The US fund manager with a danger alert

The head of global fund manager MFS says the Australian market is overpriced.

Summary: Boston-based MFS Investment Management CEO Robert Manning says the US is in recovery mode, but has flagged a looming slump in bond prices when the US Fed stops buying treasuries. He also believes the Australian sharemarket is overpriced, and not helped by the high $A.
Key take-out: Australian stocks look set to rise further but are not offering the same value as their overseas counterparts.

Key beneficiaries: General investors. Category: Growth.

Robert Manning, the chief executive of MFS Investment Management of Boston, is in Australia to deliver a powerful message to Australian institutions and Eureka readers.

MFS is one of the largest global fund managers and it has some $18 billion under management in Australia, mainly invested in its global equity portfolio.

MFS has been one of the best performing investment managers in the world, so his conclusions are worth listening to. Manning’s major point is that the American treasury bond market is being “rigged” and that 10-year US treasuries in current market conditions should carry a yield of about 4.5%. But because the US Federal Reserve is a huge buyer, the rate is down to around 1.8%.

Eventually this buying will be curtailed and, in time, stopped. When that happens the prices of long-term treasury notes in the US will slump and enormous losses will be suffered by longer-term bond investors. Manning and MFS are telling anyone who will listen not to be long in US bond securities.

His second message is that MFS believes that America is a recovery story, and that longer term the American sharemarket has a lot further to run. He points out that the current price earnings ratio on the S&P stocks is just over 12.5, whereas on the basis of current interest rates (albeit artificially low) the PE ratio should be much closer to 16.5. But, if interest rates are going to rise, is the PE simply adjusting for that artificial interest rate difference?

Manning says that the curtailment of the bond buying will coincide with a US recovery. So profits will increase, which will push up share prices despite the bond problem and the lift in interest rates. Manning believes that two major events will drive the American economy forward. The first is the recovery in the housing market, which he believes is now well underway. Prior to the global financial crisis the housing sector represented about 6% of American GDP, and it has fallen to about 2%. MFS believes that while it will not return to its old levels it will double to around 4%. That will be an enormous driver of both the US economy and American consumer confidence. And, as that confidence rises, the whole American economy will benefit.

The second driver of American prosperity will take longer to eventuate but it will be just as dramatic – the huge discoveries of shale, oil and gas. These discoveries will not only make American independent of Middle Eastern oil but they will drive a major resurgence in related industries including fertiliser and chemicals, which will spread to the whole US manufacturing sector.

Accordingly America is a recovery story.

MFS are also keen on emerging markets, but a lot of their investment in those areas is via major international companies that have big stakes in those markets. It is a very safe way of being involved.

MFS has very little exposure to the Australian market because Manning believes it is overpriced. He says that Australian price earnings ratios are substantially higher than those in America and the growth story is not nearly as exciting. Because Australian interest rates are higher than the US, the price earnings ratio should actually be lower than America. And so we have a situation where, in theory, Australian stocks should be on a price earnings ratio lower than 12.5% because of our high interest rates. But instead the PE ratios are much higher than America.

In addition, Australia has a very high dollar, which adds an extra degree of risk for long-term Australian equity investors from overseas.

The Manning message is a danger alert to long-term Australian investors in the sharemarket. Our stocks look set to rise further but are not offering the same value as their overseas counterparts.

A great many self-managed funds find it difficult to invest in overseas markets. It is possible to do it via units managed by major institutions or via Vanguard index funds, which charge low fees. As Eureka readers know, I have an exposure to overseas markets via the Templeton investment company. As one Eureka reader said to me, there is no excitement in these investment avenues. He is absolutely right. What we are looking at is an allocation of capital for the longer term.

MFS Global equity fund is closed and, in any event, is only available to institutions.

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