Parsing Through a Solid Backdrop for Equities

Income Strategy 4Q 2023 Letter

The Miller Income Strategy returned 11.07% net of fees in the fourth quarter of 2023 versus a 7.04% return for its benchmark, the ICE BofA US High Yield Index. One of the quarter’s more notable performances in traditional asset classes came from long-dated US government bonds, a proxy for which is the TLT ETF, which was up 12.9%. This was the asset’s fifth-best calendar quarter in twenty years. More remarkably, it was the only quarter in the past twenty years that long-dated US government bonds generated a double-digit return without a coinciding drawdown from equity markets. Every prior quarter in which the TLT was up more than it was in Q4 ‘23, the S&P 500’s return ranged from -11.4% (Q2 ’10) down to -21.9% (Q4 ’08). This is because investors tend to sell stocks and buy bonds as their psyches shift into a defensive posture, with their primary concern being a return “of” capital instead of a return “on” capital.

This past quarter’s rarely seen divergence is meaningful, we believe, because it could mark a turning point in market psychology around the persistence of inflation, a phenomenon that is notoriously hard to predict. January is the time of year when all kinds of outlooks and predictions about the coming year crop up, most of which are about as reliable as forecasts of what the weather will be next month or who will win the presidential election this year. Astute readers will note that this paragraph’s lead sentence is not a prediction but rather an interpretation of what could explain a unique combination of returns across asset classes. However, understanding the collective thinking that could elucidate market movements is an important starting point for thinking through future probabilities, as public markets are generally thought to be efficient discounting mechanisms.

Indeed, a broader look at market expectations and economic data suggests the system is in a pretty good spot right now. The bond market anticipates annualized inflation over the next two years of 2.1% as of this writing, down meaningfully from the 3.4% per year implied just nine months ago. The Commodity Research Bureau’s spot price index syncs up with this dynamic, closing 2023 at the lowest level in almost three years with continued downward movement to start this year. Fed officials are now talking about the timing and extent of interest rate cuts, as well as slowing the pace of asset sales from their balance sheet. Fed futures markets now imply a greater than 50/50 chance of a cut prior to the end of the first quarter; if that proves correct, it would be the first time in over 40 years that we have seen a rate cut on the heels of two consecutive quarters of GDP growth above 4.5%. The VIX enters the year in its 12th percentile, implying low fear broadly. In my view, these numbers indicate, other things being equal, that the path of least resistance for the market is likely higher, as it has been for most of its history.

During the fourth quarter, we eliminated two positions comprising approximately 6% of the portfolio where new information suggested that our investment thesis was wrong. As active managers, we are able to proactively make adjustments in the portfolio, a key difference from strategies that are rebalanced to a benchmark on a set frequency. Two new additions included a starter position in wood products maker Boise Cascade (BCC) as well as the debt of Gray Television, a top operator of local television stations. We think Boise Cascade is a good business trading at a compelling valuation with a fortress balance sheet, while we believe markets are too pessimistic on Gray Television’s staying power.

As always, we remain the largest investors in the Strategy and welcome any comments or questions.

Bill Miller IV, CFA CMT
Miller Value Partners
@billfour

Strategy Highlights

In the fourth quarter, the Income Strategy’s representative account rose 11.07% (net of fees), outperforming the ICE BofA Merrill Lynch High Yield Master II Index’s 7.04% gain and underperforming the S&P 500’s 11.69% gain. (Exhibit 1). The strategy ended the quarter up 12.59% year-to-date (YTD) net of fees, or 85 basis points behind the high yield index and 1,370 basis points behind the S&P 500.

Exhibit 1: Performance of Income Strategy Versus High Yield, Equity Indices, Through 12/31/2023¹

Time Period	Income Strategy (net-of-fees)	ICE BofA US High Yield Index</strong	S&P 500 Index
QTD	11.07%	7.04%	11.69%
YTD	12.59%	13.44%	26.29%
1-Year	12.59%	13.44%	26.29%
5-Year	5.58%	5.21%	15.69%
10-Year	2.92%	4.51%	12.03%
Inception (annualized since 4/2/2009)	9.95%	8.82%	15.13%

