The market isn’t pricing in rate hikes: HSBC’s William Sels

Yahoo Finance’s Julie Hyman and Brian Sozzi discuss the market action and outlook with Willem Sels, HSBC Private Banking & Wealth Global Chief Investment Officer.

Video transcript

JULIE HYMAN: And we are seeing a turbulent morning for markets, whether it is yields going higher in the US and internationally for that matter, or tech stocks in particular going down. There's a lot to dissect here. Let's bring in Willem Sels to try to make some sense of this, Global Chief investment officer at HSBC Private Banking and Wealth. And Willem, it feels like that there is a change, sort of more significant change going on in the market right now that was triggered by the Fed's commentary last week, but is sort of taking a little time to percolate through the market. Then add to that, perhaps concerns about a potential government shutdown, about the US coming up against the debt ceiling. How are you reading this right now? Is there a bigger sentiment shift?

WILLEM SELS: So everything is triggered by the bond market move. You talked about the tech stocks moving and obviously growth stocks are very sensitive to where Treasury yields are going. And so this spike in bond yields is driving that underperformance of tech stocks. I would not exaggerate that we always put, as you probably know, the emphasis on the longer term structural reasons why Treasury yields are low. And we think anything above the 150 level for 10-year US Treasury yield is exaggerated. It's global aging. It's a debt-- the debt pile that keeps bond yields low in the long run. And currently, we are just a little bit above that 150, so a bit exaggerated.

So it's right at what is triggering it currently is that concern of tapering, which we think is going to start in November and run through June. But importantly, the rate hikes are still some way off in our view with the Fed will only start to hike in 2023. The debt ceiling, the market is not really pricing in. And I don't think the market is taking it very seriously at this point in time, very low probability. If you look at the credit default swaps for the US, they're now at 15 basis points compared to Germany at 10, but Brazil at 200, so still a very low probability of default for the US.

BRIAN SOZZI: Well, I have a lot of folks telling me right now, Brian, the fundamentals of the market remain fine. It's great to be long stocks. Just keep on doing what you're doing, my man. But listen, the way I see it the fundamentals of the market are changing. I mean, the cost of credit is starting to go up, supply chain bottlenecks persist. What is the case to stay long stocks here?

WILLEM SELS: So the stocks are cheap relative to bonds even with the move. I mean, especially, you know, given that earnings have grown-- have continued to grow over the last year and the economic growth still continues, you know? The earnings have gone up, so therefore, the TE ratios have gone down. So compared to the bond markets and the earnings yield relative to the bond market yield, that's what we call the risk premium for equity markets. And that is actually reasonably attractive extends both its historical average over the last five years. So equities are still the place to be, unless you think that you're going to start to get a lot more yield on bonds or on your cash, which we don't think is going to be the case.

So we think the equity market rally continues because money will continue to be cheap. And the economic growth continues. That being said, as we are now in the mid-cycle stage, we are shifting some to somewhat higher quality stocks, so those companies, which can have strong margin power, more into large caps, and more into dividend stocks.

BRIAN SOZZI: But having profit margins for S&P 500 companies, haven't they peaked for this cycle?

WILLEM SELS: So they, you know, they are extremely high, that's correct. And that's in part because companies have managed to be very productive and the wage cost has been low. The interest rate cost has been low as well. So it obviously goes into, you know, the whole topic around inflation, are we going to have wage inflation and how long are the input costs going to be an issue. You know, we do think that, you know, supply chain bottlenecks may stay with us for some time still, but we do think that inflation will come down sort of towards the end of the first quarter or the beginning of the second quarter.

You know, companies, if they see their wage bills increase, they will have resort to automation, to offshoring, et cetera. And we're always-- there's a danger that, you know, depressing people think too much about the local issues. And certainly here in the UK, for example, we have a shortage of truck drivers. And Brexit is having an impact on local costs. But there is a lot of jobs that are very international and we're all working now on Zoom and online.

And so therefore, we're more and more competing with very smart people in India, and Poland, in Brazil, and so on, so that will keep wages in certain parts of the labor market quite low. So I don't think that margins will see a dramatic pressure. Companies will find a way around it.

JULIE HYMAN: Willem, good to see you, thank you. Willem Sels, Global Chief investment officer at HSBC Private Banking and Wealth. Appreciate it.