Citi recently released its 2026 US equity strategy outlook, projecting a "continued yet volatile bull market." The bank set a year-end baseline target of 7,700 for the S&P 500, based on an expected EPS of $320, with an optimistic scenario target of 8,300 reflecting stronger earnings growth and slightly higher valuations. A pessimistic scenario would see the index at 5,700, factoring in weaker fundamentals and valuation compression.

Citi expects AI-driven tailwinds to persist, though performance divergence between AI enablers and adopters will remain a long-term dynamic. The core theme will be broadening growth beyond this group, encompassing broader S&P 500 sector participation and the rise of US small- and mid-cap stocks. As the bull market enters its fourth year, volatility is expected to intensify, particularly given elevated growth expectations. While high starting valuations pose a challenge, they may pressure fundamentals to justify current price levels.

**Market Drivers** Citi forecasts 2026 S&P 500 EPS growth at 16.3%, above the consensus 13.7%, driven by sector-wide expansion. Technology (26.4%), communication services (17.5%), and energy (13.3%) will lead, with AI-related industries remaining key catalysts. Meanwhile, value stocks, cyclicals, and small/mid-caps—with projected EPS growth of 19% (S&P 400) and 17% (S&P 600)—will benefit from valuation discounts and earnings convergence. While the "Magnificent 7" (or "Elite 8" if including Broadcom) will contribute 6.1% of earnings growth, the remaining 493 S&P components are expected to deliver 10.8%, reflecting a "leadership-broadening" dynamic.

**AI Evolution and Productivity** AI infrastructure build-out remains central, but stock performance will diverge. Citi anticipates a 2026 pivot from "AI enablers" (e.g., chips, cloud services) to "AI adopters" (e.g., enterprise software, industry solutions), fueling corporate focus on productivity gains. Despite debates over hyperscalers' ROI, widespread AI adoption could lift aggregate productivity, though a "winner-takes-most" landscape may emerge. Supply constraints and sustained capex should sustain AI’s boom phase rather than a bubble.

**Valuations and Risks** At 25x forward P/E, the S&P 500 is historically expensive, but Citi sees modest compression to 24x under its base case, supported by: - Two expected Fed rate cuts (25bps each), - 10-year Treasury yields declining to 3.75%, - Gradual USD strength, and - Fiscal stimulus.

Key risks include high starting valuations (lower risk-reward ratios), labor market weakness triggering recession fears, geopolitical tensions, policy uncertainty (e.g., potential Trump administration shifts), and unexpected rate hikes. The Levkovich Index’s current optimism suggests near-term pullbacks (akin to 2025’s "Liberation Day" correction), though full-year returns may stay positive.