrated in non-profitable American technology companies. Other global assets, including US real estate, aren’t triggering bubble warnings, Citi said.
“When a major equity market bubble is deflating, it may undermine most global equity markets, not just the one that is deflating,” Citi strategists said. “This would suggest that a potentially deflating US bubble should be a negative for equity risk more broadly.”
Stocks that are valued on future earnings growth, and especially tech, have been leading the selloff in global equities over the past weeks. As the Federal Reserve embarks on interest rate hikes to tame surging inflation, expensive growth shares have suffered as higher rates mean a bigger discount for the present value of future profits. This marks a shift in investor outlook after tech stocks had been some of the market’s best performers for years.
Citi strategists led by Robert Buckland earlier today also said in a note that growth stocks, including the battered tech sector, will likely remain under pressure as central banks tighten monetary policy, driving yields higher. They are especially wary of growth stocks in the US, where the tech-heavy Nasdaq 100 has slumped to November 2020 lows and is down 27% this year.
Buckland prefers cheaper, so-called value stocks, according to a portfolio they’ve modeled to protect against rising real yields. They also favor UK and emerging market stocks over the US and continental Europe.
“Any stabilization in nominal yields should eventually help to stabilize real yields and hence equity valuations,” he wrote in a note.
The Nasdaq 100 index is now trading at about 20 times forward earnings, the lowest since April 2020 and at about the average level seen over the past decade, according to data compiled by Bloomberg. This compares with about 29 times seen at a record high in November.
(Updates with Willer’s comments from first paragraph)
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