Bill Miller: Bearish on Commodities, Bullish on Stocks

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Writing in the Financial Times this week, Bill Miller took a bearish stance with regard to commodities, but he also offered up three stock sectors that he thinks are rich in opportunity. In a market in which many risk assets aren't cheap, it's worth listening to someone who is intensely focused on valuations.

Valuing Bill Miller
A word on Bill Miller before we get to the heart of our subject: During the latter end of his fifteen-year streak beating the S&P 500, investors and pundits believed he could walk on water. As the Legg Mason Value Trust stumbled (badly) during the financial crisis, attitudes reversed dramatically. It was a classic case of Mr. Market overvaluing, then undervaluing the same asset -- in this case, Bill Miller himself. Personally, I always enjoy reading his commentary, as he's a very thoughtful and original observer of markets (in addition to being a good writer.)

System 1 vs. system 2
In the FT piece, for example, Miller contends that commodities markets -- and oil, in particular -- are being driven by what psychologists label System 1, automatic behaviors that are the product of the subconscious. System 2, on the other hand, refers to conscious behavior, that calls on logic and considered analysis. Which of the two systems do you think produces better investing decisions?

Commodities: Too hot to handle
Commodities markets are displaying some eyebrow-raising characteristics. As Miller points out:

According to data compiled by Barry Bannister, equity analyst with Stifel Nicolaus, commodity returns relative to stock returns are at 200-year highs on a rolling 10-year basis. One thing is clear about long-term commodity returns: they are cyclical.

I used similar observations in support of the notion that gold is in bubble territory. During the 10-year period up to yesterday, the yellow metal has generated an annualized real return greater than 16%. Let me reemphasize that this is a real return, i.e. none of it is attributable to inflation. If you believe that gold can continue outpacing inflation indefinitely, I have a golden calf to sell you.

What comes after the decade of precious metals?
The same observation holds for silver: Even after last week's massacre, its trailing 10-year annualized after-inflation return is over 21%. For reference, the equivalent return for stocks during the 1990s -- the decade for stocks -- was 14.8%. That wasn't sustainable and neither are the returns that have been achieved by gold and silver. Owners of the iShares Silver Trust (NYSE: SLV  ) and the SPDR Gold Shares (NYSE: GLD  ) should carefully review the assumptions that underpin their positions.

The top 3 stock sectors
Moving away from commodities and applying System 2 thinking -- detached and rational -- Miller asks which areas of the market offer value today. He goes on to offer up his answer:

In the assets people do not want, that have no momentum, and that are cheap. Three broad sectors and two broad themes stand out. The S&P 500 sectors are; financials, technology and health care, which are in the bottom decile of their historical valuation ranges. This means they have been more expensive 90 per cent of the time over the past 60 years or so.

The sectors that are flush with cheap stocks
I don't have access to 60 years worth of data, but using Standard & Poor's Capital IQ, I was able to identify the stocks in the S&P 500 that are trading in the bottom 10% of their historical valuation range going back to the beginning of 1995 (on the basis of the price-to-earnings multiple). Sure enough, information technology and health care are among the top four sectors in terms of their concentration in historically cheap stocks:


Number of Stocks in Bottom Decile of Historical Range

Proportion of Stocks in Bottom Decile of Historical Range

Information Technology


1 in 5

Consumer Discretionary


1 in 9

Consumer Staples


1 in 10

Health Care


1in 10

Source: Standard & Poor's.

Moreover, if we use the price-to-book value multiple instead of the price-to-earnings multiple, the sector with the highest concentration of cheap stocks is financials (21 stocks, better than one in four), followed by health care (11 stocks.) I'm a fan of financials, particularly megacaps, another one of Miller's themes. I first suggested investors look at a basket of the largest commercial banks at the end of November. Miller has large shareholdings in each of the top four banks in the Value Trust; in fact, his third and fourth largest positions at the end of the third quarter were JPMorgan Chase (NYSE: JPM  ) and Wells Fargo (NYSE: WFC  ) .

More names to look at
As far as names in health care and technology, three names that showed up in my screen and that are also holdings of the Value Trust fund are Cisco Systems (Nasdaq: CSCO  ) , Intel (Nasdaq: INTC  ) , and Abbott Laboratories (NYSE: ABT  ) . Investors could do a lot worse than to look at those stocks. Bill Miller may have misjudged the credit crisis, but he looks well positioned to outperform over the next few years.

