Citi is buying stocks again - and it’s all thanks to AI

Mega-cap tech stocks were already on a tear this year, when Nvidia completely shot the lights out. Its earnings report revealed a near-20% bump in revenues and a 26% jump in earnings. The numbers handily beat analyst estimates, and the share price roared in response. In just one day, Nvidia added US$190 billion to its market cap - a feat only matched by fellow tech giants Apple and Amazon. 

And it’s not just the retail investor that’s getting involved. Following the Nvidia report, tens of sell-side analysts upgraded their price targets for the stock. 

But Citi has gone one better, leaning into the potential that AI-linked stocks can bring to portfolios. Here is what analysts had to say in a note released earlier this week:

AI may continue to remain a kicker, given that it is not far enough developed [sic] to disappoint expectations yet. Given that AI is mostly a US mega large cap theme, this should also reduce the risk of any US underperformance.

In this wire, I’ll share the latest changes to Citigroup’s model portfolio which includes some major changes in favour of risk assets.

Key changes:

• Upgrading US equities from underweight to neutral, favouring tech, healthcare, consumer staples, industrials, and energy stocks.

• Downgrading its view on Chinese and Eurozone equities.

• Closing its long position on precious metals, maintaining a neutral rating on energy and base metal investments.

Macro disappointments

Following the banking crisis of March, the team argues that the quality of US economic data is likely to worsen in coming months. But, when put in comparison to other economies that should have been doing better than the US, the numbers look good. 

For starters, Chinese data has been very soft. The Xi administration is targeting a 5% growth rate but it may find it difficult to achieve that if youth unemployment remains where it is at the moment - 20.4%. And although industrial output is rising, corporate profits fell 20% between January and April this year. 

In the Eurozone, the data is even softer with inflation still hovering around 7% and economic growth hitting a three-month low. It’s also not helpful that Germany, the economic powerhouse of Europe, is now in a technical recession.

What does it all mean for asset allocation? 

The all-important overweight/underweight table. Source: Citi

In short, the disappointing data from economies abroad has given the team a green light to reallocate capital towards the US. They remain overweight US real rates, which is in turn, an overweight position on nominal rates (these are the US yield prints you see on TV). 

More importantly, as the US Federal Reserve nears the end of its rate hiking cycle, equities are likely to perform better. And of course, the peak in rates is great news for growth-oriented assets. 

“Given widely held bearish views, and the fact that we are still in the bad news is good news regime, we would imagine that an end of the Fed hiking cycle, not driven by a crisis situation, would be bullish for US equities.”

Reaching closure on the debt ceiling debacle has also afforded Citi the opportunity to close its long position on precious metals. They argue now is the time for gold investors to take profits.

Gold is not a strong performer, following the resolution of debt ceiling debates. Source: Citi

“There is a risk that further Fed cuts get priced out of the front-end, resulting in a stronger USD which will continue to weigh on gold in the short-term, especially in a context where both Chinese and European growth have been disappointing.” 

They continue to believe oil will be range bound and copper demand will remain subdued unless China pumps more stimulus into its economy.

Finally, the team continues to remain long government bonds and underweight on most parts of the corporate credit market. Over the last few months, credit investments have not benefited as much as equities from the perceived fading of the banking turmoil, and the more dovish Fed.

The AI trade

US equity market bears have been arguing since the start of the year that the breadth of this rally is very poor. The mega-cap tech stocks are now worth 25% of the entire S&P 500, and this large weight towards rate-sensitive stocks does carry significant risks. And the more times you mention AI, the more likely your stock price will go up - as this chart shows:

It is this chart that explains why analysts have moved US equities back to NEUTRAL. The huge weight of AI and tech stocks on US indices means you cannot afford to miss the rally.

“While price moves for AI related stocks have clearly been extreme, especially at a time when monetised use cases are still in the future, and with barriers to entry not overly high, we would still expect that it is too early to fade the moves before AI has even developed far enough to be able to disappoint expectations.”

Citi’s sell-side team are a BUY on Nvidia (price target of $420/share), a BUY on Microsoft ($340/share price target), a BUY on Amazon ($145/share price target), NEUTRAL on Tesla ($175/share price target), and a NEUTRAL on IBM (price target of $145/share).

There is also, in true 2023 fashion, a stock with the ticker code AI (C3.AI is the company name) but Citi does not cover it.

The team is also overweight global tech stocks, with a preference for the Taiwanese and South Korean markets given both those bourses have a large exposure to semiconductor stocks. Overall, 55% of the Citi model portfolio is in equities (both developed and emerging markets).