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Global markets have weathered a series of shocks in recent years, but HSBC sees some developments that could finally end its losing streak.
Key risks include higher corporate taxes, new increases in private sector debt, and changes in the relationship between stocks and bonds. Its resilience could be tested if the central bank’s support for the market is withdrawn, the central bank said in a note on Monday.
HSBC said that while the “elimination of central bank puts” could have a negative impact, it is difficult to imagine such a scenario, especially in the US where equities, wealth effects and financial conditions are highly intertwined.
HSBC said the biggest risks lie there, given the US’s outsized weight in global equities and credit. Higher corporate taxes that squeeze profitability could weigh on the market, while inflation near or below target could reverse the negative correlation between stocks and bonds (where bond prices rise as stock prices fall).
As a result, investors may reduce their equity allocations, putting pressure on valuations.
HSBC noted that private sector leverage is at multi-decade lows, but if private sector leverage rises again it could make the economy and markets more vulnerable to shocks.
Risks have been highlighted in recent years as markets have proven surprisingly resilient to bad news, from rising inflation and tariffs to geopolitical conflicts, unwinding carry trades and private credit concerns.
“Risk assets appear to continue to defy all negative factors,” HSBC strategists said.
Strategists have described the market as “Teflon,” arguing that risk assets have remained surprisingly resilient over the past five years despite a host of potential negative factors.
Deutsche Bank also questions how long its patience will last. The bank said in a report on Monday that risk assets have remained “consistently resilient”, supported by surprisingly strong global economic growth, despite higher real interest rates and rising inflationary pressures.
“The current equilibrium is unsustainable…Risk assets such as equities and credit remain surprisingly comfortable with the stagflation shock that is increasingly priced into interest rate markets,” Deutsche Bank said.
The report said that despite rising inflation pressures, interest rate markets are still pricing in only limited central bank tightening, while equities and credit assume that rising yields will not materially damage growth.
What’s behind market resilience?
One key factor is the strength of corporate earnings and economic growth, particularly in the United States, where consensus forecasts have repeatedly underestimated earnings. HSBC said that while U.S. corporate tax rates remain near multi-decade lows, its resilience extends beyond technology and artificial intelligence.
Another factor is the change in the relationship between stocks and bonds. With government bonds no longer able to diversify equity risk the way they once did, investors are reducing their bond allocations and shifting to stocks and short-term hedging strategies, which is supporting the rise in stock valuations.
Strong wealth effects are also at play. U.S. household wealth is well above pre-COVID-19 trends, with much of the increase concentrated among high-income households. Cash and cash equivalents holdings are also well above pre-crisis trends.
Meanwhile, central banks now have a much wider range of tools available to them to respond to market stresses. HSBC noted that the Federal Reserve has nearly 20 potential tools, facilities and backstops, while the European Central Bank has more than a dozen.
Lower energy intensity and relatively lower private sector leverage also help absorb market shocks. The oil price hikes associated with the conflicts in Ukraine and the Middle East had a smaller impact on developed economies than similar shocks in the 1970s and 1980s.
