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15-02-2013, 02:52 PM
Consuelo Mack WealthTrack - February 8, 2013
http://wealthtrack.com/transcript_02-08-2013.php
CONSUELO MACK: This week on WealthTrack, legendary investor Bill Miller is back in the winnerâs circle. In a WealthTrack exclusive, Miller shares what drove his Legg Mason Opportunity fund across the finish line in first place last year and how he is accelerating to the lead now. Great Investor Bill Miller is next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack, Iâm Consuelo Mack. We have an exclusive television interview with legendary investor Bill Miller this week, whose Legg Mason Opportunity Trust fund was the number one mutual fund last year, up a stunning 41%! As has been his history, Bill was looking for opportunities throughout the financial crisis, which hurt him and his investors big time some years and rewarded them handsomely in others.
It seems the rest of Wall Street is just now catching up to his early bullishness. A recent reading of the widely followed survey of investment advisors by Investors Intelligence shows the bulls growing in numbers, above 50% and the bears declining hovering around 20%. This shift in sentiment is starting to show up in mutual fund flows. Since the beginning of the year, investors have been favoring stock mutual funds over bond funds, practically for the first time since the financial crisis. But are they too late? Since the market bottom in early 2009, the S&P 500 has soared more than 120% while investors have pulled hundreds of billions of dollars from stock mutual funds. According to Miller, there is plenty of upside left.
Bill Miller is the chairman and co-founder of the investment advisory firm, Legg Mason Capital Management. He is portfolio manager of the Legg Mason Capital Management Opportunity Trust mutual fund, which he launched in 1999. Opportunity Trust was the number one mutual fund last year, having fallen to near the bottom of the heap in 2011, after a more respectable 17% advance in 2010 and a spectacular 84% gain in 2009. For 20 years, Bill was the sole manager of the Legg Mason Capital Management Value Trust where he became the only fund manager on record to outperform the market for 15 years in a row, from 1991 to 2005, before taking a beating in the financial crisis.
A deep value investor known for buying unloved and battered down stocks that he believes are selling far below their intrinsic value, Miller is in his element with Opportunity Trust, where he is a major shareholder. I began the interview by asking him what went right last year.
BILL MILLER: A lot of what went right is what went wrong in 2011 when we had a bad year, and in 2011 people thought that we were going to have 2008 again, except it would be located in Europe. And so Italian bonds, Spanish bonds, everything went crazy, and people sold off American stocks in sympathy with that, and so our fund did poorly even though our stocks did well. When it turned out that we didnât have 2008 redux, the fund did spectacularly well in 2012, and I think part of what happened was so many people try and surf the market and react to short-term stuff, so people changed their asset allocation and changed what they were buying based on the fears of 2011. We just stayed the course. So when those fears didnât come to pass, we had a great 2012.
CONSUELO MACK: So the things that people were fearful of- and this is kind of a trademark of your deep value investing- is they were fearful of anything related to housing, right? You invested in airline stocks which I will talk to you about in a minute. Donât ask me. I just canât imagine anyone investing in airlines stocks.
BILL MILLER: Just me and David Tepper it turns out right now.
CONSUELO MACK: Exactly right, and some financials, so explain to me, number one, how you view the housing stocks now. Letâs just start with them.
BILL MILLER: Well, the housing stocks since the fall of 2011 are up 150, 200%, and what was bizarre about, Iâll call it October/November of 2011, was a company like Pulte Homes, a major home builder, was trading at half of where it was trading in 2008 at the bottom of the financial crisis. So it was at three years later after home prices had dropped 35%, after Pulteâs book value had gone from 25 to 5, after they had written off billions of dollars of land and after non-distressed home prices started up, it was half the value it was in 2008. That just made no sense. So Pulte was upping 150% from November of â11 to November of 2012. So what happened was that people were so terrified of a repeat of 2008 and a further downdraft in housing that they put these housing stocks at crazy valuations even though the evidence would suggest otherwise.
CONSUELO MACK: So let me stop you there, because youâre right. Other people were terrified and they just, they didnât want to get anywhere near the housing stocks. So what is it... I mean, how are you not terrified? I mean, how are you not saying to yourself, the market is smarter than I am possibly, and maybe they know something that I donât know, or maybe these things are just not going to come back for several more years? I mean, I donât want to be so early that Iâm going to lose my shirt and my shareholderâs shirt on this.
BILL MILLER: Well, I lost a fair amount of their shirt in 2011 by being early, but we werenât years early; we were months early in that.
CONSUELO MACK: Right, but how do you overcome that fear that most of us have?
BILL MILLER: Well, the question is, what kind of mistake are you likely to make? So if you take something like financials where we made mistakes in 2008, those mistakes prove to be in the case of... you know, you make a mistake on a Bear Stearns or on an AIG, it can be a fatal mistake. These financials are highly levered, and theyâre subject to confidence, whereas the housing companies, by and large, it was sort of the opposite of that, which is if you make a mistake, it was a time mistake. They werenât going to go out of business. Their balance sheets were okay, and mathematically you know that thereâs a couple percent scrappage every year. You know that thereâs in-migration. You know that thereâs household formations of 1.1 million. You know what the existing inventory is.
