AI Sparks Valuation Fear: Citi Strategist Eyes Long-Term Multiples

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AuthorAkshat Lakshkar|Published at:
AI Sparks Valuation Fear: Citi Strategist Eyes Long-Term Multiples
Overview

AI's growing influence is reshaping investor sentiment towards financial services and software stocks, prompting a re-evaluation of long-term valuations. Citi strategist Drew Pettit highlights that while current earnings remain robust, the market is reacting to potential future valuation multiples, a phenomenon dubbed the 'terminal multiple problem'. This shift mirrors past reactions in the software sector, where tech advancements led to adjusted future expectations. Citi advises balancing growth and cyclical stock exposure amid global diversification trends.

AI's Valuation Conundrum

Artificial intelligence is increasingly seen as a disruptive force, not for immediate earnings, but for the long-term valuation of financial services firms. Investors are grappling with how to price in AI's potential impact, leading to significant market movements. Drew Pettit, Director - US Equity Strategy / ETF Analysis & Strategy Research at Citi, clarifies that this concern centers on future valuation multiples, a situation he likens to the recent shifts observed in the software sector.

The 'Terminal Multiple' Problem

Pettit explained that this market reaction is not driven by current earnings, which remain stable. Instead, it reflects a recalibration of how investors view companies' future worth. A minor adjustment in long-term valuation multiples can trigger substantial stock price fluctuations today. This occurred previously with software stocks, where downward revisions in future expectations, not fundamental weaknesses, drove declines. The same dynamic could now affect financial stocks if growth assumptions are cut.

Strategic Sector Allocation

Despite these valuation concerns, Citi maintains a view that opportunities exist in both growth and cyclical stocks. However, Pettit stresses the importance of a balanced sector exposure, acknowledging that no segment of the US market is currently considered cheap. Investors are urged to hold diverse assets to navigate aggressive market rotations effectively.

Global Diversification Trend

Citi's global outlook favors emerging markets, with a positive stance on Japan, neutrality on the US, and underweight positions in the UK and Australia. Within emerging markets, India is viewed neutrally, with potential upside from trade developments and foreign investment, though other Asian markets currently hold higher preference. This global perspective is supported by changing investor behavior, evidenced by US investors increasing their international equity allocations in January, signaling a broader move towards global diversification and the use of fixed income for stability.

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