Big institutional investors may get caught out, says Citigroup
Consumer prices are ahead this week and Citigroup has ideas on the stocks that could be worth buying ahead of that.
Ahead of important consumer price inflation data this week, Citigroup is recommending investors put money into beaten-down smaller companies.
September's CPI is set to be released at 8:30 a.m. Eastern on Wednesday, with Wall Street analysts forecasting the month-on-month core print, which omits energy and food, to fall to 0.2% from 0.3% in August. The inflation gauge will be watched by the Federal Reserve ahead of its next meeting in just over two weeks time, where it's widely expected to hold interest rates.
Exposure to the iShares Russell 2000 exchange-traded fund IWM, which tracks 2,000 U.S. small-cap companies, is the best option ahead of that inflation data, Stuart Kaiser, head of U.S. equity strategy at Citigroup, told clients in a recent note.
After a stronger start to the year, the Russell 2000 RUT is down 5.6% over five consecutive weeks, the longest such losing streak since May 2022, according to Dow Jones Market Data. Down almost 9% from a 52-week high reached Aug. 13, the index is nearing one definition of correction territory. IWM declined more than 5% in September and is up 0.3% so far this month. The more rate-sensitive group of stocks has been hit harder by fears over higher-for-longer U.S. interest rates.
"There is a fairly recent precedent for the combination of low positioning and positive inflation data to spur sharp rallies in small-cap stocks," said Kaiser, pointing to one instance in July 2024, when the ETF rallied 11.5% in one week.
His colleague, quantitative research analyst David Chew, sees IWM at risk of a short squeeze in the near term. That occurs when multiple investors start to buy an asset to cover bets against it, boosting the price further. The number of short positions against the ETF has almost reached a four-year high, and if it rises 4.3%, quantitative funds will be forced to cover those shorts and switch to more bullish long positions, he said.
Kaiser hence recommends buying IWM call options ahead of CPI data. A call option gives the buyer the right to purchase an underlying asset at a specified price before a predetermined expiration date.
Options are implying a rise or decline of 98 basis points for that ETF on Wednesday, which is lower than the 12-month average of a plus or minus 125 basis-point move, he said. IWM call options are also significantly more attractive in value in relation to the S&P 500 SPX and the Invesco QQQ trust QQQ, which replicates the Nasdaq-100, he added.
"We don't see soft inflation as a complete game-changer for equity markets, but lower yields and bond volatility would be positive for equity sentiment and good for rate-sensitive areas like IWM, XLU [State Street utilities select sector SPDR ETF] XLU and XLRE [State Street real estate select sector SPDR ETF] XLRE," he said.
For the S&P 500, options imply a climb or fall of 58 basis points on Wednesday, compared with a 12-month average of a move up or down of 73 basis points.
The bank also remains tactically positive on equity risk ahead of the third-quarter earnings season.
"We like large growth stocks in the run-up to 3Q where both financial results and commentary around the AI spending and return outlooks will drive markets," Kaiser wrote, adding that he recommends exposure to large-cap growth via the QQQ or through sectors including hyperscalers, large-cap banks and healthcare artificial-intelligence.
-Nora Redmond
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