Bill Miller of Miller Value Partners just published his third-quarter letter. As per usual, it is original thinking.
As stock markets are displaying a bout of volatility we haven't seen in a while, talking heads are debating whether to stand on the sidelines or get out. But not Miller. He sees a bull market and doesn't see it ending. He starts by describing the current choppy environment:
"...Fed Chairman Powell said we are 'a long way' from a neutral federal funds rate — an economy growing at 4%, wage inflation beginning to pick up, and the unemployment rate at 50 year lows all contributed to raising the level of angst in bonds as yields reached their highest in 7 years. This did not initially spook stocks, which had a strong 7.7% gain in the quarter, but in the first week of October, U.S. equities came under pressure and small-cap stocks fell three weeks in a row for the first time since November of 2017. Most other markets globally have significantly trailed the U.S. this year, with emerging market indices particularly hard hit."
If you are at all actively checking on your portfolio, and I'd guess most of you are, you get the picture. There have been some volatile down days, with small-caps and tech taking the brunt of it. Miller notes how people are changing the story from Federal Reserve tightening is bad for stocks to another version of Fed tightening is bad for stocks. Miller prefers to observe what actually happens. He believes it is futile to call the end of the bull market or predict how the economy will respond:
"I think if you told people that the U.S. economic expansion would be one of the longest in history, with the most consecutive months of job growth ever, and that last quarter GDP rose at a 4% rate, with corporate profits at all-time highs while unemployment was at 50-year lows, they would say that inflation would have to be at or near the top of the list of things to worry about, yet so far this year the core rate is 1.9%."
I have to admit that's exactly what I've been thinking (and preparing for). We should finally see inflation picking up and there's the off chance it will really break out to the upside.
I've also pointed out valuations in the stock market, as per indicators GuruFocus tracks (like the famous Buffett indicator):
But Miller isn't having it, saying "So, to reiterate some things I have been noting in these letters for the past 10 years: It’s a bull market in stocks and it will continue until it ends, and no one knows when that will be."
He then does go on to sketch two scenarios on how it can end.Â
"It will end when either the economy turns down and earnings decline, or when interest rates rise to a level where bond yields provide significant competition for stocks," he said.
But he doesn't think this is upon us yet. One major factor influencing this logic is that stock market valuations are undemanding compared to other asset classes:
"I have seen some folks saying that will be at 3.5% or more on the 10-year, which I find implausible as bonds will still be trading at close to 30 times a return stream that does not grow, while stocks are at just under 17x next year’s earnings, and those earnings will likely advance about 5% or a bit more over the long term. During the bull market of the 1990s, bond yields averaged 6%. Today’s rates are still among the lowest in history, and only 2 years ago they WERE the lowest in history. Valuations of stocks do not appear demanding compared to returns available in other asset classes."
Even more unusual, he actually thinks this is an environment where people will withdraw from bond funds and allocate toward equity funds:
"I do think people will begin to notice that bond returns in the past 5 years have been the lowest ever recorded and that is likely to only get worse if inflation continues its upward trajectory. During the “taper tantrum” of 2013, rates got to around this level and people then started to take money out of bond funds and shifted it to equity funds. We have not seen that yet — money is still coming out of equity funds — but the probability of it happening is rising. It is worth noting stocks were up over 30% that year due in part to that phenomenon."
There's only one conclusion for Miller, which is to continue to invest and buy stocks he likes:
"Stocks are not cheap, but then they rarely are unless bad things are happening, and it is hard to find much bad news in the current state of the economy. We are not having any particular difficulty in finding names we like and that we think represent excellent value. We have sold some companies to make room for others but remain fully invested."
Miller's top three U.S.-based holdings are Amazon (AMZN, Financial), Restoration Hardware (RH, Financial) and Bausch Health (BHC, Financial). I don't agree with Miller and subscribe to the school of thought that this is a great time to be very cautious. It is, however, amazing to read such a different view from a great investor who is never afraid to deviate from the thinking of his fellow value investors.
Disclosure: Author is long Bausch Health (BHC).
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