Investors should buy the dip, but be ready with these geopolitical hedges, says Citi

By Jamie Chisholm

Critical information for the U.S. trading day

Early market action Monday indicates relief that the weekend's attack on Israel by Iran may signal the peak of tensions in the region. Some of the risk-off trades from Friday are being unwound, with stock-index futures higher on the session.

But Citigroup is wary: "Even if escalation isn't anyone's main aim, the significant likelihood of the continuation of back-and-forth attacks opens the possibility of an event (e.g. a large amount of civilian casualties) that cannot be left without a major escalatory response," says the U.S. bank.

Citi have raised their price for Brent crude (BRN00) over the next three months from $80 a barrel to $88 a barrel. An attack by Israel on Iran's uranium enrichment program would see crude spike above $100, but any de-escalation of tension in the region, perhaps later this year "should see prices fall back to the $70-80/bbl range quite sharply."

If the bad scenario came to pass, then Citi says sees risk assets struggling and a flight into government bonds. "When risk aversion is rising fast, the best hedges are typically the ones where positioning is the most aggressive on the 'wrong side.'"

For example in currencies, the South African rand (USDZAR), Taiwan dollar (USDTWD) and Polish zloty (USDPLN) would be under pressure, while the Swiss franc (USDCHF), China's renminbi (USDCNH), Thai baht (USDTHB), and Czech koruna (USDCZK) would outperform.

Citi's preferred risk-off trades would be to go long oil, obviously, and to buy the traditional haven Japanese yen, which means shorting the U.S. dollar/yen cross (USDJPY), which sits at a 34-year peak.

However, Citi says the risk of an oil price spike is low, such geopolitical events often don't impact the market for long, and its base case is that "global markets should move back to trading the Fed."

"Short of a more prolonged and expanded Middle East conflict, we would view related fundamental disruptions [to oil supply and shipping] as temporary. Thus, related equity price weakness should be generally bought into," says Citi.

It's good that the contribution to S&P 500 SPX aggregate earnings is broadening out, says Citi, with the energy sector providing notable support. "We remain comfortable with our $245 earnings per share estimate for the S&P 500."

Still, the bank notes that the S&P 500 has overshot its year end target of 5,100 as implied earnings growth has risen. The current valuation of 22.5 times trailing twelve months (TTM) earnings is above the high end of Citi's fair value range, which is closer to 20 times TTM. Citi is also wary that the Levkovich Index, its lead sentiment indicator, recently moved into euphoric territory.

Citi feels that after recent good gains the S&P 500 is due "a digestive phase as we move through Q2," though that doesn't diminish the bank's "underlying structural bullishness related to the fundamental set up."

"That said, euphoric sentiment usually needs a catalyst to unwind," says Citi. "The latest events may be a trigger, but we see high implied growth expectations as the bigger issue as the Q1 reporting season unfolds. Friday's action regarding the Bank sector was symptomatic of that."

Markets

U.S. stock-index futures (ES00) (YM00) (NQ00) are higher even as benchmark Treasury yields BX:TMUBMUSD10Y rise. The dollar index DXY is lower, while oil prices (CL.1) pull back and gold (GC00) trades around $2,350 an ounce.

The dollar/yen cross (USDJPY) is eyeing 154 for the first time since 1990 with still no sign the Japanese authorities have intervened to support their currency.

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The buzz

U.S. economic data due on Monday include March retail sales alongside the April Empire State manufacturing survey, both at 8:30 a.m. Eastern. Business inventories for February and the home builder confidence index for April will be published at 10 a.m.

New York Fed President John Williams makes a TV appearance at 8:30 a.m., and San Francisco Fed President Mary Daly speaks at 8 p.m.

Goldman Sachs (GS) and Charles Schwab (SCHW) will release earnings before the opening bell rings on Wall Street, and Skillsoft (SKIL) will present its numbers after the close.

Apple (AAPL) has lost its spot as world's top smartphone seller as iPhone sales drop 10%.

Aluminum and nickel prices are surging after a ban on fresh trading of Russian-origin metals by U.S. and U.K. authorities.

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The chart

There were signs on Friday that the rally in the price of gold had become overextended, and sure enough it fell swiftly from record highs. But as the chart below from Sentimentrader shows, such extremes in momentum gauges such as the relative strength index are quite common in gold price rallies.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

   Ticker  Security name 
   TSLA    Tesla 
   NVDA    Nvidia 
   AAPL    Apple 
   NIO     Nio 
   GME     GameStop 
   TSM     Taiwan Semiconductor Manufacturing 
   AMZN    Amazon.com 
   AMD     Advanced Micro Devices 
   AMC     AMC Entertainment 
   PLTR    Palantir Technologies 

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-Jamie Chisholm

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04-15-24 0642ET

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