Both the American bond market and Australian shares face dangers that are being ignored.
That is the warning that was delivered to Australians at the weekend by one of the world’s largest and most successful global investment managers — Robert Manning — the chief executive of MFS Investment Management of Boston.
In the case of Australian shares the market danger is emerging because global liquidity is combining with self managed superannuation funds, and private investors who are finding bank deposit rates too low so are swinging to the yields offered by shares (lead by banks).
At this point the long-term valuation danger this creates is well in the back ground as shares roll further upwards.
But Manning and MFS believes the Australian share market does not offer value compared to the US because Australian price earnings ratios are substantially higher than an average of just over 12.5 in America.
Worse still, Australian interest rates are higher than the US, so the price earnings ratio should actually be lower than America. And the US has a better growth story.
But just as the quest for yield in the Australian stock market is making our shares over priced compared to the US, so America has its own yield danger.
Manning is telling anyone who will listen that the America has a “rigged” long term bond market which will eventually collapse.
In normal circumstances 10 year American bond yields should be around 4.5 per cent but because of US Federal Reserve buying, the yield is around 1.8 per cent.
Manning believes America is a recovery story (he is a bull on US shares) and its economy is going to be driven by much higher investment related to shale gas/oil and the recovery of the US housing market.
MFS believes that currently American housing is only 2 per cent of US GDP and while it will not recover to the peak of six per cent set before the GFC, it will recover to four per cent.
And that housing recovery is starting now. Those two recovery forces will eventually cause the Federal Reserve to stop buying US bonds and when that happens yields will return to normal levels — causing big losses for those holding long term US bonds.
Manning believes American profit growth will outweigh the adverse affects of the bond collapse. But it’s an alert that the momentum of the US recovery is a major disruption to global markets. And as Australian companies pump more and more money out in dividends and capital returns, so long term growth will be affected.