Bill Miller is a legendary investor who is more aggressive and growth-oriented than most value investors.
I also think he's very creative and less constrained by the value philosophy than most. I always read his insights, but think his latest quarterly note left out an important dimension of his market outlook:
"Following the least volatile, smoothest ascending market ever in 2017, 2018 is more normal, that is, more volatile, but the direction has been, as is usually the case most years, higher. There is no shortage of issues to overcome if the market is to continue its advance. Trump’s wall between the U.S. and Mexico is small compared to the towering wall of worry the market has been climbing since March 2009, which has kept investors liquidating U.S. stocks in favor of bonds. This wall is more like the horse of a different color in the Wizard of Oz, whose color was constantly changing."
I really like Miller's point that this year's market is merely less freaky, but not an outlier at all in terms of volatility. The market has indeed climbed a wall of worry and I don't dispute that's what it does most years.
Miller points out it is constantly something different, but the general attitude isn't new. As a counterpoint, I would like to mention the thing that matters is attitude in the context of valuation. I don't mind people worrying about the market. Like most value investors, I usually like it when people are very, very worried about the market; the current conundrum being valuation. The fact the S&P 500 trades at very rich multiples and the Federal Reserve is on a rate hike path (which we're not hearing enough about), however, does give me pause.
"...This bull market will end the way all bull markets end: when the economy rolls over and earnings decline and unemployment rises, or when stocks get too expensive relative to the returns available in other assets..."
To this I would like to add it could end were inflation to get out of control. High inflation could crush the stock and bond market.
"...No one knows when either of these events will occur, although they assuredly will at some point. What is the case now is that the economy and earnings growth are both strong, as is dividend growth (8% year over year), returns on capital and margins are high, and inflation is low."
What I think is missing in Miller's note is perspective on the potential upside versus downside. Under the "Market" tab on GuruFocus, you can find market projections with a statistical basis. These are pretty scary:
This projection is actually directionally on par with that of shops like GMO that have a great reputation for being right about this kind of stuff.
They are scary because U.S. market valuations are at the high end of the range.
The U.S. market as a percentage of gross national product is 147%. To give you an idea of the upside-downide potential here, the lowest the market has hit, historically, is 35% and the highest it has ever been is 149%. That's 74% down versus 1.36% up.
No, we don't know when the trend we are in ends. That's true. But we do know there isn't much potential upwards and there's potential for carnage.
"Stocks are not expensive relative to bonds, trading at around 17x forward earnings compared to over 30x the return stream of 10 year treasuries...."
Previously, Miller dismissed the yield curve as another irrelevant data point. Maybe it is, but if you are going to argue stocks versus 10-year Treasuries, I have to bring it back up.
Stocks are an asset class with very high duration (sensitivity to interest rates), especially stocks trading at high multiples. Maybe the 10-year still doesn't compete with them. But with the two-year at a decent interest rate, that is starting to look a lot better. It is some yield and much less risk. Competition did increase over the past year.
I really like to read Miller's notes to offset the bearish arguments I find so compelling. I don't think this is his most convincing bullish note, but I am not arguing sell all stocks either. I do think it isn't the right time to be greedy. I have fewer stocks and more fixed income. I've allocated a lot of capital toward idosyncratic investments and hold some precious metals and royalty companies. I may miss out on a real winner, but if the market marches on I'll have reasonable returns. But when the downside comes into play, I'll do much better than most. When it sells off hard, I'll have the capital to load up on attractive equities for cheap.
Disclosure: No positions.
