Citi turns 'underweight' on US stocks

Citi Group headquarters in New York.
Adam Jeffery | CNBC
Citi Group headquarters in New York.

U.S. equities are out of favor with global strategists at Citi, who have downgraded the asset class because of the potential impact of more Federal Reserve interest rate hikes and stalling corporate profitability.

Citi strategists led Robert Buckland highlighted the potential for weaker earnings per share (EPS) momentum in the U.S., in a note released on Tuesday. EPS is an important metric used by analysts and is used an indicator of a company's profitability.

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"Fading EPS momentum and rising Fed funds mean that, after six consecutive years of outperformance, we cut the U.S. to underweight," Citi said in the note.

Despite the downgrade, the analysts still saw some favorable conditions for the U.S. in 2016, including the availability of credit for small businesses. They forecast that EPS for S&P 500 companies would grow by 7.1 percent during the year, as the economy digests stronger dollar and weaker oil prices.

"Decent EPS momentum and continued central bank support mean that we prefer Europe, excluding U.K., and Japan equities," Citi said in the note.

The bank predicted a stronger first half for the S&P 500 this year (with a mid-2016 target of 2,300 points) and then a modest pullback in the second half of the year to 2,200 points. This pullback would come as the Fed adds to the rate hike it announced in mid-December last year and as pressures on margins and uncertainty about the 2016 U.S. presidential elections weigh.

"We see large-caps outperforming small-caps (in the U.S.), while valuations also favor larger companies," Citi added in the note. "A rising bond yield should support an investment style change towards value stocks over growth."

The S&P 500, which tracks the biggest U.S.-listed companies, ended 2015 down 0.73 percent after three straight years of double-digit gains. On Monday, it had its worst start to the year since 2001.

However, the overall bull market for stocks is in its seventh year. A wave of global liquidity from central banks has helped to prop up developed economies in recent years and has been the main driver behind stock markets. Many analysts have grown concerned over valuations as equity benchmarks have pushed higher.

David Kostin, chief U.S. equity strategist at Goldman Sachs, told CNBC in December that stock markets could be mostly flat in 2016. Meanwhile, Alain Bokobza, head of global asset allocation at Societe Generale, told CNBC last week that he was expecting the S&P 500 to absorb the Fed rate hikes this year and finish the year flat at around 2,050 points.