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Equity positioning is still low despite stock market rally, HSBC strategist says

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Key Points
  • HSBC Private Banking is overweight growth stocks and quality large caps, including telecoms and tech. Global Chief Market Strategist Willem Sels will not be "chasing that rotation into low quality, overly cyclical sectors."
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Equity markets have continued to rally in recent months even as the black cloud of the coronavirus pandemic continues to hover over the global economy.

In particular, cyclical sectors such as banks and automotives have seen a windfall from investors looking to capitalize on the anticipated economic recovery, with markets fueled by an unprecedented arsenal of stimulus from central banks.

This has led to questions about whether stock markets have become unmoored from reality, but Willem Sels, global chief market strategist at HSBC Private Banking, believes that equities by-and-large remain supported by four factors.

Liquidity and the reduction of tail risks due to policy measures from governments and central banks are a key driver of the general upward trend, Sels told CNBC's "Squawk Box Europe" on Wednesday.

"Secondly, the relatively low expectations that investors have around earnings. Now analysts have started to upgrade those, but certainly still earnings expectations are relatively low and markets have benefited from that," he added.

Despite the expected hit from the pandemic, earnings season thus far has produced more positive than negative surprises, with many now significantly revising up their forecasts, but Sels also suggested that positioning in stocks is still low.

"Investors are quite skeptical, a lot of cash as well with our clients but also when you look at surveys, U.S. investors are only 23% bulls, usually that is between 20% and 45% so we are at the bottom end," Sels said.

He also highlighted that much of the economic data focus is forward looking, with PMI (purchasing managers' index) readings signaling a much more positive perception of the future than key data points for the last few months would suggest.

Sels argued that investors should be looking at equity valuations in relative terms against the corporate bond market.

"If you look at where investment-grade BBB ratings (medium quality corporate credit) are, and you incorporate the fact that we believe that you are going to continue to have that support from central banks that is going to remain with us — the bond market is even talking about yield curve control," he said.

"Plus you also incorporate the fact that the technology sector has grown in size and weight within the indices, and typically commands a much higher premium obviously, or multiples than other sectors, you can explain the valuations."

Sels said clients are beginning to look beyond FAANG (Facebook, Apple, Amazon, Netflix, Google) megastocks and into "outside the box" technology players which cross into other sectors, with specialist technology companies now integral to industries like healthcare, online consumption, automation and finance.

Sticking with 'quality' stocks

HSBC Private Banking remains overweight growth stocks and quality large caps, including telecoms, technology and some health care names, and Sels said he would not be "chasing that rotation into low quality, overly cyclical sectors."

Quality stocks are companies with high profitability, stable long-term performance and strong balance sheets, while growth stocks are those generating significant and sustainable cash flow with earnings performance increasing at a faster rate than their industry peers.

Sels believes that an uneven "U-shaped" recovery will mean every company is positioned differently in terms of cash flow and balance sheet strength.

"The Fed has recently warned that with regard to interest rate coverage, the number of companies below 1x interest rate coverage has gone from 18% to 25% just in the past quarter," he said.

"Lending standards are starting to be tighter, so the quality of the balance sheet remains important, so therefore we are not going into the low quality, we continue to stick with quality stocks."

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