It’s time to pause on U.S. stocks, say Citigroup strategists. They say invest in these places instead.

The S&P 500’s
SPX,
+0.24%
estimated second-quarter earnings decline is 7.2%, which if ends up as the actual quarterly fall, will mark the biggest drop since a 31.6% drop seen in the second quarter of 2020, notes John Butters, senior earnings analyst at FactSet.

Our call of the day from Citigroup, meanwhile, is wary on how much more Wall Street stocks have to give, especially after a blockbuster first half. Those analysts have downgraded U.S. equities to neutral from overweight last quarter.

“Our U.S. strategy team thinks megacap growth is set for a pullback, while U.S. recession risks could still bite,” U.S. equity strategist Scott Chronert told clients in a note that published Monday.

“Investors continue to weigh the risk of a higher for longer Fed relative to a rolling sector recession condition that implies a less defined ultimate outcome. We look for a [second half] pullback to get more aggressive in U.S. equities headed into 2024,” said Chronert.

The strategist said Citi’s base case remains an 18 to 19 times [forward price earnings P/E] multiple on full-year earnings. As FactSet’s Butters notes, the current 18.9 times forward 12-month P/E ratio for the S&P 500 is above the 5-year average of 18.6 and the 10-year average of 17.4.

“The mega cap tech/growth leadership during [first half 2023] has lifted S&P 500 valuations above the high end of our fair value model,” said Chronert, who noted this hasn’t been supported by earnings follow through or lower 10-year yields.

For one thing, he sees growth stocks setting up for a pullback as “AI euphoria enters a more digestive phase.”

“In turn, generative [artificial intelligence] has emerged as an incremental growth driver. Thematically, we acknowledge this opportunity. However, longer term, we look for differentiation between companies with a definable revenue and earnings opportunity relative to a more general productivity enhancement angle,” he said.

Citi provided this chart, which shows the U.S. sectors they’ve cooled on — tech hardware, household products, food and beverages and healthcare equipment. They turned more positive on capital goods, materials and chips.

As for alternatives to Wall Street, Citi boosted Europe stocks to overweight, saying the previous rally has “completely unwound,” they trade at a record discount to the U.S., and could get lifted by a weaker dollar and China stimulus. They are overweight basic resources, industrials, healthcare, media, technology and telecoms.

Citi also bumped emerging markets equities up to overweight, replacing the U.K., which was cut to neutral due to a lack of exposure to growth and the burden of a strong pound.

“EM offers a more interesting risk/reward profile, with exposure to a combination of growth and materials. It could also benefit from USD weakness, rate cuts, and potential improvement in China sentiment,” said strategist David Groman. They remain overweight on China, saying “current valuations provide an attractive entry point” if Beijing delivers big policy support.

Japan stocks, which have had a stellar run this year, remain an underweight as they caution that a rush of foreign money into that market could reverse.

Read: Too early to celebrate? Why inflation data means a pivotal week for the U.S. stock market lies ahead.

The markets

Stocks
DJIA,
+0.62%

SPX,
+0.24%

COMP,
+0.18%
have opened little changed, with bond yields steady
TMUBMUSD10Y,
3.987%

TMUBMUSD02Y,
4.851%,
the dollar
DXY,
-0.20%
higher and oil
CL.1,
+0.55%
lower.

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The buzz

Consumer prices are due Wednesday, with the annual core rate — stripping out food and energy — forecast to dip to 5% from 5.3%. For Monday, wholesale inventories are due at 10 a.m., followed by consumer credit at 3 p.m. and plenty of Fed speakers — Vice Chair Michael Barr, San Francisco President Mary Daly and Cleveland Pres. Loretta Mester.

In China, factory-gate prices fell deeper into deflation in June, with consumer prices flat.

Icahn Enterprises
IEP,
+20.20%
stock is up 5% after The Wall Street Journal reported that Carl Icahn finalized amended loan agreements with his banks on Sunday that untie his personal loans from the trading price of his company’s shares.

Agricultural sciences group FMC
FMC,
-11.15%
cut its second-quarter and full-year outlook and shares are down 6%.

Helen of Troy stock
HELE,
+18.49%
jumped 4.1% toward a five-month high in premarket trading, after the consumer products company reported forecast-beating profit and sales.

Sales events from big retailers this month could give consumer spending a lift. Amazon’s
AMZN,
-2.04%
Prime Day for July 11-12 will be followed by discounts from Best Buy
BBY,
+0.73%,
Walmart
WMT,
+0.91%
and Target
TGT,
+1.30%.

Read: 5 hacks to get the best deals on Amazon Prime Day — and other summer sales

Bank earnings are coming at the end of this week from JPMorgan
JPM,
+0.56%
and others. Here are the ones analysts favor most.

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The Kremlin says Putin met with Russian mercenary leader Prigozhin after a short-lived mutiny last month.

The chart

The biggest sovereign wealth fund investors in the world, who collectively manage $21 trillion in assets, say inflation and geopolitical risks are their top growth worries for the next year, according to an annual survey from Invesco:

Top tickers

These were the top-searched tickers on MarketWatch as of 6 a.m.

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