So the big debate about housing was the so-called shadow inventory, the foreclosures and things like that, and so as we looked at that, itâs like, okay, if weâre going to make a mistake, itâs because the shadow inventory is bigger than we thought, but ultimately this has to work. Mathematically it must work, and Warren Buffett had said the same thing many times about this. Heâs got a big exposure to housing, so were just copying him in that sense. We had came to the same conclusion; it had to work.
CONSUELO MACK: Right, so letâs juxtapose that to the financials. The government is much more involved. I mean, you know all the arguments against buying a Citigroup or a Bank of America. There will only be a few standing, and itâs going to be a totally different business model. Itâs not going to be as profitable. Whatâs your answer to that, to those arguments?
BILL MILLER: Well, there are several different threads running through that. One of them is just a mathematically challenged thread which is that the capital positions of all the major banks, the top six to eight banks, is radically better than itâs ever been in history. So there is no risk to those... almost all of them now meet the Basel III requirements which donât kick in until 2018 or 2019, and in part, our thesis on Bank of America last year was it didnât matter how much money Bank of America reported that they might have lost. It mattered what their capital position was, and once their capital position got sound enough, the stock would recover because people were worried about capital. And so I think all of the top six or eight banks have no capital issues whatsoever. Maybe the more salient issue is, okay, but under Dodd-Frank and this increased rate, what can they actually earn, and for how long can they earn this?
And so a couple things have happened. One of them is that the regulatory burdens are much greater, but who can best bear regulatory burden, small community banks or gigantic banks? Answer: gigantic banks. So weâre going to see a lot of pressure on the smaller banks I think to merge. The next issue on the big banks is that, like in any industry, when the industry gets more oligopolistic, pricing gets better. So a lot of whatâs happening right now, youâre seeing criticisms of people like Wells, JP, BankAmerica that, with the Fed buying all these mortgage-backed securities, and even though interest rates on mortgages are the lowest theyâve ever been, the spreads are still wide. Like why arenât the spreads, you know, narrower? The answer: thereâs less competition in the industry. So why should JP or Citibank or Wells give up profit when they need profit? Thatâs what they need. So the oligopolistic character of the business is now tending towards greater profitability.
The key thing for us with the banks is that the Fed right now is limiting the banks to a dividend payout ratio of about 30%, and at the end of the day, once they all meet the Basel III requirements, thereâs no reason for the Fed to be that involved, and I think then youâll begin to see, I think, payout ratios move towards a 40 to 50% level. Wells Fargo just raised their dividend 14 or 15% yesterday or the day before.
So what weâre looking at right now is also this goes maybe with a topic weâll talk about a little bit later, but I think weâre in the beginning of a giant bond bear market which means the yield curve is going to get very steep for the next couple of years as interest rates rise. Well, steep yield curve is fantastic for banks, and I think theyâre going to be in a sweet spot where their cost of funds are going to be low, but their ability to actually replace some loans that are burning off and assets that are burning off at better rates of return are going to be good.
CONSUELO MACK: Airlines. Explain to me airlines, because I can remember in the many years Iâve been covering Wall Street is that airlines literally you blinked, and they had gone up like 30% and then they were down. They were such leading indicators, and they moved very quickly, and it was a lousy business for years. So whatâs the deal with airlines, and which airlines in particular?
BILL MILLER: So the airline industry may be the worst industry in the history of modern capitalism to invest in. People have tried to invest in it and have always failed. Even Warren Buffet.
CONSUELO MACK: Even Warren Buffett. Exactly.
BILL MILLER: Even Warren Buffett with a preferred stock didnât do well with airlines, and thatâs because the airline industry historically had everything wrong with it. It was highly regulated. It was highly capital intensive. It was unionized. It was selling a commodity product. It had baffling regulations which the companies had the hoops they had to jump through. If an airline went bankrupt, theyâd go out of business, and they just came back again. You know, fuel costs were 30% of the cost, and they were unpredictable, and even worse, it was one of those industries where... in many industries, if your business gets better and more people buy your product, thatâs good. Right? But in airlines, the more people that buy the product, that are on the planes, the worse the experience is for the customer. So there was perversity from A to Z in airlines.
Now, whatâs different right now about airlines? The major thing is massive consolidations. So up until about three or four years ago, the largest market share of any U.S. airline was around 12 and a half percent. Well, 12 and a half percent in a commodity business with all those problems I just mentioned is a recipe for, you know, disaster, for multiple bankruptcies which weâve seen. Well, now that weâve had massive consolidation, and so with Delta and Northwest, with United and Continental, with now perhaps...
CONSUELO MACK: American and USAir.
BILL MILLER: ... American and USAir, but the big two, Delta and UAL now control over 50% of the industry, and you add in Southwest. Youâre in the 60s. You put AMR and US Airways together, youâre in the 70s. Well, now youâre talking about three or four companies controlling the majority of the business, and thatâs why youâve seen pricing power. Thatâs why youâve seen free cash... the industryâs been free cash flow positive for the past five years, and only free cash flow positive in one of the previous 25 years, yet... and we were kind of early on this, because we bought during the crisis some bonds of UAL. They were selling secured bonds. They could only get a couple hundred million dollars of it issue off at around 17%. Now they can borrow at four to five percent unsecured. So the credit markets have figured out...