Source: Bloomberg, Miller Value Partners

Top Contributors

Western Alliance Bancorp (WAL) was the top contributor during the quarter. The regional bank reported 3Q23 and Earnings per Share (EPS) of $1.97, -18.6% year-over-year (Y/Y) (+0.5% sequentially), ahead of consensus of $1.91. Total deposits rose 6.5% sequentially to $54.3B at the end of the quarter, with insured and collateralized deposits representing 82% of total deposits as of quarter-end, while the bank’s common equity tier 1 (CET1) ratio expanded 50bps sequentially to 10.6% as of quarter-end. Tangible book value per share (TBV/share) came in at $43.66 (P/TBV of ~1.5x) as of quarter-end, +17.5% Y/Y, as TBV/share has now grown at a 19.2% compound annual growth rate (CAGR) since the end of 2013, with management highlighting that this is more than 6x the growth rate of its peers over the same period. Management is guiding for 4Q23 deposit growth of $250MM, loan growth of $150MM, net interest margin (NIM) of 3.65%, and net charge-offs of 10bps, at the respective midpoints, and also reiterated their expectation for a return to prior balance sheet guidance for loan and deposit growth of $500MM and $2B per quarter, respectively, in 2024.
The Buckle (BKE) was another top performer during the quarter. The retailer reported 3Q23 net sales of $303.5MM, -8.7% Y/Y, slightly below consensus of $304.0MM, and EPS of $1.04, -16.1% Y/Y, ahead of consensus of $0.88. The company generated 3Q23 free cash flow (FCF) of $53.7MM, bringing trailing-twelve month (TTM) FCF to $216.6MM, or a FCF yield of 9.0%. Management maintained its quarterly dividend of $0.35/share and also declared a special cash dividend of $2.50/share, implying a twelve-month yield of ~8.2%.
Jackson Financial Inc (JXN) reported 3Q23 Adjusted Operating EPS of $3.80, -10.4% Y/Y, ahead of consensus of $3.53. Registered index-linked annuity (RILA) sales rose 43.5% Y/Y to $807MM in the quarter, while total annuity account value rose 10.1% Y/Y to $218B, primarily driven by higher equity markets over the TTM period, with capital ratios rising. During the quarter, management returned $123MM to shareholders (3.0% of market cap) via $71MM of share repurchases and $52MM in dividends, and remains on track to achieve its 2023 capital return target of $500MM at the midpoint, or 12.3% of the company’s market cap.

Top Detractors

B Riley Financial (RILY) was the top detractor during the quarter. Investors were concerned that Brian Kahn, CEO of Franchise Group, for which B Riley recently helped orchestrate a management-led buyout with a $281MM investment, was named as a co-conspirator in securities fraud from his previous business relationship with Prophecy Asset Management, despite Kahn vehemently denying these allegations. Later in the quarter, management disclosed in its investor day presentation that it has a more than $200MM loan outstanding to Kahn in addition to its investment in Franchise Group’s buyout.
Organon & Co (OGN) missed consensus top-line and bottom-line consensus expectations driven by weakness in the company’s Women’s Health segment, which has been negatively impacted by generic competition, leading the market to conclude that management’s prior guidance for a return to growth may have been optimistic.
Medifast Inc (MED) fell on the heels of a dividend elimination in conjunction with a $20MM investment in LifeMD, a provider of virtual primary care services, to provide OPTAVIA clients with a weight management program that includes GLP-1 drugs, establishing the company’s entrance into the medically supported weight loss market.

Strategy Highlights by Jack Metzger, CFA

¹The performance figures reflect the results of the Income Strategy Composite net of management fees and certain other expenses. For important additional information about Income Strategy performance, please click on the Income Strategy Composite Performance Disclosure. Past performance is no guarantee of future results.

The ICE BofA US High Yield Index tracks the performance of below-investment-grade, but not in default, U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market, and includes issues with a credit rating of BBB or below, as rated by Moody’s and S&P. The iShares 20+ Year Treasury Bond ETF (Ticker: TLT) seeks to track the investment results of an index composed of US Treasury bonds with remaining maturities greater than 20 years. The Commodity Research Bureau BLS/US Spot All Commodities Index is a measure of price movements of 22 sensitive basic commodities whose markets are presumed to be among the first to be influenced by changes in economic conditions. As such, it serves as one early indication of impending changes in business activity. Fed funds futures are derivatives based on the federal funds rate and are a direct reflection of collective marketplace insight regarding the future course of the Federal Reserve’s monetary policy. The CBOE Volatility Index, or the “VIX”, is designed to produce a measure of the 30-day expected volatility of the US stock market based on the prices of S&P 500 call and put options

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. References to specific securities are for illustrative purposes only. Portfolio composition is shown as of a point in time and is subject to change without notice.

Portfolio holdings and portfolio discussion are for a representative Miller Income Strategy account.

References to indices and their respective performance data are not intended to imply that the Strategy’s objectives, strategies, or investments were comparable to those of the indices in technique, composition or element of risk nor are they intended to imply that the fees or expense structures relating to the Strategy or its affiliates, were comparable to those of the indices. The indices are unmanaged and cannot be invested in directly.

The performance information referenced herein does not imply that future results will be similar. There can be no assurance that the Strategy’s investment objectives will be achieved and a return realized. Returns for periods greater than one year are annualized.

The views expressed in this commentary reflect those of the author as of the date of the commentary. 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. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Data from third-party sources cited herein is believed to be reliable, but may not have been independently audited by Miller Value Partners.