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Dream run in US stocks set to end: HSBC

All good things must come to an end, including the dream run in U.S. equities, according to HSBC, which has downgraded its view on the country's stocks to underweight from neutral.

"Global equities initially shrugged off the start of Fed [Federal Reserve] tapering. But, as the Fed continues to cut asset purchases this year and markets start to anticipate the first rate rise in 2015, we think this will present a headwind for equities, particularly in the U.S.," Garry Evans, global head of equity strategy at HSBC wrote in a report on Wednesday.

According to the bank's forecasts, the S&P 500 will rise just 4 percent to 1,900 in 2014, following gains of 30 percent in the previous year.

A trader works on the floor of the New York Stock Exchange.
Getty Images
A trader works on the floor of the New York Stock Exchange.

"With earnings key, we favor countries and sectors with the greatest potential for upside surprises. So we cut the U.S. to underweight because earnings are near record highs, valuations look stretched relative to the rest of the world, and the Fed is moving towards ending monetary easing more quickly than other developed-market central banks," Evans said.

While he doesn't expect U.S. earnings to fall from here, Evans says there are signs of a slowdown in earnings momentum – a contrast to Europe where earnings are likely to see a strong rebound from depressed levels. The bank is overweight Europe equities, forecasting 14 percent upside for the FTSE Eurofirst 300 index this year.

(Read more: Europhoria or europhobia: Which camp are you in?)

"And it is a similar story on monetary policy," said Evans. "Whilst the policy environment remains attractive in absolute terms, the direction of change is negative relative to other regions. Whilst the Fed has now begun to scale back its extraordinary measures, there is scope for the ECB [European Central Bank] to loosen policy further given the on-going disinflationary pressure in the euro zone," he said.

As a result, he said that valuation premium of U.S. stocks could come under pressure over the coming quarters. The country's equities are trading at a price-to-earnings ratio of 20 - a 20 percent premium to the wider global market, according to HSBC.

"Our analysis shows that markets tend to underperform in the short term when valuations reach such an extreme," he said.

(Read more: Doll: 10% stock correction coming, gold going down)

Contrarian call: Underweight Japan

Despite widespread investor optimism over the prospects for Japanese equities, the bank maintains its underweight position on the market.

"Investors are almost unanimously positive on this market - so it is hard to see where the next marginal buyer will come from," Evans said.

"Our analysis of EPFR [fund-tracking firm] data shows that long-only funds are still underweight, but the least underweight they have been in the 10 years for which we have data; they are unlikely to buy more until signs appear that Japanese companies will raise ROE [return on equity] and improve corporate governance," he added.

Other factors contributing to the bank's dull outlook for the market include an expected slowdown in economic growth following the consumption tax hike in April.

(Read more: Is the honeymoon over for Japan equities?)

Additionally, Evans argues that analysts appear to be overly optimistic about the impact of a weaker yen on corporate earnings.

"Almost 35 percent of Japanese production is now overseas, compared with 37 percent of sales which come from overseas. Our work suggests that the yen has much lessimpact on earnings than 10 years ago," he said.

"This indicates that earnings may disappoint analysts' optimistic forecasts," he said.

—By CNBC's Ansuya Harjani. Follow her on Twitter: @Ansuya_H