Bill Miller Letters Archive

1993 Q1 – Market Commentary

The first quarter belonged to Bill Clinton, who undoubtedly would have been the best performing money manager in America if only those pesky conflict of interest rules were not around. The stocks he likes: autos, airlines, energy and especially natural gas, did wonderfully; but the ones he did not like: profiteering health care companies, the sinful alcoholic beverage and tobacco stocks, the gluttonous foods, were horrid. Bonds, which he loves, soared, and carried stocks with them.

Your fund rose 3.3% in the quarter, well ahead of the 2.4% return achieved by growth stock funds, which trailed the major indices.

The first quarter’s return in long bonds was a spectacular 6.85%. Thirty year treasury yields fell from 7.39% at the beginning of the year to a low of 6.72% in early March. The S&P 500 was up 4.36%, while the more economically sensitive Dow was up nearly 5%.

The first quarter of the year is when investors’ fancies often turn to cyclicals, as the search for bargains meets the optimism accompanying a new year. Romance then gives way to reality as the year unfolds and the earnings’ disappointments multiply. That, anyway, is the normal pattern.

Most diversified stock funds with an objective of long term growth will lag in periods when economically sensitive stocks – autos, airlines, energy, commodity cyclicals – do well. Growth funds are often underweighted in cyclicals because most of them are bad long-term investments.

Cyclical stocks typically have bursts of strong performance as the economy emerges from recession and the market begins to anticipate a recovery in earnings. As the economy expands, these stocks lag, even as earnings begin to materialize. Finally, they fall sharply when the market expects recession and the consequent collapse in their earnings. Over a full economic cycle the performance is usually uninspiring, and over the longer term, often abysmal. General Motors sells today for a lower price than it did in the 1960s, and airlines have earned no money in the aggregate since Kitty Hawk.

This year’s move into cyclicals may be more soundly based than last’s, since it is underpinned by a stronger economy, concerns about how much growth is left in the growth stocks of the 1980s, and by the Clinton administration, whose activist government policies would benefit industrial companies and slow the growth of many visible American companies, especially, in health care.

We are underweighted in cyclicals, for reasons noted above and in previous shareholder letters. Our major cyclical commitment is banks, which are leveraged to an economic upturn but which still sell at single digit multiples on 1994 earnings. We believe banks also have a very positive secular story driven by consolidation and rapidly growing capital, which will lead to acquisition, less competition, and fast dividend growth. Despite the strong rebound in banks from the 1990 lows – the lowest valuations ever for those stocks – and the sharp correction of the past few weeks, we think this move has many years to go.

We established a new position in Citicorp common in the quarter after meeting with its CEO John Reed. The company, America’s largest bank, has a terrible long-term record, selling today for less than it did in 1929. But it has finally embraced cost control and the idea that the bank is in business to earn a return for its owners. It has an unparalleled global franchise and we expect earnings to approach $4.00 per share next year. The stock is $27.00. In contract, Caterpillar, one of the market’s favorite cyclicals, recently wrote off most of the book value it took its entire corporate history to build, and is expected to earn $4.15 in 1994. It sells at $68.00.

We also bought biotechnology leader Amgen in the quarter, and added modestly to our other health care holdings. These stocks sold off sharply in response to attacks on their profits by the new administration and fears about the effects of health care reform. Amgen was also penalized by a sales slowdown in Neupogen, its major product, a slowdown we believe was seasonal and not indicative of longer-term problems. Amgen trades around $40.00, should earn $3.00 next year and should grow about 20% per year. It does not raise prices on its drugs, so even drug price controls would not inhibit its growth (though other aspects of health care reform could).

The spectre of health care reform haunted the market in the first quarter, and we are shortly to hear the broad outlines of the administration’s plan. Reorganizing 14% of the GDP, which is what health care represents, is a gargantuan task and one that is highly unlikely to even begin, much less be completed, this year. We believe meaningful legislation will not be passed before next year and that the more comprehensive the changes sought, the greater the likelihood of delay. We have been spending a lot of time analyzing health care companies and expect to make additional investments in this area, valuation permitting.

Investors are the economy’s judges, says George Soros, who made a billion dollars betting against governments in the currency market last year, and who has made a recent foray into gold. Bonds rose sharply in the first quarter and the administration was too quick to conclude the markets were ratifying its policies or, more accurately, proposals.

Raising tax rates for individuals and corporations, raising taxes on tobacco and alcohol, raising taxes on energy, increasing regulations on business, moving toward managed trade, and attempting to halt the growth of the largest creator of jobs in the 1980s, the health care industry, does not strike us as bullish. Despite the administration’s glee at them, rising bond prices are not portents of prosperity. Bond holders are happiest during depressions.

Markets ebb and flow, and after flowing steadily since October of last year, some ebb would not be unexpected. Returns are enhanced by buying when prices are down, a strategy we intend to follow should the market begin to judge the administration differently in the next few quarters – which we judge likely.

As always, we appreciate your support and welcome your comments and suggestions.