Investors should prepare to buy the dip as rally eases

The rally in US stocks is showing signs of fatigue, and investors should be ready to buy into any declines, according to Citigroup Inc. strategists.

There are 19 out of 24 industry groups that are at or near overbought readings currently, a team including Scott Chronert wrote in a note. “The message is to expect pullbacks and buy into them,” they said.  

The US equity rally since late October has been heating up amid optimism that the Federal Reserve will start cutting interest rates next year while the economy avoids a serious slowdown. But the gains had gotten extreme by some measures, with the S&P 500’s relative strength index at one point showing the benchmark was the most overbought since 2020.

Signs of a pullback are starting to emerge after the S&P 500, Nasdaq 100 and Russell 2000 slumped on Wednesday, with all three indexes no longer overbought as indicated by their RSI. Some in the market speculated that expiring zero-day options traded Wednesday helped accelerate the selloff as dealers sold more to re-balance their positions before expiration. US equity futures are rising on Thursday.

Chronert expects the S&P 500 to end next year at the 5,100 level, up 8.5% from the latest close, underpinned by “consistent” sector-level earnings growth and a broadening of the rally beyond mega-cap technology stocks.

Against that backdrop, technology and industrials are among the strategist’s overweight positions. He also raised banks to overweight amid attractive valuations and surprisingly solid fundamentals, while retail and durables also move to overweight as consumer concerns may be increasingly priced in.

Quantitative peers including Hong Li in a separate note also cautioned against chasing the risk-on equity rally “given the fragile nature of the recent volatile rotation.” They continue to favor growth for early 2024. 

Chronert said soft landing sentiment and optimism about lower interest rates helped drive the market action into the year end. “The implication is to expect volatility ahead, but with an eventual Fed pivot as a north star,” he said.