CONSUELO MACK: They figured out.
BILL MILLER: ...but the equity market is still trading these things at, you know, three times or four times enterprise value at EBITDA, or EBITDA in that case. So we think that thereâs a lot of upside left. Theyâve done very well. USAir has more than doubled this year early on. Deltaâs now doing well. UAL is the laggard, so I think UAL is the best value in the industry right now, but then there are other new entrants like Spirit Airlines which we donât own. Itâs fairly thin, but itâs like Ryanair. Itâs a very low-cost producer. That company can probably go 20% a year for the next five to seven years, and it trades at 10 times earnings. So itâs a very interesting industry now, much more interesting than it used to be.
CONSUELO MACK: So how long will you give, you know, an industry like the airlines. Obviously, theyâve done very well for you now, but for kind of the market to catch up with you. Is your willingness to stick with a company as long as it has been in the past?
BILL MILLER: Weâve been tending to be over, again, the decades saying weâre willing to be a year early on fundamentals if the stock is cheap enough. I think now weâre probably a little closer to that, saying weâre willing to be a quarter or two early on fundamentals, but not a year or two years on fundamentals. And again, in this kind of market, which is kind of a just-in-time market, this is a market where we have negative real interest rates and guaranteed negative returns on TIPS, so people are terrified, and in a terrified market you donât need to be early, because you can make plenty of money just when things visibly turn.
CONSUELO MACK: Right, so speaking of TIPS, Treasury Inflation-Protected Securities, you just said that you think that we are at the beginning of a major prolonged bear market. Now the Street, as you know, is littered with people who have made that kind of prediction for like the last five years. Whatâs different now? Why are you so convinced that this is the beginning of the bond bear market?
BILL MILLER: So the question is, how long are you willing to lose money? And when the S&P500 right now yields more than the 10-year Treasury, we havenât seen that since the 1950s except during this crisis, and we saw it in the 1940s and 1950s because of the Great Depression, but it was obviously a great time to buy stocks when they yielded more than bonds, and Iâd say the same thing right now and, more importantly, theoretically the 10-year Treasury, whatever the benchmark Treasury is- we use the 10-year- ought to have a yield roughly equal to the nominal GDP growth, and nominal GDP should be four to five percent normalized. Five would be more normal, but in a new normal world, a PIMCO world, maybe itâs four, but itâs not 180, and thatâs...
CONSUELO MACK: Right, and nominal being including inflation.
BILL MILLER: Yeah, inflation plus real, inflation plus real. So that would mean that the 10-year ought to be four to five percent. During the great bull market of the 1990s, the 10-year was six percent, and we had a great bull market, so if interest rates rise, thatâs not going to be an inhibitor to the market doing well. In fact, I think it will be an accelerant to the market doing well because so much moneyâs parked in bonds. We have a bubble in bonds at least equal to the bubble in housing in 2005 and the bubble in Internet stocks.
CONSUELO MACK: Stock market. You are on record of being bullish on stock market. You think 2013 is going to be another really good year. How good and why?
BILL MILLER: I think the stock market with balance sheets the best theyâve ever been in corporate Americaâs history, with housing coming back and with the Fed going to be accommodative toward 6.5% unemployment and 2.5% inflation, stocks are pretty much the only game in town. Whatâs the risk? The big risk in terms of political dysfunction that appears, most of those risks appear to have dissipated at least short term. Europe is a risk. Chinaâs a risk. Iran, Israelâs a risk. Thereâs always risk but given that thereâs always risk, I think stocks are basically where you have to be.
CONSUELO MACK: So which stocks do we have to be in, Bill Miller, or do you have to be in? Iâve got to ask you about Apple, you know, disappointing earnings report recently. So whatâs your take on Apple?
BILL MILLER: Apple is the Dr. Jekyll and Mr. Hyde of the stock market. Itâs the Dr. Jekyll in the sense that they are one of the greatest product innovators creating products that people love and a brand that people love, and theyâre Mr. Hyde in their completely idiotic and dysfunctional capital allocation which is the worst probably in the history of corporate America among good companies. So they have $135 billion of cash. They have much more cash than Amazon has market cap. Tim Cook said when they had $90 billion of cash, he said it was way too much. They had not possible reason to use it, announced a modest dividend and a modest share buyback that would not even draw down the cash at all, not one dollar. A year later, $135 billion of cash. Cash is equity. Equity has a cost. The cost of equity, if youâre optimistic like me, itâs six percent. If youâre historical like others, itâs eight percent. So take six or seven or eight percent and multiply it times $130 billion, and thatâs how much theyâre destroying value every year with dumb capital allocation. They could double the dividend tomorrow and still have a big share buyback and never touch the cash. So Appleâs a case where when the company had a massive growth rate... and itâs still got a good growth rate... the stock went up because people didnât care about the bad capital allocation, but now itâs in the Microsoft camp. Now itâs in the Cisco camp.
