Bill Miller vs. Meredith Whitney - Why They're Both Right

Throughout the credit crisis there has been an uncertainty in the air causing unwillingness, by many, to take a firm position on whether to be bullish or bearish on the market and particularly, the financial sector. Two high profile exceptions to this silence are Bill Miller, the outspoken bull of financials who is the portfolio manager at Legg Mason’s Value Equity Fund and Meredith Whitney, the former Oppenheimer analyst who gained celebrity status after she predicted the crash of financial sector stocks and who recently started her own firm, Meredith Whitney Advisory Group. You may be wondering how I can view both a bull and a bear as being correct at the same time about the same sector. The answer is that this is not a fair game nor is there a level playing field. The game is rigged, at least for now by the effects of government intervention on a global basis.

Let’s start with the bear view: Meredith Whitney’s reputation as a financial sector oracle began in October of 2007 with her remarks concerning Citigroup’s (NYSE: C) balance sheet worries. Since her famous call the financial sector (NYSE: XLF) has declined over 60% and Citigroup has not closed above $40 per share since. Also, since her call, a total of 61 financial institutions (25 in 2008 and 36 in 2009) have failed according to the FDIC many of them banks, some followed by SPDR KBW Bank (NYSE: KBE). She has described financials as “grossly overvalued” and claims that the earnings power of these banks are “negligible.” The economic climate, the housing market, and the recent credit card reforms enacted by the Obama administration all make Whitney’s argument reasonably convincing. Housing prices have fallen 32.2% from their peak and 19.1% in the first quarter of 2009. GDP declined 2.6% in the first quarter of 2009 and the unemployment rate probably jumped from 8.9% to 9.2% according to a survey recently conducted by MarketWatch. Clearly, things could be better, but will they get any worse? Have we reached bottom yet? Whitney doesn't think so.

It is time to look at the bullish case: Bill Miller thinks so.

Bill Miller had beaten the S&P 500 for 15 consecutive years until a series of underperformances in 2006, 2007 and 2008. He is an outspoken bull on the financial sector. Here are some excerpts from a May 14 moneynews.com article by Dan Weil that caught my attention.

"Banks, in fact, are flush with cash, have deposits flowing in, and have $800 billion of excess reserves on deposit at the Fed,” he writes in his quarterly note to investors.

"Most of the big banks that have reported results recently are profitable (Wells Fargo (WFC) had record profits), and most improved their capital ratios."

To those who pooh-pooh the profits, such as superstar bank analyst Meredith Whitney, Miller says, "Not surprisingly, the same analysts who expected the banks to report losses in the first quarter dismiss the earnings as due to nonrecurring items, unusual market conditions (very wide spreads) and accounting gains.”

But “when those same conditions led to large losses being reported last year, those losses were considered all too real,” he points out.

Miller makes some interesting points. The unconvinced ask; how real are the earnings? Will the market and the economy recover? Will deals return along with underwriting fees? It is a reasonable possibility that financials are not nearly as bad as they were at the end of Q208; for starters, people have stopped using the term “Armageddon” to describe the situation in the sector. The modification of FAS #157 (mark-to-market) should prevent (or postpone and smooth out) “paper” losses for the banks, and the large spread due to abnormal market conditions should continue to keep margins wide in lending activities, creating a potential for a profitable second quarter.

There are also economic data that indicate more favorable market conditions ahead. Single family building starts increased by 2.8% from 356k to 368k, and single family housing building permits also increased from 360k to 373k, suggesting that although these are very small gains, the numbers appear to have stopped falling rapidly and a bottom may be near in the housing market. There may be a modest increase in home construction activity. However, I recognize that home construction activity remains at near a decade low.

US consumer confidence data rose sharply in May to 54.9 from 40.8 in April, its highest level in 8 months. Interestingly enough, if you listened to Miller three months ago ending May 26th, you would have made 48.09% if you invested in the financial sector (XLF). The sector has literally melted up.

Maybe banking analysts, considering the events they just witnessed in the financial sector, are not ready to believe any good news from the banks just yet.

I am following interest rates inching up and the bond vigilantes pouring cold water on the holy grail of mortgage rate targets: 4%. Mortgage applications rise and fall rapidly these days, a trend is yet to be had. Gas price are rising again, another head wind.

I attended the Fitch Ratings Global Banking Conference in New York last week. Three big take-aways from David Riley’s presentation on “The Financial Crisis, Policy Response and Sovereign Credit Risk” are:

• Banking crisis and recessions feed each other, especially if international

• A delay in restoring the financial sector health is costly for the economy and taxpayer

• Monetary and fiscal policies must be supportive of the real economy

The government seems to be on the same page, as Fitch suggests, as the old Goldman (GS) boys, oh I mean Washington boys, read the same charts and thankfully are students of history drawing similar conclusions. Their efforts, coordinated on a global basis, may drag the US economy and the world out of recession as soon as the end of this year.

