Citi warns of downside for US equities as these factors weigh on valuations

US equity valuations could come under pressure from a combination of rising long-term bond yields, a weaker dollar, and widening credit spreads, according to Drew Pettit, Director at Citi.

Pettit said that while sentiment has improved after recent policy announcements, some structural risks are starting to show up in valuations. “Higher long-end rates, we think, lower fair multiple for the index,” he said, referring to the S&P 500.

He explained that three specific macro trends are weighing on valuations. “Higher Treasury rates, a lower dollar, and higher US credit spreads all set us up to a point where we think the high end of kind of fair value for the S&P 500 has moved from 24 times… to something closer to 22 times.”

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This means that even though the index currently trades at 24 times earnings, Citi sees fair value closer to 22 times, implying a downside of about 500 points. from current levels of around 5,800.

Long-end yields have risen steadily in recent weeks, driven partly by market concerns over increased US fiscal spending and a ballooning deficit. As the US government issues more debt to fund spending, bond prices fall and yields rise—raising the cost of capital for companies and pressuring equity valuations.

At the same time, wider credit spreads—the difference between corporate and government bond yields—indicate that lenders are demanding more compensation for risk, especially from lower-rated borrowers. This makes debt more expensive for companies and raises concerns about financial health in some parts of the market.

“The valuation pressure is already starting to creep in here because of the rate moves and the other macro moves that have been associated with it,” Pettit said.

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Despite these headwinds, Citi remains constructive on select US equities. “We still have conviction in growth stocks… Growth, to us, is defensive, and it’s a great way to fight back against valuation because you can grow that E (earnings) into the higher multiple,” Pettit added.

While the broader market may consolidate, he believes secular growth themes, particularly in technology and communications, still offer attractive opportunities.