HSBC Analysts Advise on Stock Valuations

HSBC analysts recommend investors focus on stocks with less demanding valuations as the S&P 500 hits record highs.

The benchmark index is currently trading at a premium of over 15% above historical averages. Excluding major tech companies, valuations still exceed historical norms. Out of 12 sectors, seven are priced at over a 10% premium to their historical averages.

Analysts attribute high valuations to the dominance of large companies, encompassing not only Big Tech but also big retail, banks, and pharmaceuticals. These firms have notably driven equity index returns this year, with a few corporations responsible for over half of returns in most sectors.

These prominent companies report above-average earnings growth, averaging 20 percentage points higher than sector averages. Their profitability is also impressive, with many achieving Return on Equities (ROEs) above 30%.

Consequently, these large corporations enjoy premium valuations, trading at forward price-to-earnings ratios exceeding 30x on average.

Despite these high valuations, HSBC identifies investment opportunities in companies with less demanding valuations. They have pinpointed a range of buy-rated companies across financials, consumer discretionary, and tech sectors, trading at a 15% discount or more to sector averages. Notable stocks include Target Corporation (NYSE:TGT), Biogen (NASDAQ:BIIB), Cisco Systems (NASDAQ:CSCO), Salesforce (NYSE:CRM), and Johnson & Johnson (NYSE:JNJ).

Conversely, HSBC discourages investment in small caps at this time, noting their historical underperformance following a Federal Reserve easing cycle that isn’t paired with a recession.

With a gradual easing cycle and anticipated rate cuts projected to bring the target range to 3.25-3.50% by September 18, 2024, HSBC cautions that while lower rates may offer some relief, small caps might refinance at rates higher than historical averages. Additionally, the disparity in profit margins and ROEs between small caps and larger firms remains considerable.