Intel shareholders should earn acceptable returns over the next few years but nothing like what the stock delivered for its early shareholders. You might get another shot at that kind of windfall -- this company could be "the next Intel".

Fool contributor Alex Dumortier, CFA has no beneficial interest in any of the stocks mentioned in this article. You can follow him on Twitter. Intel is a Motley Fool Inside Value pick. Intel is a Motley Fool Income Investor pick. The Fool has created a bull call spread position on Cisco Systems. The Fool owns shares of and has bought calls on Intel. Motley Fool Options has recommended a diagonal call position on Intel. The Fool owns shares of Abbott Laboratories, JPMorgan Chase, and Wells Fargo. Alpha Newsletter Account, LLC owns shares of Abbott Laboratories and Cisco Systems. Try any of our Foolish newsletter services free for 30 days.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (13)

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 May 11, 2011, at 3:57 PM, john64daley wrote:

    Bill Miller bullish on stocks? Since when is he not bullish? He was bullish on Bear Stearns all the way down.

  • Report this Comment On May 11, 2011, at 4:51 PM, TMFAleph1 wrote:

    That's the kind of comment that is symptomatic of the attitude I describe in the second paragraph.

    Did you bother to read more than just the headline?

  • Report this Comment On May 11, 2011, at 8:10 PM, MegaEurope wrote:

    So what if you desribed the attitude? It's still true. Miller's embarrassing performance over the last 10 years indicates serious flaws in his investment approach.

  • Report this Comment On May 11, 2011, at 8:13 PM, Shanteram wrote:

    Any out-of-favor sector may be expected to recover , eventually, and it hardly takes a wizard to so predict, but to suggest that precious metals can't continue to beat "inflation", or the bogus numbers that governments publish as such, in the face of exploding government expenditures and massive creation of fiat currencies, is disingenuous and as moribund as his name, "Dumortier", would etymologically imply.

  • Report this Comment On May 11, 2011, at 9:15 PM, jimmy4040 wrote:

    I think that you're half right on financials. I think there is little downside risk at this point, but I haven't seen the new profit making model yet You might be early, but not wrong. However in any case favor the big guys over the regionals who could get by new real estate problems again next year, or even late this year.

    Health care is like the airline industry. If you can figure out a way to make consistent money there, you're one in a million.

  • Report this Comment On May 12, 2011, at 3:36 PM, ldkoehler wrote:

    New Constructs provides ratings for all 10 sectors based on the aggregation of models for companies in those sectors and gives attractive (buy) ratings to the consumer discretionary, health care, and consumer staples sectors. Free report:

    The technology sector is rated as neutral, but if you look at the component ratings, you can see that it's very close to getting an attractive rating. The tech sector has some great ETFs.

    Blog post:

    It actually looks like there are blog posts about ETFs in every sector posted.

  • Report this Comment On May 12, 2011, at 3:53 PM, ryanalexanderson wrote:

    Hi Alex,

    Really enjoy your articles. A nice counterfoil to those of us who are commodity-enthusaistic.

    Commodities are indeed cyclical when you have a stable money supply. If we were close to a stable money supply, I would agree with you and Bill Miller.

    However, we've come to the point today where people are perceiving "stable money supply" to be ZIRP with "no more quantitative easing". This never ceases to amaze me. The concept of "quantitative easing" was unthinkable a few years ago. Hell, ZIRP was unthinkable a few years ago. And now ZIRP is considered status quo in the US, and repeated QE is considered a mildly controversial action.

    And ZIRP is indeed status quo! A move up to the healthy long-term average for interest rates - the average that underpins the history of commodity cycles - would cripple the economy. Particularly the financials.

    So, there's your choice. Loose money, where commodities win, or tight money, where financials lose. This doesn't mean one shouldn't own both. I would. I don't think it's an either/or. But nobody in power has the cojones to pull a Volcker and bring us back into a situation where the supply expansion of money will be less than the supply expansion of commodities.

  • Report this Comment On May 12, 2011, at 3:56 PM, ryanalexanderson wrote:

    Postscript: I do completely agree with you on your other article, though - stay the hell out of Treasuries! No argument with that.

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