Citi: AI boom weakens U.S. stocks' sensitivity to rising rates; S&P 500 valuation already above fair range.

Citi analysts believe that AI-driven earnings growth and changes in investor ownership structure are weakening the traditional link between U.S. Treasury yields and U.S. equity valuations, with rising rates potentially having a greater impact on economic growth expectations than on stock valuations. The firm's valuation model shows a fair P/E range of 17.1x to 22.1x for the S&P 500, while the current P/E has reached 22.4x, reflecting optimistic market sentiment. Citi notes that since late August, cyclical and defensive stocks have been weighed down by rising rates, but growth stocks have held up relatively well thanks to AI earnings expectations. In addition, the recent rise in Treasury yields may partly stem from increased government bond supply rather than an overheating economy. The shift in pension systems toward defined contribution plans, younger investors' preference for higher equity allocations, and continued inflows of overseas capital are also supporting U.S. equity valuations. However, Citi believes the key question facing the market is what incremental capital can continue to drive stocks higher from here.