The long-awaited rotation into small-cap stocks may be losing steam again as Citigroup doubles down on large-cap U.S. equities, arguing that artificial intelligence-led earnings growth continues to outweigh concerns about slowing economic momentum and elevated interest rates. That could have implications for ETFs tied to the small-cap trade, particularly as investors continue favoring mega-cap technology and AI exposure.
According to GuruFocus, in a recent note, Citi said S&P 500 companies posted 27% year-over-year earnings growth in the first quarter, sharply ahead of earlier expectations for 14% growth. The bank added that next-12-month earnings-per-share estimates for large caps have climbed more than 14% so far this year, supported largely by technology and AI-linked companies.
By contrast, Citi warned that smaller companies remain more vulnerable to high borrowing costs, weaker pricing power and margin pressure — a combination that could keep the widely anticipated small-cap rebound from fully materializing.
Citi Says AI Spending Is Keeping Large Caps In Control
Speaking to BNN Bloomberg following a weaker-than-expected U.S. GDP reading, Drew Pettit, director of U.S. equity strategy at Citi Research, said AI infrastructure spending continues to dominate earnings growth even as traditional cyclical sectors weaken.
"We think over half of it is AI," Pettit said while discussing the S&P 500. "When you start thinking about the industrials, market impact directly is pretty low to us, but when you start thinking about areas like the consumer, I would definitely say the consumer, that's where you get a little bit of concern."
Pettit added that investors may need to stay focused on "secular growth, tech, AI," while "small-cap probably continues to underperform when you have macro readouts that look like this."
The comments come as investors reassess expectations for Federal Reserve rate cuts amid sticky inflation and rising long-term Treasury yields — conditions that tend to weigh more heavily on smaller companies dependent on cheaper financing.
Citi also argued that AI-related capital spending is helping create a "different growth regime" for mega-cap technology firms, allowing investors to justify premium valuations as long as earnings momentum remains strong.
"You can buy high valuations if growth comes through and you have upward revisions," Pettit said.
ETFs Linked To The AI And Large-Cap Trade
The renewed focus on earnings durability and AI exposure could continue supporting large-cap and growth-oriented ETFs that are heavily concentrated in mega-cap technology names.
Among the most closely watched funds are the Invesco QQQ Trust (NASDAQ:QQQ), which provides exposure to Nasdaq-listed technology and growth companies, and the SPDR S&P 500 ETF Trust (NYSE:SPY), the world's largest ETF tracking large-cap U.S. equities.
Investors seeking a more concentrated growth tilt may also look at the Vanguard Mega Cap Growth ETF (NYSE:MGK) and the Roundhill Magnificent Seven ETF (BATS:MAGS), both of which are heavily exposed to AI-linked market leaders.
Meanwhile, small-cap ETFs such as the iShares Russell 2000 ETF (NYSE:IWM) could remain sensitive to shifts in interest-rate expectations and broader economic growth concerns.
Pettit said investors should focus less on traditional valuation frameworks and more on companies with "pricing power," "earnings momentum," and the ability to expand margins despite a slowing macro backdrop.
"On the growth side, you still feel good about the cash returns. You actually feel better about the cash returns versus six months ago, and on the back-end infrastructure side, they have great pricing power and they're continuing to beat and raise. We're happy to stay there," Pettit said, referring to the large-cap AI trade.
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