CONSUELO MACK: So itâs there. Itâs that kind of mature. Itâs that ...
BILL MILLER: Now the market is saying, as the market has taken Microsoftâs multiple down every year, why do you have $85 billion of cash? You generate two billion a month. Why? Why arenât you raising the dividend 25% a year instead of 15? Why arenât you buying back stock? And so I think thatâs the dilemma with Apple. I think Apple at $450 a share has huge optionality. Itâs nine and a half times earnings. Itâs going to grow probably 15 or 16% this year consensus, 12 to 14 next. Coke grows six to eight percent and trades at 17 times earnings, so if Apple had a capital allocation like IBM or like McDonaldâs... McDonaldâs pays out 100%of free cash flow to shareholders and trades at 15, 16 times. Apple would be up 50% on just sensible capital allocation.
CONSUELO MACK: From your lips to Tim Cookâs ears. I donât know whether itâs going to happen or not. Whatâs the most radical position in your portfolio?
BILL MILLER: The autos are probably a very good example. We added Ford to the portfolio in the fourth quarter. The auto companies have radically restructured. They can be profitable at nine million cars, never before. Their wage rates are competitive globally. Ford just doubled their dividend. Weâre at about 14 and a half to 15 million units right now. Equilibrium is 16, 16 and a half, and thatâs equilibrium. The fleetâs the oldest itâs ever been. Weâre looking at years of rising earnings in the auto companies.
CONSUELO MACK: Car sales.
BILL MILLER: And their balance sheets are great, and they trade at two and a half times or three times enterprise value to EBITDA. They ought to trade 50% higher easily. So thatâs a case where I think... the biggest thing we have in our portfolio is... and maybe to answer your question a different way is people look at our portfolio and say, âThatâs a scary portfolio because everything in it is very cheap but very risky,â and our comment is or my comment is, âHistorically it might have been risky, but the fundamentals are so powerful here.â So again, Pulte homes, risky at $3.50. Itâs $21 today. I would argue itâs more risky today than it was at $3.50, but I still donât think itâs very risky at year one of problems an eight or nine-year housing cycle. So I think thatâs the thing we have going for us in the Opportunity Trust. I think thereâs a lot of tailwinds in a portfolio thatâs had... you know, weâve beaten the market eight out of twelve years, but two of those four years were really bad, â08 and â11, but we had a great year last year. Weâre up over 10% in the first three weeks of this year, and I think that the outlook is good.
CONSUELO MACK: Is there any way that you would try to mitigate those down years?
BILL MILLER: Well, yes. Thatâs a great question, because thereâs two things. One of them is those two big down years were both the result of the same phenomenon expressed differently. One of them was in the crisis of 2008; what we had was the fundamental economic relations that held the economy together blew apart. Commercial paper market got crushed; a former triple A company like AIG went effectively bankrupt. So when the economic relations that exist in the society blow apart, you either get that right and realize it, like John Paulson did at least inâŚ
CONSUELO MACK: Very, very few did.
BILL MILLER: ... and you make a huge amount of money, or you donât realize it like me and you lose a lot of money. 2011 was different which is where people thought it might happen again, but it didnât, in which case we got hit hard, but it turned out that we were right and the rest of the people were wrong. That was just a quotational error. So I think from the standpoint of mitigating risk, part of what weâre trying to do is to say, are we seeing risk that could be systemic? If there are, that are rising. So take an example. If rates start to rise in Italy and Spain again, we will probably put on various hedges just to protect against that tail. One of the things that we actually did that worked out great last year was in 2011 at the end of the year, we bought a lot of really high yielding mortgage REITs and BDCs- business development companies. So the yields were anywhere from 12 to 15%. So our overall portfolio yield was well above the market, in fact, 50% higher than the stock market. That helped us last year during corrections, because those things didnât go down very much.
CONSUELO MACK: Didnât go down as much, right.
BILL MILLER: So our yield right now is maybe market or a little bit below, and I think our protection this year, if we need it, will be through various hedges when the market kind of spikes up as itâs done recently.
CONSUELO MACK: Final question, One Investment for a long-term diversified portfolio, what should we all have some of in our portfolio?
BILL MILLER: Most people are way overweight bonds based on history. Theyâre way underweight stocks because theyâre fearful. Itâs hard to go against your psychology if youâre fearful to take more risk. So I think the answer to that would be, okay, take the lowest possible risk in equities which is to buy the largest, most successful, most stable companies with high dividends. Call it the S&P top 50 or top 100, and theyâre extraordinarily cheap based on history. Theyâre cheap based on comparison with bonds, and their dividend yields are higher than bond yields, and theyâre also less volatile in the market as a whole, and so I think thatâs probably the single best risk-reward for the average investor.
CONSUELO MACK: Bill Miller, so great to have you back. Iâm so glad Bill Miller is back in more ways than one.
BILL MILLER: Oh, thank you. Thanks for having me on. Itâs great.
CONSUELO MACK: Especially on WealthTrack. Thanks, Bill.
