Citi sees a correction coming because too many inexperienced investors are plowing into stocks

Published Wed, Aug 4 20219:19 AM EDTUpdated Wed, Aug 4 202110:12 AM EDT

Stocks are hovering around record highs amid strong second-quarter earnings results, but Citi believes the market is vulnerable to a 10% correction, thanks to novice investors piling into speculative technology names. "Too many inexperienced investors are plowing into technology ideas that seem overvalued at 20x revenues, complaining that the often older investment community does not understand the disruption taking place and are too handicapped by traditional metrics," the firm wrote in a note to clients. Analysts led by Tobias Levkovich said the action is reminiscent of the 1999-2000 era, which was the last time "panic/euphoria was this ebullient for months before cracks emerged and indices fell." Amid this backdrop, the firm said a 10% correction is "very plausible." Such a dip would bring the S & P 500 to around 4,000, which is the firm's year-end target for the benchmark index. The S & P 500 closed at a record 4,423.15 on Tuesday. A neutral outlook Citi also cut its outlook for the U.S. stock market to neutral on Wednesday. The firm believes rising rates will hit growth stocks in the coming months. Given the outsized importance of technology stocks for the U.S. stock market, any weakness could weigh on equities broadly. That said, Levkovich was quick to note that he doesn't believe the overall S & P 500 is in a bubble as was the case in 2000. "Equities have been sustained meaningfully this year by powerful earnings growth. Central bank support has been another unique feature with commentary of eventual tapering having little if any negative impact," he wrote. Of the 340 S & P components that have reported second-quarter results, 88% have topped earnings estimates, according to data from Refinitiv. When it comes to revenue, 87% have exceeded expectations. Citi said earnings have been so strong in part because of easy scalability for technology companies, while cyclical names have benefitted from favorable year-over-year comparisons and cost-cutting measures. "Consumers have wage growth and stimulus money to spend, plus corporations have stepped up capex given low financing rates," the firm said. But looking ahead, Levkovich pointed to several factors that could pressure stocks. "We worry about higher taxes, cost pressures eating into profitability, tapering and more persistent inflation all coalescing in September," he said, noting that the month is typically a tough one for the S & P 500. "Sentiment remains very extended … and our lead profit margin indicator is still signaling caution." Citi's year-end S & P target is on the low end of analysts' forecasts. According to data compiled by CNBC , the average target is 4,316. Bank of America is the most bearish with a 3,800 call, while Oppenheimer is the most bullish at 4,700. —CNBC's Michael Bloom contributed reporting.

A trader works inside his post on the floor of the New York Stock Exchange.

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