Investing.com -- Citi has downgraded U.S. equities to Neutral from Overweight, reflecting the current uncertainty in the macroeconomic outlook, elevated valuations, and mounting earnings downgrade pressures.

While some tariff-related risks have been priced out following President Donald Trump’s 90-day pause on trade restrictions, Citi believes the U.S. remains vulnerable to further economic drag.

“Tariffs, as they stand, could negatively impact U.S. earnings per share (EPS) the most,” the analysts wrote in a note titled "New World Order," highlighting that the U.S. market is still trading at roughly the 80th percentile valuation multiple versus history.

Citi’s proprietary Earnings Revision Index recently hit “recessionary” levels of -40%, underlining the risk of further downgrades. The Wall Street firm’s new top-down forecast for global earnings growth is 4%, well below the 10% expected by bottom-up consensus.

Strategists estimate that existing tariffs could be a six percentage point drag on MSCI All-Country World Equity Index EPS growth this year. Against this backdrop, Citi warns that “cracks in the U.S. exceptionalism story could dominate the equity investing environment over the medium-term.”

As part of its regional reallocation, Citi upgraded Japan to Overweight, pointing to more attractive valuations and a reduced risk of U.S. trade conflict. Japanese equities are trading at the 15th percentile valuation multiple over the last 25 years and have already priced in bearish EPS scenarios.

Citi also sees Japan “as likely as any market to see reprieve from U.S. tariffs via bilaterial negotiations with the Trump Administration,” strategists said.

The U.K. equities were also upgraded to Overweight as well, with Citi citing “cheap valuations, while its Defensive nature could help if volatility persists.”

The bank maintains its Overweight stance on continental Europe, pointing to fiscal stimulus tailwinds and expectations of further rate cuts by the ECB.

Alongside the U.S., Citi also downgraded emerging market (EM) equities to Underweight from Neutral, driven by China’s heavy exposure to current tariffs and the risk that elevated trade barriers could persist despite recent signs of progress.

In terms of global sector strategy, the bank retains a balanced approach, with Tech being its preferred growth sector, Financials on the Cyclical side, and Health Care as the top Defensive pick.

Citi expects market volatility to persist due to ongoing macro and policy uncertainty but sees potential for a significant rebound by year-end if trade talks progress, particularly with signs of easing tensions with China.

The firm’s MSCI All-Country World Index target of 1050 suggests a possible 12% gain.