Bill Miller: Wishful Thinking About the Market?

by: The Manual of Ideas

Bill Miller prominently underperformed the market last year by betting big on financials just before they collapsed. As of March 31, the largest holdings ofMiller's Legg Mason Value Trust included AES Corp. (NYSE:AES) (6.3%), Aetna Inc. (NYSE:AET) (5.8%), UnitedHealth Group Inc. (NYSE:UNH) (5.1%), eBay Inc. (NASDAQ:EBAY) (4.3%), Yahoo Inc. (NASDAQ:YHOO) (4.2%), CA Inc. (NASDAQ:CA) (4.1%), Sears Holdings Corp. (NASDAQ:SHLD) (4.0%), Inc. (NASDAQ:AMZN) (4.0%), Cisco Systems Inc. (NASDAQ:CSCO) (3.9%), and IBM Corp. (NYSE:IBM) (3.9%).

Miller continues his bullishness on select financial stocks and appears to suggest that the recent market rally could be the beginning of a new bull market. Writes Miller in his Q1 letter,

The rally that began following the March 6th bottom at 666 on the S&P 500 has had a different character from those embedded in the bear market that began with the credit disruptions of August 2007. Whether it is the beginning of a new bull market, which it will be if the economy begins a sustainable period of growth later this year, or if it is just a solid rally in an ongoing bear market, which appears to be the overwhelming consensus, is of course unknown at this point.

If it is a bear market rally, it is one we have not seen since the late 1930s. Its behavior is much more like the rally that ended the 1973-1974 bear market, or the one that began off the bottom in 1982, or even that which erupted in March 2003 from the last debt deflation scare. It has been longer and broader off the bottom, with fewer chances to get in, than the bear market rallies that characterized the post-war period. We have had six straight weeks of gains (seven for the NASDAQ), whereas the most we could muster in 2008 was three weeks of gains.

This move has been led by the classic early cyclicals: financials, housing, and consumer discretionary names such as retailers and restaurants - an encouraging sign that may be signaling the end of the long period of economic decline that began in December 2007. Another hopeful note is the strength of stocks in emerging markets, which are highly sensitive to incremental economic growth. China is up over 30 percent this year, Korea over 20 percent, India 17 percent, and most other Asian markets are higher by double digits on the year. In the Americas, Brazil and Venezuela are up over 20 percent, Chile and Argentina are up double digits, Canada is up 6 percent, as is the NASDAQ in the U.S.

The breadth of the rally globally is a good sign. The S&P 500 is still down 4 percent, and the Dow Jones Industrial Average is down almost 8 percent, but it will be hard for them to remain down if most other global markets are able to hold their gains. This global bear market and financial crisis have shown how interconnected and correlated the world’s economies and asset values are: Just as decoupling was wrong on the downside, it almost certainly will prove to be wrong on the upside.

As much as we'd like to agree with Bill Miller, his commentary may reflect wishful thinking as much as reality. Comparing the recent up-move in the stock market to historical rallies has almost zero predictive value, in our view. What matters is whether the economy is on a sustainable upswing. We have not seen convincing evidence to this effect, leaving us skeptical that the bear market is over.

Don't get us wrong. We invest for the long term and don't try to time the market. As such, we are betting that Bill Miller will be right -- eventually. However, if Miller is picking investments with the view that the recent rally will continue unabated in the short term, he may be in for another rude awakening. In our view, investors should choose companies that will do well even if the bear market continues for quite some time to come.

Disclosure: No positions.