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The opposing point of view by Bill Miller. Please scroll all the way
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John
Fortune.com: Retirement Guide 2002: Stocks vs. Bonds
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RETIREMENT GUIDE 2002
Bill Miller
(Photo: Evan Kafka)
STOCKS OR BONDS
· Bill Miller: Sultan of Stock
· Bill Gross: Bond King
Protect Your Dreams
Best-Laid Plans
FORTUNE 40
Stocks vs. Bonds
Real Estate: Invest Where You Sleep?
Pension Funds' Seamy Side
Retirement Guide
Stocks or Bonds? Bill vs. Bill
Can bonds beat stocks for a third year in a row?
Two legendary fund managers offer answers--and surprising views on
the state of the markets.
FORTUNE
Monday, August 12, 2002
By David Rynecki
Bill Miller: The Sultan of Stock
Miller, who oversees Legg Mason Value Trust fund,
is the only manager to have beaten the S&P 500 for 11 years in a row.
FORTUNE: Is the selloff almost over?
MILLER: Look, you can never call a bottom. We began
buying some of the telecom equipment names in spring and summer of
2001 because we thought more than a year into the decline a lot of
those stocks were within maybe three to six months of bottoming. We
were early. It was a mistake. But there are a whole host of things
going on now that tell me that the market is in a bottoming process.
Take the duration of the decline--22 months. That's equal to the '73-
'74 decline. Go back to the Great Depression, and that market was 30
months from the peak in 1929 to the bottom. What we're seeing is
something the vast majority of people haven't seen before because
this is a once-in-a-generation--or once- or twice-in-a-century--type
of event. What's good is that the levels of pessimism reflected in a
lot of the technical indices, the outflow of mutual funds, the
declining retail participation, the significant decline in
speculative activity, the drying up of the new issue calendar--these
all indicate a bottoming process.
FORTUNE: So is this a golden opportunity?
MILLER: Not really. If the market's valuations were
seven or eight times earnings, or even ten times earnings [the S&P
500 is trading at an average 2002 price/earnings ratio of about 22],
I'd say it was a golden opportunity. There is an opportunity to do
quite well, but overall market valuations are not compelling. Even if
we are right that the equity market is attractive right here, that
doesn't mean that the difficulties that led to this situation have
disappeared and that we'll have 15% returns. We're in the camp of 6%
to 8% annual returns--not thrilling, but wonderful compared with
losing money.
FORTUNE: Then what will it take to beat the S&P
500?
MILLER: The key is avoiding the areas that have
been terrible. Most stocks, something like 60%, are outperforming the
market. Sometimes the market is a democracy, meaning everything goes
up. Sometimes it's a meritocracy, and few things go up. In all
markets I look for very high rates of return over my forecast time
horizon. A stock may be performing very poorly in this environment
and still be a great investment over a number of years. We want to
know how stock prices depart from underlying value and why. That can
be on the upside as we saw with the Internet, when most companies
weren't worth anything like the market thought they were worth. What
we want is the reverse--tremendous pessimism, people believing that a
business is broken, scandal, something everybody is fleeing from--in
short, what we're seeing today. That has pointed us to business
models that are in the process of changing and that people don't
fully understand, like Barry Diller's USA Interactive, or companies
that are right in the cross hairs of what everyone is most afraid of,
like Tyco.
FORTUNE: Tyco? Why would you go near something that
radioactive?
MILLER: What's so radioactive about Tyco? We own a
lot of it. We bought it in the first quarter, which was obviously
early, but have been buying 500,000 shares a day for quite some time.
Tyco's problems, so far, are not Tyco's problems. They are [ex-CEO]
Dennis Kozlowski's personal problems. There is no ongoing SEC
investigation of Tyco's accounting--not yet, at least. The SEC
conducted such an investigation in 1999 and found there wasn't any
issue with Tyco's acquisition accounting. What's scaring people right
now is that they look at what WorldCom did and wonder if Tyco didn't
do the same. We are not in that camp. As we go through the company,
our central valuation is about $30, twice where it's trading. With a
better environment, we could see it go to the mid-40s. We think
there's a big margin for safety in the stock.
FORTUNE: You've been particularly vocal about stock
options.
MILLER: Yes. The promiscuous issuance of options
creates a serious problem for the equity investor because the equity
investor is suffering substantial yearly dilution of his future
returns as a portion of those returns are transferred to management
and employees. In that environment bonds have the great advantage
that management cannot take those returns away, whereas the equity
investor has been a full participant on the downside but only a
partial participant on the upside.
FORTUNE: What's to be done?
MILLER: If stock options cannot be honestly
accounted for, then they should be eliminated. Companies that lobby
to keep the estimated expense of stock options off the income
statement are advertising their intent to deceive and contributing to-
-almost causing--the crisis of confidence. We're systematically
paring down or eliminating positions in the portfolio where we have
evidence that the management manipulates the stock option program to
their advantage or ignores shareholders' majority votes on
resolutions. We're really raising the threshold for managements. Now,
if I'm so interested in corporate governance then why am I buying
Tyco? Tyco is going to get a lot better corporate governance than it
has had, and so are a lot of other companies. If we believe there is
going to be better responsiveness to shareholders, that is a big plus.
FORTUNE: Other than Tyco and USA, where do you see
opportunities?
MILLER: We've ramped up some of the more
speculative names like Nextel and AES. I also think some of the
financials are well positioned: Fannie Mae in the low 70s, Citigroup
below $40. [Mortgage insurer] MGIC is another value. Here's a company
that earns 25% on equity every year and has grown its earnings every
year for ten years at 15%, has a sterling balance sheet, is
overcapitalized, and trades at nine times earnings. For people with
an appetite for scarier things, Lucent and Qwest are attractive.
FORTUNE: You've said the guy with the lowest
average cost wins. How so?
MILLER: A lot of people will pay $30 for a stock,
and it goes to $20 and they wait for the stock to act better before
they buy more. But if it goes from $20 to $30 and you doubled the
position at $20, now your average cost is $25. If you wait you gain
nothing. We would prefer to buy stocks at the exact low, but as
Bernard Baruch said, "Nobody buys at the low or sells at the high
except liars." We know that when we buy them they're going lower, and
we should be willing to continue buying.
FORTUNE: So what's the bottom line?
MILLER: The second half of the year is going to be
much better than the first.
FORTUNE: Will bonds beat stocks again this year?
MILLER: At the beginning of the year, I thought
stocks would outperform bonds. I've been wrong, since bonds are about
2,500 basis points ahead of the S&P 500. Given the wide gap, I
believe bonds will outperform stocks this year. Looking out three to
five years, I think stocks will outperform bonds from here.
Or will bonds beat stocks? See Bill Gross: The Bond
King.
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