In his quarterly letter, Legg Mason's Bill Miller explains to fund shareholders why his one-legendary performance has gone to the dogs.
The short version? The market has gone temporarily insane.
Here's the long version:
Dear [Legg Mason Value Trust] Shareholder,
A group of us were standing around a few weeks ago when Warren Buffett
wandered over. Chris Davis had dubbed us the Value Support Group, as we all
adhered to that approach to investing. We were commiserating over how badly
we had done in this market, how valuation appeared not to matter and had not
for the past couple of years, how it was all about momentum and trend, and how
we were all losing clients and assets over and above our losses in the market.
It seemed like we needed a 12-step program to cure us of our addiction to
buying beaten-up stocks trading at large discounts to our assessment of their
intrinsic value.
Mason Hawkins said, "Warren, I'm an optimist. I think this whole thing
can turn quickly, and surprise people. Are you an optimist?" "I'm a realist,
Mason," the sage replied. Warren went on to say he was optimistic long term,
and backed that up in a talk the next morning on the remarkable history of
growth, innovation, and wealth creation the U.S. had produced over the past
200-plus years. He also offered a sober assessment of the current challenges
we face, and said it would take some time to work through them.
He then made the perfectly sensible point that as we are all net savers,
we should be happy if stock prices declined a lot more, so we could buy even
better bargains. That is a point Charlie Ellis elaborated on in his fine
book, Investment Policy, a few years back. As a matter of logic, it is
irrefragable. As a matter of psychology, I think most of us value investors
think we have plenty enough bargains already, and may not be able to handle
that many more. Or more accurately, our clients may not be able to. We are
value investors because we are persuaded of the logic of buying shares of
businesses when others want to sell them, and we understand that lower prices
today mean higher future rates of return, and high prices today mean lower
future rates of return.
The best time to buy our funds or to open an account with us has always
been when we've had dismal performance, and the worst time has always been
after a long run of excess returns. Yet we (and everyone else) get the most
inflows and the most interest AFTER we've done well, and the most redemptions
and client terminations AFTER we've done poorly. It will always be so,
because that is the way people behave.
[Aside: This is smart and true. Miller's Value Trust has lost almost half its assets, some from withdrawals, some from losses. The fund is likely a vastly better buy now than it was when Miller was the only mutual fund manager anywhere who had beaten the S&P 15 years in a row--now that it looks like that performance was luck and/or that Miller has lost his touch. The reason the fund is likely still not an excellent buy is that it's just too damn expensive.]
John Rogers, the founder of Ariel Investments, came in to see us last
week. John has been an outstanding investor for 25 years or so, but like
almost all value types, is going through one of his toughest periods now. His
assets are down, similar to the experience we've had. He said it was the most
difficult market he'd seen, a judgment I would have given to the 1989-1990
market, up until the frenzy erupted over Fannie Mae and Freddie Mac, which
sent financials to what looks like a capitulation low on July 15th. I am now
in John's camp.
A point he made that I have likewise noted to our staff is that this is
the only market I have seen where you could just read the headlines in the
papers, react to them, and make an excess return. I have used the mantra to
our analysts that if it's in the papers, it's in the price -- which used to be
correct. Indeed, it borders on cliche in the business that by the time
something makes the cover of the major news or business publications, you can
make money by doing the opposite. There is solid academic research to back
this up. But in the past two years, you didn't need to know anything except to
sell what the headlines were negative about (anything related to real estate,
the consumer, or finance) and buy anything that was going up and that
everybody liked (energy, materials, industrials).
I am reminded of what John Maynard Keynes, himself a great investor, said
once about investing, "It is the one sphere of life and activity where
victory, security, and success is always to the minority and never to the
majority. When you find anyone agreeing with you, change your mind. When I can
persuade the Board of my Insurance Company to buy a share, that, I am learning
from experience, is when I should sell it."
It has been explained to me that it was obvious we should not have owned
homebuilders, or retailers or banks, and that I should have known better than
to invest in such things. It was also obvious that growth in China and India
and other developing countries would drive oil and other commodities to record
levels and that related equities were the thing to own. "Don't you even read
the papers?" was a common comment.
While I am quite aware of our mistakes, both of commission and omission,
when I ask what is obvious NOW, there is little consensus. If there is
something obvious to do that will earn excess returns, then we certainly want
to do it.
Is it obvious financials should be bought now, having reached the most
oversold levels since the 1987 Crash, and the lowest valuations since the last
great buying opportunity in 1990 and 1991? Or is it obvious they should be
avoided, since the credit problems are in the papers every day and write-offs
and provisioning will likely continue into 2009?
Is it obvious energy stocks should be bought on this correction in oil
prices from $147 to $123, a correction that has wiped 25 points off the prices
of companies like XTO Energy and Chesapeake Energy in just a few weeks? Or is
it obvious that oil had reached bubble levels at $147, and that buying the
stocks here, down 30% from their highs, is akin to buying homebuilders down
30% from their highs in 2005? If you had bought Tesoro Petroleum or Valero
Petroleum when their prices broke late last fall -- remember the Golden Age of
Refining story that took Tesoro from under $4 to over $60? -- you would be
looking at losses in this year greater than if you had bought Citibank or
Merrill Lynch.
I do think some things are obvious: it is obvious the credit crisis will
end, and it is obvious the housing crisis will end, and that credit markets
will function satisfactorily and house prices will stop going down and then
start moving higher. It is obvious that the American consumer will spend
sufficiently to keep the economy moving forward long term. It is obvious that
the U.S. economy, already the most productive in the world, will get even more
productive and will adapt and grow. It is obvious stock prices will be higher
in the future than they are now.
Sir John Templeton died a few weeks ago, full of riches and honors, as he
so deserved to be. The legendary value investor got his grubstake by famously
buying shares of companies selling for $1 a share or less when war began in
1939. He didn't know then that the war in Europe would spread to engulf the
world, nor how long it would last, nor how low prices would ultimately go. He
always said he tried to buy at the point of maximum pessimism, but he never
knew when that was. He was, though, a long-term optimist, as is Mr. Buffett,
as am I.
Bill Miller
July 27, 2008
