Citi Strategist Warns of Looming 10% Market Drop — Why He Could Be Right

What Citigroup is warning about

Back in June, Levkovich told the hosts of CNBC’s Closing Bell, “Hitting new highs, leading to new highs means markets never correct, which doesn’t quite make sense.”

That same month, Levkovich wrote a note to Citi clients saying the company would be maintaining its cautious view over the short term.

The June note adamantly stuck to his year-end target of 4,000 for the S&P 500, which was 5% below the index’s level at that time. The index is currently hovering around 4,500.

But now, Levkovich is anticipating a correction could come as soon as September.

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Four factors are in play

Levkovich cites four factors that cause concerns: the Federal Reserve’s discussions on tapering, rising inflation, pressure on profit margins and corporate tax hikes.

The Fed’s impact and interest rates

The Fed's been purchasing Treasury securities and mortgage-backed securities at a rate of about US$80 billion per month and US$40 billion per month, respectively.

The central bank said back in June that it would continue the practice until “substantial further progress” had been made toward the Fed’s employment and price-stability goals. Some analysts anticipate that may happen sooner than later.

Levkovich notes a significant part of the S&P 500’s move back to record highs is due to the Fed’s easy-money policies.

The Fed had previously committed to keeping interest rates close to 0% until March 2024, but looming inflation has observers now preparing for as many as two rate hikes in 2023.

Corporate margins and inflation

U.S. President Joe Biden has proposed raising the corporate tax rate from 21% to 28%, which opponents say could disrupt the country’s economic recovery and cut corporate earnings — as much as 13% according to some estimates.

The White House has indicated it's flexible on the 28% rate, given its need to bargain with Congress to get other key economic legislation passed.

Companies are also facing narrower margins as consumer prices continue to rise. It's why legendary investor Warren Buffett once called inflation, “a gigantic corporate tapeworm.”

How investors should use this information

Together, those four risks have Levkovich calling for a double-digit stock market slide in the coming weeks.

Which means investors can’t be complacent about their stock choices. When deciding between an asset that promises value or growth, Levkovich suggests investors should prioritize value.

He does anticipate growth will see a resurgence later this year but isn't sold on it as a well-rounded investing strategy.

“If you think of the last decade or so, you’ve had growth outperforming value tremendously, so investors are conditioned to buy growth,” Levkovich told Closing Bell in July. “And as a result, one of the things I worry about is the idea that value is kind of a dalliance, it’s a fling, and then they go back to their true love: growth.”

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Picking investments to ride out volatility

While a red-hot stock market has made it easy for investors, if Levkovich's predictions are right, you’ll have to be more intentional about where you invest going forward.

Borrowing Buffett’s strategy, look for companies that offer clear value, regardless of the state of the economy.

Levkovich has warned that while the overall indexes may take a hit, individual stock pickers can still do well. But individual stocks can get expensive. With the help of a popular investing app, you can buy fractional shares of big-name stocks to get a slice of their profits.