Bill Miller 3Q07 Commentary

I consider Bill Miller to be one of the best value investors out there. In fact, I consider him to be quite special and unique in the value investing and contrarian investing arena. There are only a few value investors out there who are able to analyze so-called high-growth industries and actually make money. Bill Miller is one of the few value investors who has successfully invested in companies like Amazon and Google. I wasn't really following him that much a few years ago but I consider his Amazon call, when practically everyone thought it was a trashy dot-com, to be one of the best investing calls I have encountered in my short investing life. I remember looking at Amazon back then and didn't know how it could make any money. The consensus view, which was also my view, was that Amazon has zero barriers to entry so what's to stop someone from setting up their own merchandising website? Well after the fact I read Bill Miller's reasoning (I don't recall his exact words but it had to do with the fact that Amazon has massive scale that cannot be replicated (just like Google right now) and its capex was inevitably going to decline (once you roll out a system, the costs will drop) and it is such a smart proposition that I have followed him ever since.

Anyway, Bill Miller released his 3rd quarter commentary and you can check it out here. Like many value investors who avoided cyclicals and commodities, Bill Miller hasn't done too well this year. I'll quote what I find insightful but you should read his full commentary:

The stock market can close down for a while and it
really doesn’t matter all that much. The primary
function of the stock market is not to finance
company operations, it is to price assets.

Miller mentions this to explain the importance of credit markets (I'm not going to delve into that) but I found it insightful. I never really realized that the main function of stocks markets these days is to provide a pricing function. Some people out there like to attack stock markets because they don't do much for the economy at times but now I can defend it :)

The stock market rally has been led by the same groups
that have led for 5 years: energy, materials, industrials,
and technology. The same laggards, lagged: consumer,
financials, and healthcare. Growth stocks continued to
shine and traditional value stocks did not.

This market has been remarkably serially correlated. In
plain talk, what has gone up keeps going up, and what
has not, does not. Valuation has not mattered at all.
What has mattered is price momentum. This is very
similar to what we saw with tech, telecom, and internet
names in 1999. It is not yet that extreme, but it is pretty
extreme.

The best quintile of stocks based on traditional valuation
factors such as price to earnings, price to book,
price to sales, and dividend yield, has underperformed
the market by over 1000 basis points this year. The
best quintile on price momentum alone, using 3 and 9
month price trends, has outperformed by 1400 basis
points.

There are two camps right now: those that believe that the cyclicals/commodities/emerging markets/etc are going to keep going up; and those that don't. Bill Miller is in the latter camp and I'm in that camp. Similar to Miller, I have been proven wrong all year long (I shorted (via an inverse fund) the TSX on expectation of a commodity correction and this has been a disaster so far.)

If credit is becoming harder to come by, if spreads are
widening, if growth is slowing, then it seems to me the
leadership is about to change. The same strategies that
led when the global economy was emerging from fears of
deflation and entering a period of accelerating growth
and synchronized recovery are very low probability bets
to lead if the global economy is peaking, the US is
slowing appreciably, and credit spreads are widening, not
narrowing.

Where will the new leadership come from? The same
place it usually does: the old laggards. I think the new
leadership will be US, large-cap, dollar-based, and grow
to encompass what no one wants to own today, especially
financials and consumer. I also think so-called growth
stocks will continue to do fine. When growth becomes
scarcer and the discount rate becomes lower, growth
becomes more valuable.

He says to look at the 52 week low lists to find some opportunities. Needless to say, those are littered with homebuilders, mortgage lenders, investment banks, and so forth. The interesting thing is that he gives the green light to growth stocks. I'll be curious to see how that pans out. There is a theory that growth, especially technology, will do well in a slowing economy (sectors like tech also benefit from a declining US$).

That [Countrywide Financial], by the way, we think is in
the $40’s compared to its current price of about $14-15.

Miller is still bullish on CFC. He thinks it is worth $40 while the market is placing a much lower value. I'm tracking CFC but don't have a strong opinion on it yet. One of the big bullish arguments is that it will be a 'last survivor' and gain market share. Even if housing drops, mortgages will need to be financed and the bulls will argue that CFC will the one to provide that business.

Today fear dominates the pricing of housing stocks, of
mortgage related securities, of financials, and of many
consumer stocks. Confidence and optimism underlay the
pricing of energy, materials, industrials, and non-US
stocks, especially those of emerging markets, and China in
particular.

I'm on the same wavelength as Miller. I am concentrating my search on homebuilders (PHM bonds, BZH), building material suppliers (OC warrants) and debt insurers (ABK).

I am reminded once again of the quote that sits in the
front of Ben Graham’s Security Analysis, from Horace’s
Ars Poetica: “Many shall be restored that now are fallen
and many shall fall that now are in honor.” (The quote
does not say “all” by the way, just “many”).

Pretty good quote for contrarians everywhere... and certainly something that describes Bill Miller's strategy.