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Bill Miller's Buying Opportunity of a Lifetime

Bill Miller, the legendary investor who beat market averages for 15 years straight, recently sent investors an unequivocal message: Now is the time to buy large-cap stocks. In fact, this is the buying opportunity of a lifetime.

As he puts it:

U.S. large capitalization stocks represent a once in a lifetime opportunity in my opinion to buy the best quality companies in the world at bargain prices. The last time they were this cheap relative to bonds was 1951. I was 1 year old then, but did not have then sufficient sentience or capital to invest. I do now, and if you are reading this, so do you.

It's important to emphasize that Miller thinks large caps are cheap not only by stand-alone metrics like P/E ratios, but relative to bonds. James Paulsen, chief economist at Wells Capital Management, has a nice chart illustrating this:


The wide gap at the far right of this chart is what Miller's referring to when declaring stocks cheap relative to bonds. Notice that this "undervaluation" gap is more extreme than the "overvaluation" gap that occurred in the late '90s. In a similar vein, I recently showed that the Dow's average dividend yield was briefly higher than the yield on 10-year Treasury bonds. Barron's points out how rare this is: "Over the past 50 years the Dow's yield has exceeded that of the 10-year Treasury for only one period -- the end of 2008 into early 2009, as the financial crisis climaxed."

Does all this mean large-cap stocks are a buy? I think it does. More on that in a second. First, though, here's what I imagine the bears' rebuttal will be.

Bear clawed
If you could ask Mr. Market why there's such a chasm between stock and bond prices, his answer would be clear: looming deflation. If prices fall, thought goes, fixed income will protect your purchasing power, while corporate profits will be eaten away and stock prices will disintegrate. That's why investors are willing to pay a premium for bonds while eschewing stocks.

Viewed this way, the valuation gap between stocks and bonds isn't bullish at all. It's among the most bearish signs imaginable, predicting deflation that could crush the economy.

Picky bull rebuttal
Problem is, it's hard to refer to "the economy" as a unified body these days. Thanks to the recession's dirty work, "the economy" is almost perfectly bifurcated: one part is doing really well, and another is gasping for air. There's very little in between.

You see this in the job market. Obtaining a job today seems split between "easy" and "completely impossible" depending on your marketable skills. Reuters blogger Felix Salmon sums this nicely: "most Americans [are] actually doing OK, with an unemployable underclass bearing the brunt of the recession."

The average result of this shows an economy that's plodding along at a frighteningly slow pace, but the individual components of that average couldn't be more polarized, tell far different stories, and will have wildly varying futures.

The same holds true for companies. Viewed as a whole, the S&P 500 average might look dicey given the specter of deflation. But the 500 individual components of that average are anything but equal.

For example, I pulled up data on all S&P 500 companies and found that:

  • 242 (48%) reported higher earnings per share (EPS) over the past 12 months than they did in 2007, when the economy and market last peaked. The median EPS growth for these companies was a solid 33%.
  • The remaining 258 companies saw EPS fall during the same period, with a median decline of 35%.

I think that's remarkable. With few exceptions, the S&P 500 is split almost perfectly between companies that are either doing extremely well, or extremely badly.

What's more, and here's where Miller's call comes back into play, the average market cap of the companies that grew earnings during this period was 25% larger than those that saw earnings fall. All S&P 500 companies are fairly big, but it's predominantly the really huge ones that have done well over the past few years.

There could be several explanations for this, not least of which is lobbying power. But a big one I'd focus on is that larger companies tend to have their footprints all over the globe. In fact, you can find several megacap stocks like ExxonMobil (NYSE: XOM  ) , Intel (Nasdaq: INTC  ) , and Coca-Cola (NYSE: KO  ) that do the overwhelming majority of their business overseas. This is seriously important, since diversification helps offset deflationary pressures in the U.S. with strong growth from regions like Asia and Latin America. Large-cap stocks, in other words, are relatively detached from the U.S. deflation that our bond market seems to foretell.

Large-cap companies also have access to credit in ways smaller companies can't dream of. IBM (NYSE: IBM  ) , for example, just sold three-year debt with a 1% interest rate. Johnson & Johnson (NYSE: JNJ  ) sold 10-year notes for 2.95%. These numbers are borderline absurd. Smaller companies can also raise debt thanks to investors' insatiable appetite for fixed income, but the interest rate advantage that large companies hold over smaller rivals is truly huge.

In many ways, it's never been a better time to be a big multinational company. But at the same time, their stock valuations will hear nothing of it.

It's Miller time
To tie this all together, large caps are generally faring much, much better than the economy as a whole, yet valuation-wise they're still lumped into a broad group we call "the market" as if they were merely average. Why? Perhaps it's the explosion of index-based ETF trading. High-quality large caps are indiscriminately bought and sold alongside lower-quality names, as if the merits of all companies are equal at a time when, in fact, inequality is running wild. My Foolish colleague Alex Dumortier has a few other possibilities. Whatever the reason, Bill Miller sees this disconnect as the opportunity of a lifetime, and I can't disagree.

How about you? Sound off in the comments section below.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel owns shares of Johnson & Johnson and ExxonMobil. Intel and Coca-Cola are Motley Fool Inside Value selections. Johnson & Johnson and Coca-Cola are Motley Fool Income Investor picks. The Fool owns shares of and has written puts on Intel. Motley Fool Options has recommended buying calls on Intel. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Coca-Cola and ExxonMobil. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (13) | Recommend This Article (67)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 17, 2010, at 3:22 PM, ryanalexanderson wrote:

    Good article, Morgan. But I'm a bit surprised that you (and Bill Miller) didn't mention the words that are on many minds: "bond bubble".