BILL MILLER: Pleasure.
http://wealthtrack.com/transcript_02-08-2013.php
CONSUELO MACK: This week on WealthTrack, legendary investor Bill Miller is back in the winnerâs circle. In a WealthTrack exclusive, Miller shares what drove his Legg Mason Opportunity fund across the finish line in first place last year and how he is accelerating to the lead now. Great Investor Bill Miller is next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack, Iâm Consuelo Mack. We have an exclusive television interview with legendary investor Bill Miller this week, whose Legg Mason Opportunity Trust fund was the number one mutual fund last year, up a stunning 41%! As has been his history, Bill was looking for opportunities throughout the financial crisis, which hurt him and his investors big time some years and rewarded them handsomely in others.
It seems the rest of Wall Street is just now catching up to his early bullishness. A recent reading of the widely followed survey of investment advisors by Investors Intelligence shows the bulls growing in numbers, above 50% and the bears declining hovering around 20%. This shift in sentiment is starting to show up in mutual fund flows. Since the beginning of the year, investors have been favoring stock mutual funds over bond funds, practically for the first time since the financial crisis. But are they too late? Since the market bottom in early 2009, the S&P 500 has soared more than 120% while investors have pulled hundreds of billions of dollars from stock mutual funds. According to Miller, there is plenty of upside left.
Bill Miller is the chairman and co-founder of the investment advisory firm, Legg Mason Capital Management. He is portfolio manager of the Legg Mason Capital Management Opportunity Trust mutual fund, which he launched in 1999. Opportunity Trust was the number one mutual fund last year, having fallen to near the bottom of the heap in 2011, after a more respectable 17% advance in 2010 and a spectacular 84% gain in 2009. For 20 years, Bill was the sole manager of the Legg Mason Capital Management Value Trust where he became the only fund manager on record to outperform the market for 15 years in a row, from 1991 to 2005, before taking a beating in the financial crisis.
A deep value investor known for buying unloved and battered down stocks that he believes are selling far below their intrinsic value, Miller is in his element with Opportunity Trust, where he is a major shareholder. I began the interview by asking him what went right last year.
BILL MILLER: A lot of what went right is what went wrong in 2011 when we had a bad year, and in 2011 people thought that we were going to have 2008 again, except it would be located in Europe. And so Italian bonds, Spanish bonds, everything went crazy, and people sold off American stocks in sympathy with that, and so our fund did poorly even though our stocks did well. When it turned out that we didnât have 2008 redux, the fund did spectacularly well in 2012, and I think part of what happened was so many people try and surf the market and react to short-term stuff, so people changed their asset allocation and changed what they were buying based on the fears of 2011. We just stayed the course. So when those fears didnât come to pass, we had a great 2012.
CONSUELO MACK: So the things that people were fearful of- and this is kind of a trademark of your deep value investing- is they were fearful of anything related to housing, right? You invested in airline stocks which I will talk to you about in a minute. Donât ask me. I just canât imagine anyone investing in airlines stocks.
BILL MILLER: Just me and David Tepper it turns out right now.
CONSUELO MACK: Exactly right, and some financials, so explain to me, number one, how you view the housing stocks now. Letâs just start with them.
BILL MILLER: Well, the housing stocks since the fall of 2011 are up 150, 200%, and what was bizarre about, Iâll call it October/November of 2011, was a company like Pulte Homes, a major home builder, was trading at half of where it was trading in 2008 at the bottom of the financial crisis. So it was at three years later after home prices had dropped 35%, after Pulteâs book value had gone from 25 to 5, after they had written off billions of dollars of land and after non-distressed home prices started up, it was half the value it was in 2008. That just made no sense. So Pulte was upping 150% from November of â11 to November of 2012. So what happened was that people were so terrified of a repeat of 2008 and a further downdraft in housing that they put these housing stocks at crazy valuations even though the evidence would suggest otherwise.
CONSUELO MACK: So let me stop you there, because youâre right. Other people were terrified and they just, they didnât want to get anywhere near the housing stocks. So what is it... I mean, how are you not terrified? I mean, how are you not saying to yourself, the market is smarter than I am possibly, and maybe they know something that I donât know, or maybe these things are just not going to come back for several more years? I mean, I donât want to be so early that Iâm going to lose my shirt and my shareholderâs shirt on this.
BILL MILLER: Well, I lost a fair amount of their shirt in 2011 by being early, but we werenât years early; we were months early in that.
CONSUELO MACK: Right, but how do you overcome that fear that most of us have?
BILL MILLER: Well, the question is, what kind of mistake are you likely to make? So if you take something like financials where we made mistakes in 2008, those mistakes prove to be in the case of... you know, you make a mistake on a Bear Stearns or on an AIG, it can be a fatal mistake. These financials are highly levered, and theyâre subject to confidence, whereas the housing companies, by and large, it was sort of the opposite of that, which is if you make a mistake, it was a time mistake. They werenât going to go out of business. Their balance sheets were okay, and mathematically you know that thereâs a couple percent scrappage every year. You know that thereâs in-migration. You know that thereâs household formations of 1.1 million. You know what the existing inventory is.
