Small Cap Earnings Recession Over, Says Citi's Scott Chronert on Market Outlook

Market Strategy Amidst Government Shutdown

• 💡 The current U.S. government shutdown, now in its second day, does not alter the overall market strategy, according to Citi's U.S. equity strategist Scott Chronert.
• 🎯 A tactical adjustment was made for Q4: communication services were lowered to market weight from overweight, a position held since 2023.

AI Tailwind and Tech Sector Strength

• 🚀 The fundamental setup for the market remains solid, primarily driven by the AI tailwind and growth sectors.
• 💻 Despite tactical shifts, there is continued positivity towards the tech sector, with a particular focus on semis and software, indicating ongoing support for the AI trend.
• ⚠️ Expectations for upcoming quarterly earnings are high, suggesting that simply meeting or beating numbers may not be enough to sustain stock prices in the short term for some names.

Consumer Discretionary and Rate Sensitivity

• ⚖️ The strategy involves navigating two distinct markets: one influenced by AI and another by traditional macro metrics.
• 🛒 A move towards consumer discretionary is noted, with a keen interest in retail, consumer durables, and apparel, including homebuilders.
• 📉 This positioning aims to align with areas that will fundamentally benefit from falling Fed rate cuts and lower interest rate sensitivity, especially looking towards 2026.

Small and Midcap Constructiveness

• 📈 Scott Chronert has become more constructive on small and midcap stocks, a shift from earlier in the year.
• 📊 This is driven by a combination of factors: historically, small caps perform well coming out of recessions, and while a soft landing is anticipated, lower Fed rates are beneficial.
• 📊 A significant point is that small caps have been in their own earnings recession for two years, with Q2 results showing the first positive inflection in earnings growth, suggesting a potential turnaround.
• 💡 The combination of traditional rate sensitivity and improving fundamental signs makes the mid-cap space increasingly attractive.