    Above and beyond deflation concerns, it seems impossible to untangle genuine bond valuation with the purchases of the Federal Reserve. And the expectation among traders for such purchases. Should we be using this as the benchmark to compare stock valuations against?

  • Report this Comment On August 17, 2010, at 4:07 PM, jmt587 wrote:

    I don't deny your broader point, but to quibble with one of your "remarkable" stats, did you check the EPS growth rate for the 125th best and 375th best stocks in the S&P 500 at any other point in time? 33-35% growth for the 125th and 33-35% shrink for the 375th sounds reasonable to me, maybe a little high on the high side, and a little low on the low side, but not remarkably so.

  • Report this Comment On August 17, 2010, at 6:29 PM, TheDumbMoney wrote:

    I share jmt587's sentiments, but overall, I think this article is "spot on." Some of these companies are no longer truly "American" companies at all. Instead, they are international companies with American brands.

    But always the worry: What if deflation occurs virtually everywhere? Europe, despite recent positives from Germany, has large problems. Japan is still in trouble. What if China, as Chanos says, is in a huge bubble? What if it all goes kaput at once? Then the fact that KO does so much business elsewhere besides the US isn't going to matter, because what other major markets are there? In other words, while I generally agree, and while I own (virtually exclusively) high-quality large-caps (though my largest position is cash, actually), I worry it is a mistake to link the pricing of these companies primarily to worries about the American situation alone. To me it seems a potentially plausible alternative reading of our globalized markets is that people are worried about a more global deflationary meltdown. But on the other hand (the third hand?), if that is so, why then are people continuing to bid up less attractive (in my view, especially in such a world) and more highly-leveraged internationalist companies like CAT? Is it just algorithm-driven? The more I study this stuff, the more convinced I become that I'm chasing my own tail and should invest, primarily, in more time with my family.

  • Report this Comment On August 17, 2010, at 6:29 PM, kcanant wrote:

    <i>Bill Miller, the legendary investor who beat market averages for 15 years straight, recently sent investors an unequivocal message</i>

    Where can I find Mr. Miller's full message?


  • Report this Comment On August 17, 2010, at 6:31 PM, ragtopbull wrote:

    To think that these large cap's with substantial overseas business have a natural hedge against a deflation scenario in the U.S. seems a little naive. If the U.S. experiences deflation it is likely to become a global contagion in short order with unhappy results for all.

    Fool on!

  • Report this Comment On August 17, 2010, at 6:34 PM, kcanant wrote:
  • Report this Comment On August 17, 2010, at 7:09 PM, jrj90620 wrote:

    Deflation?Who are you kidding?It would be possible if debts were in real assets(such as gold that can't be created for nothing) but not when most all debts are Dollar debts.They can be wiped out by the Fed for nothing.The world's biggest debtor is the U.S. Federal govt.They wouldn't survive a deflation and won't have to.

  • Report this Comment On August 17, 2010, at 7:40 PM, drstocks1 wrote:

    While large international companies have their american earnings buffered by their overseas holdings, in times of a true international deflation/depression the US economy guided by the Fed is where the safest investments are located and where catastrophe is least likely to occur. That is why we have so much international investment in our country.

  • Report this Comment On August 17, 2010, at 11:17 PM, MMTInvestor wrote:


    Enjoyed the article, as I always do. (Your commentary is always intelligent, well argued, and, IMHO, one of the best parts of The Fool). I largely agree with you, Bill Miller, GMO's Jeremy Grantham, et al. that quality large cap issues are relatively cheap and worth buying. I would, however, assert that they're not dirt cheap (on the whole), and that in a deflationary spiral they could get a whole lot more attractive. My advise: they're the best part of the equity markets right now, but be nimble, selective, and always, always ladder into positions, saving lots of cash for later.

    That's my bullish/bearish take on your piece. What say you?

    Foolish best,


  • Report this Comment On August 20, 2010, at 11:07 AM, DavidTheJust wrote:


    Great article. You mention one of the things that has largely been ignored in evaluating large companies - they can currently borrow money at absurdly low rates. It is not difficult to make money when you can borrow at 1% or even 3%.


  • Report this Comment On August 20, 2010, at 11:50 AM, phyrne wrote:

    david and morgan, i second its a great be doing great aquisitions with my company if i could borrow at that also love a headoffice registered in a nonaccountable domain so the company could never get sued ahh bliss

  • Report this Comment On August 21, 2010, at 11:59 PM, jsGreenmachine wrote:

    Bill Miller is a good man and one must respect his opinion. I equate his run of 15 straight S&P beats to any hot streak. The key to history books is what you do after the streak is broken. His call on Blue chips is clearly intelligent analysis and simply a calculated play. He has always been a bottoms up guy and that is the winning way to invest in the long run. If individual research yields more than normal bites in the big cap. quality companies, then that's probably where the valuable fish are. Personally, I also have been sighting fins in the deep waters of top notch conglomerates: i.e.: GE, ITT, HON, ITW, PHG, BRK, TEF,TXT. Good article.


  • Report this Comment On August 23, 2010, at 1:16 AM, huhongyan wrote:

    it is really helpful for me to say!

    Thanks for your posting; Hope you can keep going.

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