Citi: S&P has room to rise by year-end, but earnings breadth and AI investment returns face tests

Has the earnings base broadened as the index nears its all-time high?

As of the report’s publication, the S&P 500 index had risen about 1% in the fourth quarter and was near its all-time high. Citi still sees a path higher by year-end, but its previously stated 8100-point target now looks aggressive, though still attainable.
With the third-quarter earnings season nearing its halfway point, the magnitude of earnings surprises is consistent with Citi’s view that they are returning to more normal levels, and is weaker than the outsized surprises in the first and second quarters. Sectors outside technology and energy have shown no significant growth in their contribution to index earnings per share; the trend in small-cap earnings surprises has also been subdued.

The Federal Reserve kept interest rates unchanged on the day the report was published, in line with market expectations; markets still expect a rate hike in December and have priced in two more hikes before September of the following year. Citi hopes expectations for hikes after December will ease, while noting that the Fed’s impact on stock price movements has been inconsistent this year.
Citi sees the direction of oil prices as key to inflation and, in turn, interest rate expectations. Recent client discussions indicate that investors generally expect oil prices to remain high for an extended period; given that expectation, the bank believes the upside from an early, positive resolution of the conflict could outweigh the downside risk of a prolonged conflict.

Citi estimates that more than half the weight of the S&P 500 index is associated with AI tailwinds, while another portion is driven more by traditional macroeconomic and corporate fundamentals. AI buildout is therefore an important pillar of the bank’s assessment of the index’s direction.
Recent equity and debt issuance supported market sentiment toward companies involved in AI infrastructure, and the semiconductor sector rose over the past week. Microsoft’s revenue performance announced that day supported the investment-return thesis, but Google’s results were weaker.
Investors want to see a better balance between revenue growth and capital spending. Citi believes successful financing has strengthened confidence in semiconductor fundamentals; a moderate slowing in capital spending guidance could also be interpreted as easing financing pressure. Both could support positive performance before year-end.

Citi had already prepared for a scenario in which Democrats win across the board. The bank believes the Senate outcome will be the focus: Republicans retaining control of the Senate could provide a tactical boost, while larger Democratic seat gains could mean greater potential headwinds.
Citi expects next week’s midterm elections to affect both parts of the index through their implications for the 2028 presidential election and their more direct impact on the buildout of AI infrastructure.