By Jules Rimmer
Just 84 stocks, classified as AI-related, account for 35% of the S&P 500 SPX index earnings and make up 50% of its market capitalization. But after the steepling rally of recent months, investors have been trying to judge whether this is truly a structural bull market (one based on more fundamental, longer-term drivers rather than short-term or tactical factors) or simply an AI-bubble.
The call, set out in a U.S. equity strategy note published by Citi on Friday, is that this is no bubble, some valuation metrics are compelling and so to ride the AI-enablers (those companies developing AI technologies) for now.
In the medium term, though, a team led by Scott Chronert predicts there’ll be a handoff in market leadership to the AI-adopters (those companies actually using the technologies in their operations) who will be the beneficiaries of this huge boost in productivity and profitability.
Since the end of 2022, AI-related stocks have significantly outperformed other tech stocks (25% of the S&P 500) and the 25% of the index (some 269 stocks) that isn’t categorized as tech or AI-related. One surprising observation that Citi’s research team makes is that in aggregate, the AI names trade at lower PEG ratios (price-to-earnings growth, a valuation metric often used to assess fast-growing companies) compared to other sectors.
Moreover, the report examines the Sharpe ratio (a risk-adjusted measurement of an investment’s return, wherein the higher the score the better) for AI-related earnings and discovers it is notably higher than other sectors. This reinforces the preference Citi maintains for “growth as defensive” in terms of its approach to portfolio construction.
Chronert and his colleagues, Drew Pettit and Patrick Galvin, also point out that AI-related stocks stand out for metrics such as operating leverage, return-on-equity trends, sales per employee and gross margin improvement.
For Citi, most of this leads to a more structural case for large-cap stocks to outperform – the AI infrastructure build-out has more room to run. Investors have articulated concerns about current equity valuations as the S&P 500 trades on a price-earnings ratio of 24-26 times roughly – relatively stretched in historical terms.
Citi strategists maintain that “the evolution of S&P 500 construction is such that concentration in a relatively small number of stocks with exceptional fundamental trends is impacting our view of historical compares.” They are “steadfast” that longer-term fundamentals ultimately determine U.S. equity market direction.
So, while mindful that the market is at or near all-time highs, Citi insists the AI build-out will remain a key market driver over the next year or two. Thereafter, the transition will be towards those stocks who can actually adopt, implement and benefit from the AI technological innovation.
-Jules Rimmer
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08-04-25 0713ET
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