Bill Miller of Miller Value Partners is a tremendous value investor who tends to run an original portfolio. I say original because it will contain the typical value fair, but Miller has also been a huge fan of Amazon (AMZN, Financial) for years. I love to read his quarterly letters because they are bullish, which contrasts with my own views. His latest quarterly commentary from July 10 is no exception. Here are the paragraphs I found most striking and why:
"There is other good news. Christine Lagarde, the head of the International Monetary Fund, will become the new head of the European Central Bank. Mark Carney, head of the Bank of England, is the favorite to succeed her at the IMF. Both are excellent choices in my opinion, with Lagarde widely expected to follow the policies of her predecessor Mario Draghi, which won broad acclaim."
Miller apparently keeps close tabs on these kind of nominations that more traditional value investors in the Warren Buffett mold often ignore. I agree on the appointment of Lagarde, who I’ve found quite impressive and who seems extremely measured and open minded. I am not as big a fan of Draghi’s policies as Miller, but I get that Draghi is in a very tight spot.
"Back here, President Trump has nominated Judy Shelton and Christopher Waller to the Fed. Shelton is the more unconventional selection and has advocated for a return to the gold standard or some other tie in to commodity prices in order to stabilize the dollar. Waller is the director of research at the St Louis Fed where his boss is James Bullard, who is regarded as one of the more dovish Fed governors and who supported a cut in rates at the June Fed meeting, the only governor to do so. Both nominees seem likely to be confirmed and are expected to be advocates for lower rates for longer."
Both in Europe and in the U.S., we are likely to see central bankers who support dovish policies and continue extremely low interest rates and quantitative easing programs.
"Lower rates for longer should lead to higher stock prices for longer, as they support a continuation of the record expansion. Stocks generally move in the direction of earnings and those, while slowing, show few signs of reversing. Over the duration of this expansion nominal GDP has grown 50% as has consumer spending, not surprising since consumption makes up over 70% of GDP. It’s more good news that the consumer is in good shape with a solid balance sheet, jobs are plentiful, wages are rising, and the savings rate is very solid at over 6%. A healthy consumer should also underpin continued economic growth and, in turn, the stock market."
Here Miller practices some cherry-picking by focusing on the consumer. Bears would talk about the debt on corporate balance sheets or debt at the federal as well as local level in the U.S. Government debt is completely out of hand in places like Italy and Japan. These are not small economies. China doesn’t seem to be doing all that well, based on the sales figures from U.S. companies selling there like General Motors (GM) and Apple (AAPL) -- figures that are probably more reliable than official economic figures.
"The only bad news is the relative absence of bad news. Geopolitics remains unpredictable and could derail the market and the economy. The tariff and trade issues that have bedeviled the market are on hold for now, as negotiations continue. They could always reappear and lead to concerns about how long lasting they will be and their impact on the global economy."
Today, the Wall Street Journal is reporting about Iran being forced to back down from harassing an oil tanker by a U.K. warship. We are not at Cuba crisis levels of alarm, but there is much going on geopolitically. The U.S.-China trade tension is far from over. The U.K. is on the verge of a Brexit. In Hong Kong protestors forced their own government to stand down.
"A risk that led to a very steep decline in the fourth quarter of 2018 is a Fed that pays more attention to its models than forward-based market indicators. Chairman Powell has, properly, moved away from his remarks that rates remained a long way from neutral and his, and other Fed governors’, recent comments indicate we are at neutral or probably a bit over as almost all global growth data and market-sensitive prices show a decided loss of economic momentum."
Here, Miller casually admits to observing a decided loss of economic momentum. Jerome Powell has indeed changed his behavior and seems to be willing to respond quickly with more easing as soon as the market starts tanking seriously. Traders have made a lot of money buying the dip on this new central banking behavior, while traditional value investors often missed that boat. At some point, however, it isn’t going to work anymore. Easing loses its value, and the Fed will be out of ammo. "What then?" I find myself asking.
"The markets, as of now, are looking for two cuts in the second half, which seems about right given all the evidence. The inverted yield curve remains a worry, but if the Fed begins to ease, as the market expects, that worry should dissipate. Bond spreads have narrowed recently, another bullish indicator for stocks. As Warren Buffett (Trades, Portfolio) noted at the Berkshire Hathaway annual meeting, stocks are very cheap compared to bonds. The best reaction to Fed rate cuts would be a steadily rising 10-year yield which would signal both expectations of faster growth but also inflation that was headed in the direction of the Fed’s long-held target of 2%. A steepening yield curve would be quite bullish for equities."
Maybe stocks are cheap compared to bonds. But bonds offer terrible returns. They have rarely yielded so little. In Europe, Treasuries yield negative until seven to nine years in maturity. Bonds are awful. Does that make stocks a buy? I’m not so sure. Miller meanwhile continues to believe that the path of least resistance for stocks remains higher. He could be right about that. But this easy path also crosses a deep chasm where the fall is a long way down if there is an unfortunate misstep.
Earlier this week I wrote up several of Miller's investment ideas here.
Disclosure: No positions.
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