Markets Edition: Q4 — It’s Not How You Start, It’s How You…

PodcastResearch @ CitiScott ChronertSep 29

Citi strategists favor semiconductors over hardware and see a historically brief midterm-related equity-market dip, despite recent pressure from higher oil prices, yields, and expected Fed hikes. The speakers see scope for those pressures to ease and for rate-sensitive stocks to rebound, including if progress is made toward a resolution involving Iran. A speaker sees further S&P 500 upside but cautions that oil prices and economic conditions could sustain the hawkish Fed outlook.

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Key Takeaways

Despite WTI rising from the mid-$70s to near $100 and 10-year yields climbing from 4.6% to 5.2% since midsummer, the S&P 500 remained only 70 basis points below its all-time high; consumer cyclicals and rate-sensitive defensives suffered larger drawdowns. Against that backdrop, Citi's strategists favor semiconductors over hardware, want stronger positive fundamental revisions in software, and say Q2 revenue growth at AI-spending internet companies eased some concerns about AI CapEx.

The speakers say oil-price, yield, and hawkish-Fed pressures could moderate during the quarter, potentially creating a contrarian snapback in rate-sensitive sectors; they add that progress toward a resolution involving Iran could ease pressure on the Fed and support a relief rally in consumer and defensive stocks. The speaker sees potential S&P 500 upside later in the quarter or near year-end, but warns that oil is a linchpin if economic conditions continue to support the hawkish Fed narrative.

Citi's strategists say equities have historically tended to underperform in the weeks before midterms, then quickly return to the normal non-election-year trend, and they do not consider midterms a significant market-moving event overall. That historical pattern sits alongside the speaker's view that the S&P 500 could have upside later in the quarter or near year-end, subject to the risk that economic conditions sustain the hawkish Fed narrative.

MARKETS

Sector Preferences — Citi equity strategists favor semiconductors over hardware heading into year-end. They want stronger evidence of positive fundamental revisions in software, where valuations have improved. Q2 revenue growth among internet companies involved in AI spending also eased some concern about the AI CapEx outlook.

“Heading into the end of the year, generally speaking, we favor the semiconductor component over the hardware component. And software continues to do just fine from a performance perspective…”—

Market Divergence — Since midsummer, WTI rose from the mid-$70s to nearly $100, 10-year yields climbed about 60 basis points from 4.6% to 5.2%, and rate markets priced in four additional Fed hikes, the Citi strategist says. Yet the S&P 500 was only 70 basis points below its all-time highs. Consumer cyclicals and rate-sensitive defensive stocks, by contrast, saw drawdowns from the high single digits to low double digits.

“The equity markets have been very resilient in the face of some of the headwinds you mentioned…”—

FORECASTS

Snapback Opportunity — The speakers expect oil-price, yield, and hawkish-Fed pressures could moderate during the quarter, potentially creating a contrarian snapback opportunity in sectors hurt by higher-rate concerns. They also say progress toward a resolution involving Iran could ease pressure on the Fed and set up a relief rally in rate-sensitive consumer and defensive stocks.

“If we were to see some progress or line of sight towards a resolution that ran, I think that takes some pressure off the Fed and sets up for somewhat…”—

AI Sector Positioning

Citi favors semiconductors over hardware, sees software holding up, and finds AI-related media revenue trends supportive despite scrutiny of data-center expansion.

Midterm Market Pattern

The strategists expect limited fundamental impact from the midterms and note that historical equity weakness ahead of the vote has typically reversed quickly afterward.

Oil, Rates, and Iran

Higher oil prices, Treasury yields, and Fed hike expectations have weighed on rate-sensitive sectors, but progress toward resolving tensions involving Iran could ease pressure and spur a relief rally.

Q4 Equity Outlook

Citi sees potential S&P 500 upside and a possible late-quarter rebound in pressured sectors, while cautioning that oil and economic conditions could sustain the Fed’s hawkish outlook.