Miller is right as we have seen a melt up in financial stock prices from record lows. Whitney is right that there are still billions in toxic assets on balance sheets and with some institutions, off the balance sheet in special purpose entities.

As a portfolio manager, I predict that the short term for the financial sector will be characterized by volatility. Investors are anxious and uncertain which will cause news and commentary to move individual stocks rapidly but with government support, not necessarily the sector as a whole. Overall volatility will decrease over time, looking towards Q409 and Q110, but idiosyncratic risk will remain for some time.

Profits or losses, second quarter earnings will cause stocks to move. Individual companies will be greatly punished or rewarded for their performance, yielding a PR victory to both Miller and Whitney. The government will continue to prop up firms deemed too big to fail or vital to specific regions or industries.

For the long term, ultimately, I am bullish on financials. As the Fitch presentation suggests; without a strong financial sector economic recovery will be fleeting. This sector needs to lead the economy out of the recession and the individual financial companies that have real earnings, manage risk and their current books well, and are able to raise adequate capital will be well positioned for large gains.

Shout out to intern Andrew John Vanloon for assistance with this post.

Disclosure: Mr. Corn is Chief Investment Officer – Equities of Beacon Trust Company. Beacon Indexes (formally Clear Indexes) designed and publishes the index tracked by Claymore/Clear Global Exchanges, Brokers and Asset Managers ETF (NYSE: EXB). Through various equity strategies under his supervision Mr. Corn is long stocks in the banking and insurance industries as well and other types of financial institutions.

Comments

[Did U Think...:]

Face it, Miller did well in a bull market when you could do well by throwing darts.

Whitney did well when others thought she was insane.

Whitney is the smarter and more honest of the 2. Miller has the hand of the financial elite up his a$$ so that they can puppet his mouth moving.

Jun 01 02:38 AM

[Fighting Yoda:]

Bill Miller made money the previous 15 years when he rode the bull wave - the credit bubble, housing bubble etc. BM is thinking everything will revert back, that is not the likely scenario. Financial sector earnings were at historic bubble high in 2006. Financials contributed to 45% of S&P500 earnings, with a sector weight of 22.5%. Now the sector weight is back to 12-13%. The earnings coincided with the credit bubble. The credit is gone, the earnings for the financials is gone. The bubble business model of financials is finished.

With the ARM resets etc still to unfold WFC (Wachovia, Golden West) - there is lot more trouble for them. Same with BofA.

Meredith was right, Bill Miller was wrong, she will continue to be right.

Jun 01 02:43 AM

[Jasper M:]

Did U -
Oh, MAN, that was some visual!
Legg Mason; what a joke! They're research department hasn't been worth squat since they lost Paul Montgomery. Sad. And a cautionary tale to firms built on other people's exceptional talent.

Jun 01 03:34 AM

[CautiousInv...:]

Quite frankly, I'm surprised you did not mentioned that PPIP........the program designed to rid bank balance sheets of legacy (toxic assets).......if off to a lethargic start with some of the most eager to participate being the banks themselves who wanted to buy assets from themselves.

A related issue is the horizon of the stress test extends through 2010, while the reality is that mortgage defaults/foreclosures are growing and will be a major problem beyond 2010. Problems with prime and Alt-A loans are surging and many ARMS will be reset in 2011.

Increasing attention is also being directed on all forms CRE loans and CMBS, with close to a $1 trillion due to be rolled over inside the next three years. With growing vacancies, higher defaults and falling values, refinancing for many projects will be all but impossible. And S&P by downgrading many tranches of varying vintages, will make it difficult for the Fed assist the industry through TALF.

Banks earnings will also be afffected by legislation reforming the industry and , among other things, limiting the ability of banks to raise interest rates retroactively; making it more difficult to extend credit to those under 21; and billing changes. Since the industry fought the legislation, I think it is safe to assume they do not view it to be in their interests.

Jun 01 08:09 AM

[Ishortyou:]

it's kind of warrisome that the counties are still granting housing permits for new house starts when we still have a massive oversupply in house inventories that is prolonging the crisis. I guess those counties are not that smart to put a temporary moratorium on new hosue starts till the housing market gets better. The other thing is how in the world the banks are still lending for those new house starts?? am I missing something?

Jun 01 08:13 AM

[Gravity404:]

..."Meredith Whitney, the former Oppenheimer analyst who gained celebrity status after she predicted the crash of financial sector stocks..."

