Bill Miller 2Q 2008 Shareholder Commentary

It has certainly been a tough period for Bill Miller. In his second quarter commentary, he shares his thoughts.

(source: Bill Miller Commentary, Bill Miller. 2Q 2008, Legg Mason Capital Management)

Mason Hawkins said, “Warren, I’m an optimist. I think this whole thing can turn quickly, and surprise people. Are you an optimist?” “I’m a realist, Mason,” the sage replied. Warren went on to say he was optimistic long term, and backed that up in a talk the next morning on the remarkable history of growth, innovation, and wealth creation the U.S. had produced over the past 200-plus years. He also offered a sober assessment of the current challenges we face, and said it would take some time to work through them.

He then made the perfectly sensible point that as we are all net savers, we should be happy if stock prices declined a lot more, so we could buy even better bargains.

Warren, of course, is Warren Buffett. Nothing new from Buffett, who has said in the past that it could take a while for things to recover. Warren Buffett is not a macro investor and isn't really good with his macro calls. But he does have a very sense of history and what is logical from a long term point of view. The problem I have with Buffett's point (that we could buy more) is that this isn't the case with everyone. For instance, I personally just don't have much more capital to add. Yes, young working class people like me are better off with the current situation (since our earnings are large relative to our assets; and lower valuations imply higher future returns) but it is still difficult to suck up and accept the notion that it's good to see low prices because we can buy more.

Having said that, contrarian investors live for months like now. I remember how just about the only things trading at really low valuations over the last few years were distressed companies. If anyone ever looked at my watch list (I didn't have a blog back then though,) you would have seen trashy companies like Spectrum Brands (SPC) or Celestica (CLS) or Nortel (NT). These were the type of contrarian opportunities that were available (as far as I was concerned--there are some sectors I ignore on purpose though.) In contrast, right now you can pick up historically solid companies for low valuations.

John Rogers, the founder of Ariel Investments, came in to see us last week. John has been an outstanding investor for 25 years or so, but like almost all value types, is going through one of his toughest periods now. His assets are down, similar to the experience we’ve had. He said it was the most difficult market he’d seen, a judgment I would have given to the 1989-1990 market, up until the frenzy erupted over Fannie Mae and Freddie Mac, which sent financials to what looks like a capitulation low on July 15. I am now in John’s camp.

Bill Miller is one of the few value investors who often goes out on a limp and makes specific macro calls. I'm highly respect him but most of his "off the wall calls" turn out to be wrong. This July 15 call might turn out to be wrong as well. Recall that Miller thought that the collapse of Bear Stearns was the bottom in financials a few months ago and it turned out to be wrong.

I am reminded of what John Maynard Keynes, himself a great investor, said once about investing, “It is the one sphere of life and activity where
victory, security, and success is always to the minority and never to the majority. When you find anyone agreeing with you, change your mind. When I can persuade the Board of my Insurance Company to buy a share, that, I am learning from experience, is when I should sell it.”

Keynes captures the truth quite well. Investing, if you look at it as a business, is one of the toughest businesses out there. Only a small minority actually make any money through investing. There are a lot of wealthy folks on Wall Street and Bay Street but most of them become wealthy through selling financial instruments (brokers), cutting deals (rainmakers), or from fees (fund managers). There are a lot of millionaire fund managers but they make most of their money through fees. I think if you take a somewhat contrarian path, it may lead to success--at least that's the strategy I'm pursuing.

It has been explained to me that it was obvious we should not have owned homebuilders, or retailers or banks, and that I should have known better than to invest in such things. It was also obvious that growth in China and India and other developing countries would drive oil and other commodities to record levels and that related equities were the thing to own. “Don’t you even read the papers?” was a common comment.

That is a point that I find annoying. There are a lot of people--bloggers, message board posters, journalists, investors--that claim that some of the things that happened were obvious. If everything was so obvious I wonder why they are not millionaires now. If you thought oil&gas were going to do really well, all you had to do was to put down $50k to $100k on some high-cost E&P--these have the most leverage to oil and natural gas prices (example would be oil sands companies or coal-bed methane companies)--and you would be a millionaire now (most of them went up 10x or more). Similarly, if you thought housing was going to go bust, you could have shorted homebuilders like Beazer, or building material suppliers like USG, or housing oriented retailers like Sears and you would have cleaned up easily. You wouldn't have made as much as going long (since maximum from shorting is 100%) but it would have been plenty. Of course, buying long-term deeply out-of-the-money put options would have made you a bundle (these options would have been so cheap on these high flyers).

Sir John Templeton died a few weeks ago, full of riches and honors, as he so deserved to be. The legendary value investor got his grubstake by famously buying shares of companies selling for $1 a share or less when war began in 1939. He didn’t know then that the war in Europe would spread to engulf the world, nor how long it would last, nor how low prices would ultimately go. He always said he tried to buy at the point of maximum pessimism, but he never knew when that was. He was, though, a long-term optimist, as is Mr. Buffett, as am I.

The only thing is... I'm not sure if we have reached the point of maximum pessimism...