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Squirrel's John Bolton reports back from San Diego on what's keeping US financial markets heavyweights awake at night

Squirrel's John Bolton reports back from San Diego on what's keeping US financial markets heavyweights awake at night

By Gareth Vaughan

Bonds or equities, in which of these asset classes could we see the next major market correction?

This was a key question raised by the recent Strategic Investment Conference in San Diego run by economist John Mauldin, according to John Bolton, the managing director of Auckland mortgage broker Squirrel, who attended.

The speakers included a range of heavy hitters from the US financial markets including hedge fund manager Kyle Bass of Hayman Capital Management, who successfully predicted and benefited from the US subprime mortgage crisis.

In a Double Shot interview Bolton said one key message he got was everyone's scared of bonds.

"There's a real sense that the bond market is going to blow up, risk is being completely mis-priced in that market, that the people buying bonds are basically having to buy them. People aren't in that market by choice, and at some point the bond market will go. And it's a huge, huge, huge market," said Bolton.

"Certainly from a hedge fund perspective it was very difficult to find anyone that was even lukewarm on bonds."

Another view was that the sharemarket, after a strong run up in recent years, may be facing a correction. Proponents of this view, Bolton said, see weak aggregate consumer demand as the key concern.

These people are worried about ageing populations, little or no real income growth, and a mountain of debt that needs to be repaid that people are struggling to repay even with very low interest rates.

With fuel thrown on the fire through the likes of weak commodity and oil prices and low interest rates, those with this view suggest it's alarming there hasn't been stronger economic growth or stronger inflation coming through.

"And the issue is that if aggregate demand doesn't come back and we don't get growth, the concern is that what it means is the sharemarket's completely overvalued in terms of future corporate earnings. And as corporate earnings get revised down over time with all that underlying weak growth, that ultimately could end up in some sort of sharemarket correction," said Bolton.

Ultimately Bolton said the theme he took away was that nearly seven years on from the collapse of Lehman Brothers, credit markets aren't the major concern.

"All this money printing that central banks did around the world, and all the additional regulation we've got now in that market has made that market a bit boring. So a lot of the hedge funds are not knowing what to do anymore."

"But of course they (central banks) have inflated all of these asset markets and so the sense I got is the real risk now is probably sitting in the bond market and there's some potential risk sitting in the sharemarket," said Bolton.

"They are slightly different risks and driven by different things. But ultimately one of those is probably going to be the next correction. The bond market because it's completely mis-priced if we see inflation come back into the economy. If we don't see that inflation come through and we have real deflationary forces take over, then it will be the sharemarket."

There's more from Bolton on the conference here.

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At 2X GDP in 1981, the financial market was valued at its multi-decade trend level. Since then, the market value of corporate equities has risen 17X and debt outstanding is up by 20X.

Accordingly, financial markets today are capitalized at 5X national income. That’s an elephantine bubble by any other name. Read more

A little corroborative colour: Overvalued in Silicon Valley, but Don’t Say ‘Tech Bubble’

And for the fixed income debacle: LIBOR Describes The Exits


There is a huge asymmetric risk against bonds, investors patience will only last so long. So the least risky option is to NOT buy bonds. If you can find a way to short bonds that doesn't entail long term holding costs, even better. At these interest rates, the prospect of Global bond prices shrinking presents the closest thing to a sure bet the markets have seen in a century. As for the equity markets, on a P/E basis, the risk of us being in a bubble is high, but price deflation is not as certain as with bonds, due to QE inflation risk.