I am so sick of Whitney being credited for this. A mentally challenged blind man in a snow storm saw the financial crises looming from miles away. This didn't sneak up on any one.

Maybe I should hire a press agent. HEY I PREDICTED THAT GM WOULD FILE FOR BANKRUPCY, even after they took $30 billion of our money.

Jun 01 09:02 AM

[Dr. Roberts:]

Unlike a broken clock, Whitney got it right once. I'll take Bill Miller's track record every time along with my unrealized gains in WFC and BAC. Note to Andrew Corn, if you had any juevos it would be painful straddling the fence.

Jun 01 09:25 AM

[The Simple ...:]

Counties desperate for revenue can't make impact and related fees from sales of existing homes, nor can developers, builders, subcontractors, materials suppliers, etc. Residential construction is too important a part of the local economies, especially in the sunbelt, for them to recover without those industries going back to work. The banks are simply a part of the entire complex, they need the economies to get going as well. All of the commentators who said the best thing for a housing recovery would be to plow under all of the excess housing stock, were not being entirely facetious.

Jun 01 10:41 AM

[Harry Tuttle:]

Bill Miller is a broken clock. His comments look great when the market goes up which has been most years in his professional career. He couldn't even explain what when wrong in 2008 other than "everybody made the same mistake". The guy was even long Fannie Mae! Is this worth paying for? If you like the market buy an index-fund instead.

Jun 01 10:44 AM

[Jeff Nielson:]

The U.S. financial sector is more insolvent TODAY than the day its Ponzi-scheme first began its collapse.

Any claim to the contrary is the product of extreme ignorance or malicious deceit.

Jun 01 10:51 AM

[Whippet:]

<<For the long term, ultimately, I am bullish on financials. As the Fitch presentation suggests; without a strong financial sector economic recovery will be fleeting. This sector needs to lead the economy out of the recession and the individual financial companies that have real earnings, manage risk and their current books well, and are able to raise adequate capital will be well positioned for large gains.>>

For the same reasons, I am bullish on the big three automakers. Without a strong manufacturing sector economic recovery will be fleeting. I'm also bullish commercial real estate. Without a strong commercial real estate sector economic recovery will be fleeting.

All your base are belong to us.

Jeff Nielson couldn't be more correct.

Jun 01 11:02 AM

[Scott Weitz:]

When the govt gives you money, and buys all your garbage from you, even a nimrod could make money.

Jun 01 01:44 PM

[Tony Daltorio:]

Bill Miller is a joke, but typical of Wall Street. During the 90s, financials and tech stocks went up like a rocket. What did he own - financial and techs. No genius there - he is just a trend follower. And he is dumb enough to believe that the old trend will resume. No way - most US financial firms are worth zero.

Jun 01 02:04 PM

[jeandit75:]

"Bill Miller vs. Meredith Whitney - Why They're Both Right "

Andrew, we don't care the past...we care bout future.

Whitney should win

Jun 01 04:50 PM

[Fighting Yoda:]

Here are the financial sector profit estimates for the S&P (as % of entire S&P profits)
’06 – 45%, ’07 – 33%, ‘08 – loss --- Actuals
’09 – 13%, ‘010 – 18% --- Estimates



On Jun 01 02:43 AM Fighting Yoda wrote:

> Bill Miller made money the previous 15 years when he rode the bull
> wave - the credit bubble, housing bubble etc. BM is thinking everything
> will revert back, that is not the likely scenario. Financial sector
> earnings were at historic bubble high in 2006. Financials contributed
> to 45% of S&amp;P500 earnings, with a sector weight of 22.5%. Now
> the sector weight is back to 12-13%. The earnings coincided with
> the credit bubble. The credit is gone, the earnings for the financials
> is gone. The bubble business model of financials is finished.
>
> With the ARM resets etc still to unfold WFC (Wachovia, Golden West)
> - there is lot more trouble for them. Same with BofA.
>
> Meredith was right, Bill Miller was wrong, she will continue to be
> right.

Jun 01 05:49 PM

[Steven Alex...:]

I thought this was a good article overall. I like to see a compare and contrast between two parties with differing opinions and why. The contrast definitely helps sort issues affecting the market into more manageable buckets.

One of the main issues I keep seeing with the bullish argument is that there is nothing supporting their claim. Even the author said he was a bull but his reasoning was because the market needs to have financials lead us out. The same goes with Miller.his arguments don't have much substance. I saw Whitney interviewed on CNBC and she was very concise and built a strong case. I don't want to see the market go down but I can't see any possible reason why it's so much higher now than it was in March. The higher the market goes from here, and the more people who jump in not wanting to miss the recovery, the lower the market will go on the way back down. No one will want to be fooled a third time!

Jun 01 07:03 PM