Bill Miller sees signs of recovery

FUNDWATCH

Bill Miller sees signs of recovery
Legendary fund manager suggests market rally may be for real
By Sam Mamudi, MarketWatch
Last update: 1:57 p.m. EDT May 1, 2009

NEW YORK (MarketWatch) -- As debate rages about whether the market upturn is for real, Legg Mason Inc. fund manager Bill Miller said he sees signs for hope.
In a market commentary published Thursday, Miller points out several reasons for optimism -- the type of stocks that have been rising, the similarity of the rally to other early bull market rallies and the improving macro-economic situation.
Miller doesn't declare that the market has turned, saying it is "unknown at this point" whether that has happened, but the tone of commentary is upbeat.
"This move has been led by the classic early cyclical [sectors]: financials, housing, and consumer discretionary names such as retailers and restaurants -- an encouraging sign that may be signaling the end of the long period of economic decline that began in December 2007," said Miller in his note.
"If it is a bear market rally, it is one we have not seen since the late 1930s," he added. "Its behavior is much more like the rally that ended the 1973-1974 bear market, or the one that began off the bottom in 1982, or even that which erupted in March 2003 from the last debt deflation scare."
Miller also noted the great performance of emerging markets, pointing out that such countries are "highly sensitive to incremental growth." China, Korea, and India are up 30%, 20% and 17%, respectively, while Brazil and Venezuela are up more than 20%, said Miller.
"One difference between this rally and the others has been the presence of "green shoots" in the economic numbers -- data points that provide some hope things are getting better, or at least that the decline is slowing," said Miller. "The economic numbers are not as uniformly awful relative to expectations as they were only a month or so ago, and the first-quarter earnings season has provided some positive surprises."
Miller said that he expects the markets "to be volatile, but less so than in the past six months."
"Credit spreads should gradually shrink, and equity prices should rise as the economy stabilizes, credit begins to flow, and volatility declines," he said. "I expect stocks in the U.S. to end the year higher than where they began."
After beating the market for a record 15 consecutive years through 2005, Miller's star waned in recent years after some poor performance numbers. Last year his fund, Legg Mason Value (LMVTX:Legg Mason Value Tr;Prm
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LMVTX 29.49, +1.36, +4.8%) , was among the very worst U.S. stock funds, down 55.1%, according to Morningstar Inc. So far this year the fund is up 1.2%, while the Standard & Poor's 500 Index is down 3.4%.
Financials worries
Much of Miller's woes last year were due to his holdings in financial services companies; the sector is still his second-largest investment, making up 19.1% of the fund's portfolio. And Miller's commentary looks closely at how the government is handling financials, especially the big banks.
Miller calls the stress test "ill conceived," arguing that banks routinely undergo stress tests in conjunction with their regulators. He also states that the banks are well-capitalized according to regulatory requirements.
"The major design flaw comes in that the government has indicated that banks that are currently well capitalized will be required to raise even more capital just in case things get a lot worse, to provide an additional cushion, as the saying goes," said Miller. "This pre-emptive capital raise is exactly backward."
Miller also speaks out against the focus on tangible common equity as a measure of a bank's health.
"This new requirement is conceptually incoherent, despite its now being adopted as the gold standard of capital by sell side analysts and hedge funds who are short. They appear to have persuaded regulators it is important. It is idiotic," said Miller, who writes "equity is equity."
Another element of policy that Miller rails against is mark-market accounting, suggesting it puts undue, and unnecessary, pressure on banks.
"The underlying financial condition of banks depends on confidence and cash flows," said Miller. "The cash flows are robust, the system has record liquidity; it is clear thinking about the accounting that is wanting."