So the big debate about housing was the so-called shadow inventory, the foreclosures and things like that, and so as we looked at that, itâs like, okay, if weâre going to make a mistake, itâs because the shadow inventory is bigger than we thought, but ultimately this has to work. Mathematically it must work, and Warren Buffett had said the same thing many times about this. Heâs got a big exposure to housing, so were just copying him in that sense. We had came to the same conclusion; it had to work.
CONSUELO MACK: Right, so letâs juxtapose that to the financials. The government is much more involved. I mean, you know all the arguments against buying a Citigroup or a Bank of America. There will only be a few standing, and itâs going to be a totally different business model. Itâs not going to be as profitable. Whatâs your answer to that, to those arguments?
BILL MILLER: Well, there are several different threads running through that. One of them is just a mathematically challenged thread which is that the capital positions of all the major banks, the top six to eight banks, is radically better than itâs ever been in history. So there is no risk to those... almost all of them now meet the Basel III requirements which donât kick in until 2018 or 2019, and in part, our thesis on Bank of America last year was it didnât matter how much money Bank of America reported that they might have lost. It mattered what their capital position was, and once their capital position got sound enough, the stock would recover because people were worried about capital. And so I think all of the top six or eight banks have no capital issues whatsoever. Maybe the more salient issue is, okay, but under Dodd-Frank and this increased rate, what can they actually earn, and for how long can they earn this?
And so a couple things have happened. One of them is that the regulatory burdens are much greater, but who can best bear regulatory burden, small community banks or gigantic banks? Answer: gigantic banks. So weâre going to see a lot of pressure on the smaller banks I think to merge. The next issue on the big banks is that, like in any industry, when the industry gets more oligopolistic, pricing gets better. So a lot of whatâs happening right now, youâre seeing criticisms of people like Wells, JP, BankAmerica that, with the Fed buying all these mortgage-backed securities, and even though interest rates on mortgages are the lowest theyâve ever been, the spreads are still wide. Like why arenât the spreads, you know, narrower? The answer: thereâs less competition in the industry. So why should JP or Citibank or Wells give up profit when they need profit? Thatâs what they need. So the oligopolistic character of the business is now tending towards greater profitability.
The key thing for us with the banks is that the Fed right now is limiting the banks to a dividend payout ratio of about 30%, and at the end of the day, once they all meet the Basel III requirements, thereâs no reason for the Fed to be that involved, and I think then youâll begin to see, I think, payout ratios move towards a 40 to 50% level. Wells Fargo just raised their dividend 14 or 15% yesterday or the day before.
So what weâre looking at right now is also this goes maybe with a topic weâll talk about a little bit later, but I think weâre in the beginning of a giant bond bear market which means the yield curve is going to get very steep for the next couple of years as interest rates rise. Well, steep yield curve is fantastic for banks, and I think theyâre going to be in a sweet spot where their cost of funds are going to be low, but their ability to actually replace some loans that are burning off and assets that are burning off at better rates of return are going to be good.
CONSUELO MACK: Airlines. Explain to me airlines, because I can remember in the many years Iâve been covering Wall Street is that airlines literally you blinked, and they had gone up like 30% and then they were down. They were such leading indicators, and they moved very quickly, and it was a lousy business for years. So whatâs the deal with airlines, and which airlines in particular?
BILL MILLER: So the airline industry may be the worst industry in the history of modern capitalism to invest in. People have tried to invest in it and have always failed. Even Warren Buffet.
CONSUELO MACK: Even Warren Buffett. Exactly.
BILL MILLER: Even Warren Buffett with a preferred stock didnât do well with airlines, and thatâs because the airline industry historically had everything wrong with it. It was highly regulated. It was highly capital intensive. It was unionized. It was selling a commodity product. It had baffling regulations which the companies had the hoops they had to jump through. If an airline went bankrupt, theyâd go out of business, and they just came back again. You know, fuel costs were 30% of the cost, and they were unpredictable, and even worse, it was one of those industries where... in many industries, if your business gets better and more people buy your product, thatâs good. Right? But in airlines, the more people that buy the product, that are on the planes, the worse the experience is for the customer. So there was perversity from A to Z in airlines.
Now, whatâs different right now about airlines? The major thing is massive consolidations. So up until about three or four years ago, the largest market share of any U.S. airline was around 12 and a half percent. Well, 12 and a half percent in a commodity business with all those problems I just mentioned is a recipe for, you know, disaster, for multiple bankruptcies which weâve seen. Well, now that weâve had massive consolidation, and so with Delta and Northwest, with United and Continental, with now perhaps...
CONSUELO MACK: American and USAir.
BILL MILLER: ... American and USAir, but the big two, Delta and UAL now control over 50% of the industry, and you add in Southwest. Youâre in the 60s. You put AMR and US Airways together, youâre in the 70s. Well, now youâre talking about three or four companies controlling the majority of the business, and thatâs why youâve seen pricing power. Thatâs why youâve seen free cash... the industryâs been free cash flow positive for the past five years, and only free cash flow positive in one of the previous 25 years, yet... and we were kind of early on this, because we bought during the crisis some bonds of UAL. They were selling secured bonds. They could only get a couple hundred million dollars of it issue off at around 17%. Now they can borrow at four to five percent unsecured. So the credit markets have figured out...
