January 23, 2018
Bill Miller’s 4Q 2017 Market Letter
The year 2017 surprised most pundits in several ways. It was the only year since good records have been kept where stocks were up every single month. It was the lowest volatility year on record. It had no correction of even 3%, which was unprecedented. Economic growth accelerated globally as the year progressed and the US economy enjoyed a couple of quarters of 3% growth. Earnings grew double digits. Stocks were up over 20%, and the OECD indicates that the 45 largest economies in the world are all growing, something not seen in over a decade. The consensus appears to be “more of the same” in 2018. Strategists and investors generally are bullish on the economy, most also seem to be bullish on stocks.
There is growing concern that the great bond bull market that began in late 1981 is over (this is surely correct in my view), but divergence on what that might mean for stocks. In the Barron’s Roundtable, several commented that rising rates could compress valuations if yields went above 3% and that stocks could end the year down. I think that is wrong. I believe that if rates rise in 2018, taking the 10-year treasury above 3%, that will propel stocks significantly higher, as money exits bond funds for only the second year in the past 10, and moves into stock funds as happened in 2013. Stocks that year were up 30%, mostly as result of that shift in fund flows.
Bonds, in my opinion, have entered a bear market, but one that is likely to be benign for the next year or so. 10-year yields bottomed in the summer of 2016 at under 1.4% and now are well over 100 basis points higher. I think they will continue to move persistently, but irregularly, higher until the next recession, whenever that may be. Bonds have outperformed stocks for an entire generation and have done so with lower volatility and greater inherent safety due to their contractual payouts. That era is now over in my opinion and stocks will revert to their historic return premium over bonds as global economies grow, and central banks around the world follow the Fed in ending quantitative easing and reducing their balance sheets.
I think we are also likely to see inflation begin to stir, perhaps in a year, as labor force slack and excess manufacturing capacity both decline. Finally, I think the effects of the tax cut are only partially in the stock market. The market appears to have discounted the earnings boost to companies whose profits are mainly domestically sourced. It is not clear that a potentially material pickup in consumption has made its way into stock prices.
Many US companies have already announced special bonuses to employees or increases in their minimum wage as a result of the business tax cut and the ability to repatriate the trillions of cash currently held overseas. The employees getting such bonuses likely have a marginal propensity to consume approaching 100%. Very little will be saved; almost all will be spent, which could add significantly to growth. I think we could print 4 quarters of 3% growth or better of real GDP. If inflation hits the Fed’s target of 2%, that would imply 5% nominal GDP growth. In a “normal” world 10-year rates would tend to be around the same as nominal GDP, yet another reason to be wary of investing in bonds.
Overall, I continue to think, as I have since the financial crisis ended, that the path of least resistance for stocks is higher. The path for bonds has now shifted secularly, I believe, and they will not earn positive real returns for many years. Geopolitics remains the single greatest threat to the markets. The President’s low approval ratings and an energized Democratic Party could lead to turmoil as the debt ceiling looms in the spring and the election rolls around in the fall. The Mueller investigation remains another wild card. One consequence of increased geopolitical dislocation might be another very large increase in Bitcoin’s value, as it is increasingly seen as isolated and insulated from the conventional economic system. I think all investors would prefer more stability and less drama, except perhaps those whose only investment are cryptoassets or gold.
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The views expressed in this report reflect those of Miller Value Partners portfolio manager(s) as of the date of the report. Any views are subject to change at any time based on market or other conditions, and Miller Value Partners disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.
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