Beware ‘Micro Bubbles.’ Here’s Where to Focus When Picking Stocks.

To avoid the hype and potential bubbles, Citi recommends a three-pronged approach that includes focusing on growth stocks that trade more reasonably—the strategy known as growth at a reasonable-price, or GARP; operating leverage; and sales growth.

“This has helped avoid some of the hype within certain structural themes that could be more susceptible to aggressive unwinding,” wrote Citi.

The bank said the word “bubble” is being tossed about with abandon lately and market watchers are increasingly making comparisons to the tech bubble that ballooned in the late 1990s and peaked in 2000.

Indeed, some analysts warn the current situation appears uncomfortably similar to this period, when the Nasdaq lost more than three-quarters of its value from its peak in 2000 through late 2002. 

Citi isn’t among them. “We view the current bubble risk in equity markets differently,” the firm wrote. “It is more of a micro issue across and within certain themes. Essentially, this is a continuation of the rolling burst of various micro bubbles we have seen since 2020.”

Some of those bubbles include special-purpose acquisition companies, better known as SPACs, companies that benefited during the Covid pandemic, and unprofitable clean energy stocks.

Federal Reserve officials have raised their benchmark federal-funds rate target by 5.25 percentage points since March 2022, to a target range of 5.25%-5.50%, to cool the worst inflation in more than 40 years. Citi said the surge in interest rates was the main catalyst for breaking down some of the micro bubbles.

 “A series of micro bubbles have been popping under the surface of the U.S. markets since 2020, but the risk of more bursting remains today,” the note said. “Micro bubble risk is especially acute for investors in popular themes.”

One of the most popular themes over the past year has been artificial intelligence, which remains one of Citi’s top themes. The firm acknowledged that many growth-oriented themes, AI included, have seen some stocks “get punished when lofty expectations aren’t met with a broad beat-and-raise.”

Citi’s stock picks in this theme are
Amazon.com,

Alphabet,
and
Meta Platforms.

The bank also likes the theme of infrastructure and fossil fuels, which includes stocks such as
Aecom,

Edison International,

Chart Industries,

Martin Marietta Materials,

NOV,
and
United Airlines.
Other themes on its top themes list include digital leisure, experiential commerce, fintech, and internet-driven business.

Citi said that while the relatively narrow market leadership and wide dispersion around earnings has created headwinds for many themes, there are still opportunities for stock selection.

“In this environment in which many micro bubbles are still unwinding, or set to unwind, we stress a theme- and stock-selection focus predicated on operating leverage paired with growth at a reasonable price, and top-line visibility overlays.”

Write to Lauren Foster at [email protected]