Wall Street Firm Cites 1970s Parallels, Turns Bearish on U.S. Stocks

Quantitative strategists at Citi have turned negative on U.S. stocks, and they are drawing a less common comparison for the current market. The AI build-out is usually likened to the dot-com boom of the late 1990s. Citi's quant team, led by Alex Saunders, sees a closer parallel in the high-inflation late 1970s.

The team now recommends that a portfolio hold 5% less in stocks than its benchmark weight, a shift from its previous call to hold 4% more. It also called for a "small" short position in U.S. stocks, meaning a bet that they will fall, and said it prefers emerging-market equities.

Why the model turned

The call comes from Citi's macro regime model, which classifies the economy into phases of the business cycle. The strategists said the model is moving into late-cycle territory for two reasons.

The first is tighter financial conditions. Treasury yields are at two-decade highs, and markets are struggling to absorb a flurry of corporate bond issuance. Higher borrowing costs and a crowded bond market make it more expensive for companies to fund themselves.

The second is that positive economic surprises are slowing. Data that had been beating forecasts is doing so less often.

Together, the strategists said, those shifts threaten what has been a "Goldilocks" environment for stocks, one in which growth is strong enough to support profits but not so strong that it fuels inflation.

The 1970s comparison

The parallel the team draws is with the period before the Federal Reserve, led by Paul Volcker, raised interest rates sharply to break inflation. In that stretch of the late 1970s, stocks first gained on resilient growth and slowing inflation. Then prices began rising again, and equities fell.

The geopolitical backdrop adds to the comparison. Iran was the flashpoint then, with the Iranian Revolution, and it is again now.

The team also pointed to trend-following funds, which typically do well in stagflation, the combination of weak growth and high inflation. Based on Citi's own simulation of how these funds behave, they are coming off a strong month. Data released this week by HFR, which tracks hedge funds, confirmed a strong September for commodity trading advisers, or CTAs, a category that includes many trend-following funds.

A split inside Citi

The quant team's view runs against most of Wall Street and against Citi's own equity strategists. Citi's U.S. equity-strategy team has a year-end target of 8,100 for the S&P 500 and expects the Fed to shift in a dovish direction.

Scott Chronert, Citi's head of equity strategy, acknowledged the assumption behind that target this week. "Our [S&P 500] 8,100 target has always been premised on soft landing (if not goldilocks) economic conditions," he said. That is the same environment the quant team believes is coming to an end.

So far, the market has not moved the quant team's way. The S&P 500 closed at 7,765 on Thursday, Oct. 8, less than 1% below its record high, and the Nasdaq Composite has gained 17% this year.

Yields, inflation and economic surprises

• Treasury yields, which the quant team cites as a main source of tighter financial conditions.
• Economic data relative to forecasts, to see whether positive surprises keep fading.
• Inflation readings, the key variable in the 1970s comparison.
• Whether the Fed makes the dovish shift that Citi's equity strategists expect.