The long-term outlook for financial markets remains positive, but caution is required in the short term, suggests HSBC Investments (Canada) Ltd. in a new research note.

“Rising U.S. interest rates and persistently high energy prices are the two biggest concerns,” it explains. “On a positive note, valuations are reasonable and investor sentiment is not exuberant, so any corrections are unlikely to be deep.”

HSBC says it expects that, “while overall economic conditions should remain sound, growth over the near term will slow due to continuing rate hikes in the U.S. Until the interest rate outlook is resolved, the upside for markets is likely to be limited.” Also, many companies have absorbed higher energy prices rather than passing them on to consumers, so, “corporate profit margins could be squeezed”.

Although the firm says it is “relatively sanguine” about inflation, “expecting only a gradual increase in core CPI because of spare global capacity in labor and capital usage. Also, the corporate landscape continues to be very competitive, and the scope for general price increases is limited”.

“We expect that the coming quarter could prove challenging for markets, as investors will have to deal with further rate increases and slowing growth,” it says. So, it has reduced its equities exposure to a neutral weighting.

“Our asset allocation strategy continues to favor equities over fixed income and cash over bonds on the grounds of favorable valuations as well as sustained global growth,” it says. “However, we expect that there will be some consolidation in equity prices. Rising interest rates and high oil prices are the most important constraints facing global equities.”

“We continue to prefer Asia on the longerterm strategic grounds of attractive valuations and superior growth. We are neutral in Europe, where valuations are very supportive but the markets are cyclical and exposure to growth poses concerns,” it says. “Canadian equity holdings have been trimmed slightly, but our overall stance still favors equities.”

“We remain underweight in the U.S., but with the underperformance for this year versus the Canadian market, valuations are not as expensive,” it notes.

As for the fixed-income side, it says, “We see very little value in bonds at current yield levels and find the prospective return from the asset class unattractive. We continue to take a defensive stance.”