Entering the bull market's fourth year, volatility may well intensify and picking winners and losers in the AI race is going to be more challenging.
Nonetheless, Citi strategists expect an accommodative Fed, above-consensus earnings growth and a stronger fiscal impulse from the OBBBA to warrant a year-end target of 7,700 for the S&P 500 SPX.
The MarketWatch-compiled consensus of forecasts is at 7,500, which is 10% above Friday's close.
While forecasting a 2026 stock market return of around 13%, Citi strategists anticipate a shift away from AI enablers towards adopters and a broadening of performance among index constituents.
It's because U.S. stocks have a high valuation starting point that there will be immense pressure on index constituents to deliver on fundamentals and justify their price action.
That base case S&P 500 forecast of 7,700 from Scott Chronert and fellow researchers Drew Pettit and Patrick Galvin is set out in their 2026 outlook for U.S. equities published late on Friday. It is based on index earnings of $320 and would value the market at 24 times earnings. That's only a minor compression from the current level of 25 times, but stock selection and sectoral allocation will be more difficult as Citi sees greater dispersion in returns, especially among AI plays.
The consensus on Wall Street is for $310 of earnings per share in 2026, according to Citi, but it points out the continued resilience of earnings to date.
AI tailwinds persist, Citi notes, but there will be an increasing emphasis away from hyperscalers, whose outlook remains controversial, and in favor of those stocks able to integrate AI tools into their business practices and improving productivity as a consequence. Chronert and his team expect "idiosyncratic behavior" among the AI enablers and the portfolio construction will also be complicated by the 40% weighting these stocks represent in the S&P 500.
The Citi report recommends investors position for the broadening of performance by anticipating positive revision momentum in the value VTV, cyclical and small-cap sectors IWM. Growth stocks meanwhile, incorporating the mega-cap tech names, "need ongoing beats and raises to support performance and valuations."
The 7,700 index target is in part predicated on Citi's expectation that the Fed will cut rates twice in early 2026, faster than the market discounts at present, as it is confronted with higher unemployment, a likely corollary of those AI productivity gains. Citi projects a U.S. 10-year yield BX:TMUBMUSD10Y of 3.75% by end 2026, compared to the 4.18% at present.
If earnings surprise investors with more impressive earnings growth, Citi makes a bull case argument for 8,300 on the S&P 500, above most analysts. Their bear-case scenario of 5,700 comes into play if fundamentals disappoint and earnings multiples therefore contract.