CONSUELO MACK: They figured out.
BILL MILLER: ...but the equity market is still trading these things at, you know, three times or four times enterprise value at EBITDA, or EBITDA in that case. So we think that thereâs a lot of upside left. Theyâve done very well. USAir has more than doubled this year early on. Deltaâs now doing well. UAL is the laggard, so I think UAL is the best value in the industry right now, but then there are other new entrants like Spirit Airlines which we donât own. Itâs fairly thin, but itâs like Ryanair. Itâs a very low-cost producer. That company can probably go 20% a year for the next five to seven years, and it trades at 10 times earnings. So itâs a very interesting industry now, much more interesting than it used to be.
CONSUELO MACK: So how long will you give, you know, an industry like the airlines. Obviously, theyâve done very well for you now, but for kind of the market to catch up with you. Is your willingness to stick with a company as long as it has been in the past?
BILL MILLER: Weâve been tending to be over, again, the decades saying weâre willing to be a year early on fundamentals if the stock is cheap enough. I think now weâre probably a little closer to that, saying weâre willing to be a quarter or two early on fundamentals, but not a year or two years on fundamentals. And again, in this kind of market, which is kind of a just-in-time market, this is a market where we have negative real interest rates and guaranteed negative returns on TIPS, so people are terrified, and in a terrified market you donât need to be early, because you can make plenty of money just when things visibly turn.
CONSUELO MACK: Right, so speaking of TIPS, Treasury Inflation-Protected Securities, you just said that you think that we are at the beginning of a major prolonged bear market. Now the Street, as you know, is littered with people who have made that kind of prediction for like the last five years. Whatâs different now? Why are you so convinced that this is the beginning of the bond bear market?
BILL MILLER: So the question is, how long are you willing to lose money? And when the S&P500 right now yields more than the 10-year Treasury, we havenât seen that since the 1950s except during this crisis, and we saw it in the 1940s and 1950s because of the Great Depression, but it was obviously a great time to buy stocks when they yielded more than bonds, and Iâd say the same thing right now and, more importantly, theoretically the 10-year Treasury, whatever the benchmark Treasury is- we use the 10-year- ought to have a yield roughly equal to the nominal GDP growth, and nominal GDP should be four to five percent normalized. Five would be more normal, but in a new normal world, a PIMCO world, maybe itâs four, but itâs not 180, and thatâs...
CONSUELO MACK: Right, and nominal being including inflation.
BILL MILLER: Yeah, inflation plus real, inflation plus real. So that would mean that the 10-year ought to be four to five percent. During the great bull market of the 1990s, the 10-year was six percent, and we had a great bull market, so if interest rates rise, thatâs not going to be an inhibitor to the market doing well. In fact, I think it will be an accelerant to the market doing well because so much moneyâs parked in bonds. We have a bubble in bonds at least equal to the bubble in housing in 2005 and the bubble in Internet stocks.
CONSUELO MACK: Stock market. You are on record of being bullish on stock market. You think 2013 is going to be another really good year. How good and why?
BILL MILLER: I think the stock market with balance sheets the best theyâve ever been in corporate Americaâs history, with housing coming back and with the Fed going to be accommodative toward 6.5% unemployment and 2.5% inflation, stocks are pretty much the only game in town. Whatâs the risk? The big risk in terms of political dysfunction that appears, most of those risks appear to have dissipated at least short term. Europe is a risk. Chinaâs a risk. Iran, Israelâs a risk. Thereâs always risk but given that thereâs always risk, I think stocks are basically where you have to be.
CONSUELO MACK: So which stocks do we have to be in, Bill Miller, or do you have to be in? Iâve got to ask you about Apple, you know, disappointing earnings report recently. So whatâs your take on Apple?
BILL MILLER: Apple is the Dr. Jekyll and Mr. Hyde of the stock market. Itâs the Dr. Jekyll in the sense that they are one of the greatest product innovators creating products that people love and a brand that people love, and theyâre Mr. Hyde in their completely idiotic and dysfunctional capital allocation which is the worst probably in the history of corporate America among good companies. So they have $135 billion of cash. They have much more cash than Amazon has market cap. Tim Cook said when they had $90 billion of cash, he said it was way too much. They had not possible reason to use it, announced a modest dividend and a modest share buyback that would not even draw down the cash at all, not one dollar. A year later, $135 billion of cash. Cash is equity. Equity has a cost. The cost of equity, if youâre optimistic like me, itâs six percent. If youâre historical like others, itâs eight percent. So take six or seven or eight percent and multiply it times $130 billion, and thatâs how much theyâre destroying value every year with dumb capital allocation. They could double the dividend tomorrow and still have a big share buyback and never touch the cash. So Appleâs a case where when the company had a massive growth rate... and itâs still got a good growth rate... the stock went up because people didnât care about the bad capital allocation, but now itâs in the Microsoft camp. Now itâs in the Cisco camp.
