Bill Miller of Legg Mason Investment Management believes the Bear Stearns bailout two weeks ago marks the end of the credit crisis.
The manager of the Legg Mason Value Trust, Legg Mason Value A Dis A USD and Louvre Gestion's America Value funds says that on hearing this news he ‘put fresh money into the pot’, namely his own funds, which he admits is something he rarely does. He says that the Fed’s opening up of the discount facility to investment banks has allowed spreads to come in, leading to a rebound in financials.
Miller and co manager Mary Chris Gay are currently overweight financial services, technology and consumer discretionaries. Within the financials sector Miller singles out housebuilding stocks as an area he is investing in. He says that although the area attracts negative press, he believes the stocks are starting to outperform and points to the recent healthy performance of the index.
He has also increased his fund’s exposure towards financials with less risky balance sheets and a lack of exposure to structured products, and highlights the US Bank Corporation and Capital One as stocks to watch.
Moreover, he says investment banks such as Merrill Lynch and Lehman Brothers, may be ‘the next place to move’.
However, Miller is also predicting further consolidation within the financial system and says we could see potential changes to capital requirements within investment banks. He says that we may well see companies like Merrill Lynch and Lehman Brothers partnering with other banks, like HSBC and Wachovia, before the next credit cycle is over.
He says the current system is suffering from over capacity and as a result of this, he predicts the incentive structure of investment and commercial banks are likely to see changes.
Miller, who is also chairman and CIO at Legg Mason Capital Management, remains positive on the healthcare sector and mentions managed care, in particular, as an area where he is expecting to see positive growth.
Although he admits this has been the worst quarter he has ever experienced in terms of the performance of his Value Trust relative to the market, he is predicting an upturn in performance. He points to two other quarters in 1987 and 1990 in which his fund underperformed and says it is no coincidence that in 1988 his fund achieved an impressive turnaround.
He points in particular to the rebound in US equities, which saw the S&P 500 close 3.6 per cent higher yesterday, and in turn the increase in his fund's valuations. ‘If you have a good market, which I believe will happen, it is possible to achieve significant outperformance,’ he says.
Miller says the current market environment is not favourable for momentum investors and believes we are at a ‘tipping point’ for valuation strategies. ‘Our portfolio is as extreme as it has ever been,’ he says.
Although Miller’s Value Trust held a large position in Bear Stearns, he says his portfolio has been worse hit by other holdings. Moreover, he says the mantra of investing in high quality names with steady predictable returns during times of economic uncertainty is not necessarily true for the current crisis. He points to his position in United Healthcare, which he says is down 25%.
Co-manager Mary Chris Gay compares the current environment to that of 1991 and 1992 when the fund was at a low. She also says that while this was a period of outperformance, they held top performing stocks like AOL and Dell alongside ‘bad stocks’ like Philips Services. Yet she says less attention is paid to the stocks which underperform at a time when the fund is outperforming generally.
Against a backdrop of an economic slowdown, cheap valuations, and the stimulus of both monetary and fiscal policies, she believes at this early stage in the cycle the fund has the potential to do well. She says she is seeing a potential upside of over 90%.
‘We have experienced a 25-year streak because of the consistent implementation of our strategy, which has historically led to improving numbers,’ she says.
Over the three years to the end of March, Miller and Chris Gay have posted a loss of -13% with the Legg Mason Value A Dis A USD fund compared to an 18.6% rise by the S&P 500 TR index.