• In a third-quarter outlook report Wednesday, HSBC Private Banking said high stock market valuations are warranted in light of strong corporate earnings and with ample liquidity still sloshing around.
• Global chief investment officer Willem Sels noted that with much of the good news for cyclicals priced in, the market will struggle to deliver positive surprises.
• Sels suggested now is the time to turn to specific sector calls and themes with the strongest growth potential, while also picking areas of the market that stand to benefit from recent political pledges.

HSBC sees a healthy combination of economic growth, earnings and low rates continuing to nudge stocks higher in the third quarter, but has suggested investors will now need to be more selective on geography, themes and sectors to best capitalize.

In a third-quarter outlook report Wednesday, HSBC Private Banking said high stock market valuations are warranted in light of strong corporate earnings and with ample liquidity still sloshing around.

Willem Sels, global chief investment officer at HSBC Private Banking, noted that much of the good news for cyclical stocks — those that typically align with the state of the global economy — is already priced in. This includes the record earnings season, unprecedented fiscal support from governments, the reopening of economies and rollout of vaccines.

While the economic upswing continues to provide a tailwind in the short term, Sels suggested the market will struggle to deliver positive surprises and HSBC analysts expect slowing sequential quarterly GDP (gross domestic product) growth through the remainder of the year.

The British lender also sees the current inflation spike as temporary and anticipates that the U.S. Federal Reserve will not hike rates in the short term, with inflation concerns causing volatility until the market becomes more comfortable with the outlook.

Consumer focus

Sels suggested now is the time to turn to specific sector calls and themes with the strongest growth potential, while also picking areas of the market that stand to benefit from recent political pledges.

"The first leg of the recovery was principally driven by global manufacturing, which continued to operate during the lockdowns. The next leg should see stronger growth in services, with business surveys suggesting a strong pickup in service sentiment," Sels said.

With this in mind, HSBC is maintaining a preference for cyclical stocks overall, but with a focus on the return of the consumer, buying consumer cyclicals such as airlines, autos and luxury, along with financials, another cyclical sector which Sels said "should remain well supported by lower provisioning, rising dividends and share buybacks."

Sels and his team are also looking for select opportunities in consumer staples, which typically include essential products such as food and beverages and household goods.

Geographically, he suggested that the strongest "cyclical momentum" will be found in the U.S. and the U.K. and HSBC holds "overweight" positions in both, along with China.

"Our overweight on China may seem surprising, as data are not accelerating anymore, but we think growth will outperform relative to market expectations," Sels explained, adding that valuations are attractive following the recent volatility.

"We think market fears of tightening lending conditions are overdone, credit supply is being directed to the private sector, and our Chinese growth forecasts still stand at a very respectable 8.5% for 2021."

Policy plays

With infrastructure investment having waned across many major economies in recent years, HSBC highlighted that governments are now looking to infrastructure investment as a means of ramping up current demand and rebuilding amid the ongoing pandemic.

In the U.S., for instance, President Joe Biden's proposed $1.7 trillion American Jobs Plan is aiming to improve transportation, clean energy and social infrastructure — along with semiconductor production — over an eight-year period.

Sustainability is also in focus as governments continue to adopt and strengthen regulations and targets and HSBC sees this globally "competitive race" generating "a new growth opportunity for countries and companies."

Growth stocks — companies expected to grow at a much faster rate than the market average — took a hit early in the year as rising Treasury yields sparked fears over high valuations. However, HSBC believes that as yields stabilize, the strong earnings growth exhibited by the sector in the first quarter should help to boost tech stocks.

"The reopening will broaden consumption beyond online retailers (we therefore retired our digital consumer theme) but strong companies will require digital platforms," Sels said.

"We have launched a total security theme, as the world requires increased cybersecurity, personal and health security, and safe and healthy food."

China will remain the "engine of growth" in Asia, which is structurally outpacing developed markets and other emerging market regions, Sels said, adding that interesting opportunities lie in "high-end manufacturing, automation, electric vehicles, education and healthcare services."