CONSUELO MACK: So itâs there. Itâs that kind of mature. Itâs that ...
BILL MILLER: Now the market is saying, as the market has taken Microsoftâs multiple down every year, why do you have $85 billion of cash? You generate two billion a month. Why? Why arenât you raising the dividend 25% a year instead of 15? Why arenât you buying back stock? And so I think thatâs the dilemma with Apple. I think Apple at $450 a share has huge optionality. Itâs nine and a half times earnings. Itâs going to grow probably 15 or 16% this year consensus, 12 to 14 next. Coke grows six to eight percent and trades at 17 times earnings, so if Apple had a capital allocation like IBM or like McDonaldâs... McDonaldâs pays out 100%of free cash flow to shareholders and trades at 15, 16 times. Apple would be up 50% on just sensible capital allocation.
CONSUELO MACK: From your lips to Tim Cookâs ears. I donât know whether itâs going to happen or not. Whatâs the most radical position in your portfolio?
BILL MILLER: The autos are probably a very good example. We added Ford to the portfolio in the fourth quarter. The auto companies have radically restructured. They can be profitable at nine million cars, never before. Their wage rates are competitive globally. Ford just doubled their dividend. Weâre at about 14 and a half to 15 million units right now. Equilibrium is 16, 16 and a half, and thatâs equilibrium. The fleetâs the oldest itâs ever been. Weâre looking at years of rising earnings in the auto companies.
CONSUELO MACK: Car sales.
BILL MILLER: And their balance sheets are great, and they trade at two and a half times or three times enterprise value to EBITDA. They ought to trade 50% higher easily. So thatâs a case where I think... the biggest thing we have in our portfolio is... and maybe to answer your question a different way is people look at our portfolio and say, âThatâs a scary portfolio because everything in it is very cheap but very risky,â and our comment is or my comment is, âHistorically it might have been risky, but the fundamentals are so powerful here.â So again, Pulte homes, risky at $3.50. Itâs $21 today. I would argue itâs more risky today than it was at $3.50, but I still donât think itâs very risky at year one of problems an eight or nine-year housing cycle. So I think thatâs the thing we have going for us in the Opportunity Trust. I think thereâs a lot of tailwinds in a portfolio thatâs had... you know, weâve beaten the market eight out of twelve years, but two of those four years were really bad, â08 and â11, but we had a great year last year. Weâre up over 10% in the first three weeks of this year, and I think that the outlook is good.
CONSUELO MACK: Is there any way that you would try to mitigate those down years?
BILL MILLER: Well, yes. Thatâs a great question, because thereâs two things. One of them is those two big down years were both the result of the same phenomenon expressed differently. One of them was in the crisis of 2008; what we had was the fundamental economic relations that held the economy together blew apart. Commercial paper market got crushed; a former triple A company like AIG went effectively bankrupt. So when the economic relations that exist in the society blow apart, you either get that right and realize it, like John Paulson did at least inâŚ
CONSUELO MACK: Very, very few did.
BILL MILLER: ... and you make a huge amount of money, or you donât realize it like me and you lose a lot of money. 2011 was different which is where people thought it might happen again, but it didnât, in which case we got hit hard, but it turned out that we were right and the rest of the people were wrong. That was just a quotational error. So I think from the standpoint of mitigating risk, part of what weâre trying to do is to say, are we seeing risk that could be systemic? If there are, that are rising. So take an example. If rates start to rise in Italy and Spain again, we will probably put on various hedges just to protect against that tail. One of the things that we actually did that worked out great last year was in 2011 at the end of the year, we bought a lot of really high yielding mortgage REITs and BDCs- business development companies. So the yields were anywhere from 12 to 15%. So our overall portfolio yield was well above the market, in fact, 50% higher than the stock market. That helped us last year during corrections, because those things didnât go down very much.
CONSUELO MACK: Didnât go down as much, right.
BILL MILLER: So our yield right now is maybe market or a little bit below, and I think our protection this year, if we need it, will be through various hedges when the market kind of spikes up as itâs done recently.
CONSUELO MACK: Final question, One Investment for a long-term diversified portfolio, what should we all have some of in our portfolio?
BILL MILLER: Most people are way overweight bonds based on history. Theyâre way underweight stocks because theyâre fearful. Itâs hard to go against your psychology if youâre fearful to take more risk. So I think the answer to that would be, okay, take the lowest possible risk in equities which is to buy the largest, most successful, most stable companies with high dividends. Call it the S&P top 50 or top 100, and theyâre extraordinarily cheap based on history. Theyâre cheap based on comparison with bonds, and their dividend yields are higher than bond yields, and theyâre also less volatile in the market as a whole, and so I think thatâs probably the single best risk-reward for the average investor.
CONSUELO MACK: Bill Miller, so great to have you back. Iâm so glad Bill Miller is back in more ways than one.
BILL MILLER: Oh, thank you. Thanks for having me on. Itâs great.
CONSUELO MACK: Especially on WealthTrack. Thanks, Bill.
BILL MILLER: Pleasure.
