tl;dr
Citi's Scott Chronert predicts a potential resurgence for small- and mid-cap stocks driven by AI advancements, declining Fed rates, and improved earnings fundamentals, marking a shift from caution to cautious optimism.
**Citi Strategist Sees Turning Point for Small- and Mid-Cap Stocks as AI and Rates Shift Favorably**
In a recent interview with CNBC, Scott Chronert, a US equity strategist at Citi, highlighted a potential shift in market dynamics that could soon favor small- and mid-cap (SMID) stocks. Chronert’s analysis suggests that a combination of improving fundamentals, the tailwinds of artificial intelligence (AI), and evolving monetary policy could position SMID stocks for a resurgence.
Chronert emphasized that overall market fundamentals remain “very solid,” driven in part by the transformative potential of AI. This optimism extends to SMID stocks, which have historically been more sensitive to economic cycles. While he acknowledged that the current environment is not yet a post-recession recovery—described as a “soft-landing” scenario—Chronert noted that declining Federal Reserve interest rates could create favorable conditions for smaller companies.
A key factor in Chronert’s outlook is the resolution of what he termed an “earnings recession” for SMID stocks. Over the past two years, these companies faced challenges, but Q2 results marked a pivotal moment. “We had the first positive inflection in earnings growth in that two-year timeframe,” Chronert said, signaling a potential turning point. He added that this trend is likely to continue, with fundamentals beginning to align more favorably for SMID stocks.
The strategist also pointed to the historical sensitivity of SMID stocks to interest rates. As the Fed’s policy rate declines, smaller companies—often reliant on borrowing and more exposed to economic fluctuations—could benefit from lower financing costs and improved consumer demand. Chronert described this as a “combination of traditional, historic lower rate sensitivity, combined with signs that we’re turning the corner in terms of the fundamental set-up,” which has led Citi to become “incrementally more constructive” on the SMID space.
Despite the bullish stance on SMID stocks, Chronert noted a strategic adjustment within Citi’s portfolio. The firm is reducing its exposure to communication services stocks, downgrading their allocation from “overweight” to “market weight.” This shift reflects a broader reevaluation of sector opportunities amid the evolving market landscape.
While Chronert’s comments are cautiously optimistic, they underscore the potential for SMID stocks to outperform in a low-rate, AI-driven economy. Investors may want to monitor how these factors unfold, particularly as the Fed’s policy path and economic data continue to shape market sentiment. For now, the narrative around SMID stocks is shifting from caution to cautious optimism, with Citi positioning itself to capitalize on the change.