Can the S&P 500 rise further despite high valuations? HSBC says yes: here's why

US stocks may have further room to rise despite elevated valuations, as the earnings and productivity gains generated by artificial intelligence are not yet fully reflected in equity prices, according to HSBC’s Willem Sels.

According to Bloomberg, Sels, global chief investment officer at HSBC Private Bank and Premier Wealth, said investors remain skeptical about the sustainability of corporate earnings growth, particularly among technology and semiconductor companies.

But he argued that the market’s valuation premium has already narrowed compared with Europe.

“The US is not expensive. The markets are questioning the sustainability of earnings growth, but that's in the price because that gap has closed,” Sels said in a Bloomberg Television interview.

The S&P 500 currently trades at roughly 19 times forward earnings, compared with nearly 15 times for Europe’s Stoxx 600.

While that represents a premium for US equities, Sels believes the difference is increasingly justified by stronger earnings growth and the scale of AI investment.

AI earnings could support US stocks

Sels pointed to the widening gap between companies adopting AI and those that have yet to embrace the technology.

Businesses using AI are already showing stronger revenue, earnings and margin growth, particularly in the US, he said.

That suggests investors may still be underestimating the economic benefits of the technology as companies move from experimentation to more widespread deployment.

Semiconductor stocks are a particular example.

Sels said investors are effectively discounting some companies because they question whether earnings forecasts for 2027 can be achieved.

He expects that skepticism to diminish as companies provide greater visibility through order books, customer demand and guidance.

The argument comes as US corporate earnings continue to surprise on the upside.

S&P 500 earnings per share jumped 50.7% in the second quarter from a year earlier, accelerating sharply from 19% growth in the first quarter.

Even excluding mark-to-market investment gains, earnings increased 25%.

Forward earnings also climbed to a record $401.75 a share last week, suggesting that corporate fundamentals remain resilient despite geopolitical tensions, elevated energy prices and uncertainty surrounding monetary policy.

That strength has helped support the broader equity market.

S&P 500 forward price-to-earnings multiples have fallen about 12% since the beginning of the year even as the index has gained roughly 13%.

Bond yields remain the biggest threat

The main threat to the bullish outlook is not necessarily equity valuations but a sharp increase in bond yields.

Sels identified a 10-year US Treasury yield of around 5% as a level that could trigger significant volatility in stocks.

Higher yields make bonds more attractive relative to equities while also increasing borrowing costs for companies.

“The bond market has been back in the driving seat for stock investors recently,” as rising oil prices, inflation concerns, fiscal pressures and expectations for tighter monetary policy have pushed Treasury yields higher.

JPMorgan’s Grace Peters has also described a 5% 10-year Treasury yield as psychologically important, while Barclays’ Emmanuel Cau warned that such a move could make investors more concerned about equity valuations.

The risk is particularly relevant as companies increase borrowing to finance AI infrastructure, data centers and other capital-intensive projects.

Higher financing costs could ultimately weigh on corporate earnings and investment.

Still, Sels remains broadly bullish on equities, arguing that businesses and economies have repeatedly proved more resilient than investors expected.

Earnings could keep the rally going

The strength of the earnings backdrop has also encouraged prominent market bulls to remain optimistic.

Veteran economist Ed Yardeni has indicated that he may need to raise his already bullish 8,400 year-end target for the S&P 500.

For Sels, the combination of improving earnings, AI-related productivity gains and resilient businesses provides a powerful tailwind for stocks.

The key question for investors is therefore whether earnings growth can continue to outpace concerns over valuations and bond yields.

So far, the earnings data suggest that it can. But with Treasury yields climbing and the 10-year note approaching levels that investors consider dangerous for equities, the bond market could determine whether the next leg higher in US stocks is sustained.