Bill Miller: ‘Credit Panic Ended with Bear’

Money manager Bill Miller thinks the worst of the credit crisis is over and that conditions are shifting to favor value stocks over momentum plays.

Miller came to prominence as his Legg Mason Value Trust beat the S&P 500 stock index for 15 years. But then his legend lost a bit of luster as the fund underperformed for the last two years.

In the first quarter of 2008, the fund fell 19.7 percent, compared to a 9.4 percent loss for the S&P 500, marking the worst quarter of relative performance for the fund since its inception 26 years ago.

"While neither I nor anyone else knows if our period of underperformance is over, it ought to be, if valuation begins to matter more and momentum less in how the market behaves,” Miller writes in his first quarter commentary to investors.

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For value investors like Miller, tough economic times such as this one create opportunities.

"For investors who are trend followers… or who employ momentum strategies, price is dispositive,” according to Miller.

"When they do badly, it is because prices moved in a direction different from what they thought.”

But, for value investors, Miller notes, "price is one thing, and value is another. When prices move against us, it usually means that the gap between price and value is growing, and our future expected rates of return are higher.”

He argues that this is especially the case in momentum-driven markets, which have reigned for the past two years. "In such markets, price trends persist, and wide gaps open up between price and value.

"That is why fertilizer stocks such as Potash can go from the $20s to the $200s in two years, and why Microsoft can bid over 60 percent more than where Yahoo! was trading and still be getting a great deal,” Miller writes.

But that could be changing, he says.

"I think we will do better from here on, and that by far the worst is behind us. I think the credit panic ended with the collapse of Bear Stearns, and credit spreads are already much improved since then.”

That’s good for the value stocks Miller holds, particularly financials.

"If spreads continue to come in, the write-offs at the big financials will end, and we may even have some write-ups in the second half instead of write-downs,” he says.

"Valuations are attractive, and valuation spreads are now about one standard deviation above normal, a point at which valuation-based strategies usually begin to work again, and momentum begins to fade.”

Already, Miller points out, "Most housing stocks are up double digits this year, despite dismal headlines, a sign the market had already priced in the current malaise. I think likewise we have seen the bottom in financials and consumer stocks.”

While the economy will probably keep struggling, just like in the early 1990s, "the market can move higher, as it did back then,” Miller maintains.

Commodities, too, could hold the key to stock performance.

"If commodities break, or even just stop their relentless rise, equity markets should do well,” Miller writes. "If they continue to move steadily higher, they have the potential to destabilize the global economy.”

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