Bill Miller, the Chairman and CIO of Legg Mason Capital Management, believes the market is underestimating potential US GDP growth in 2010. Indeed, he thinks a major restocking of inventories will help drive a recovery in the US that will see the stock market rise by up to 20% this year. The fall in industrial output seen in the US has far exceeded the actual drop in demand, the shortfall having been made up from inventories. He expects to see a rapid restocking by US companies that will stimulate a sharp rise in economic growth over several quarters.
This is a (mildly edited) extract from his latest published view:
While the consensus view is for a 2.6% GDP rise in 2010, and the Federal Reserve has predicted 2.7%, Miller says there is a good chance that economic growth will exceed these estimates, possibly reaching as high as 8%. A rise in the stock market of up to 20% on the back of this recovery would not be beyond the realms of possibility.
US stocks are delivering earnings that are consistently above expectations and Miller points to the fact that since 1871 there have been 14, 10-year periods when stock market returns have been negative, including the last 10 years. In every one of the previous 13, the subsequent 10-year returns have exceeded 10% after inflation, or much higher than the long-term average real return of 6.66% and more than double the return of government bonds.
So every time stocks have performed poorly for 10 years, they have performed better than average for the next 10 years and have beaten bonds every time by an average of two to one. Miller’s view is that equities are extremely undervalued versus bonds, yet investors continue to favour bonds over equities.
Miller believes technology and financials are the two sectors most likely to benefit from any upturn, and has positioned his portfolio to reflect this. Technology is the portfolio’s largest weighting due to the strength of corporate balance sheets and the number of companies delivering record earnings. Holdings include: IBM, Cisco, Microsoft and Hewlett Packard.
His second biggest weighting is in financials. Miller believes that financials are at their most liquid since the 1930s and those companies left after the fallout of the last two years are well placed to exploit substantial market share, while the banks are looking increasingly healthier, having reported their losses to be half or less than that predicted in their stress tests.
Mega-cap stocks are best-placed to exploit growth in emerging markets in coming years, especially those that carry favoured big brand names, Miller says. Their non-US earnings mean that they will grow faster than their smaller counterparts while rising consumer demand in China, which the Chinese government is encouraging, will also provide some support for the dollar if it translates into higher demand for US exports.
Comment: if the US economy grows by 8% this year, it will confound the entire profession of economists. While he is not everyone’s favourite cup of tea (and certainly no blushing violet), I have always found Bill Miller an interesting and innovative thinker about markets, which is why he will always remain on my professional investor watch list, despite his traumatic fall from grace during the financial crisis. His point about bonds and equities is that despite the stock market’s sharp rise in 2009, inflows into bond funds massively outweighed those into equity funds.
Colin McLean, the founder of the Scottish fund management group SVM, and one of the fund managers featured in my book Money Makers, highlights some themes for investors to consider over the next ten years.
The scarcity of resources globally including food, metals and oil is likely to be a continuing trend over the next decade as demand from developing economies grows. The vibrant economies of the Far East and other emerging markets will continue to outpace the West and a large part of the coming decade will see the UK and US battling enormous fiscal deficits, with the EU only slightly better placed.
A key factor in the faster growth of many developing economies will be their stronger financial sectors. The credit boom in Western economies typically was not replicated in emerging markets and banks in those emerging markets were more conservative, leveraging to much lower levels than in the West. Conservative banking was a challenge for emerging economies in the first decade of this century, but should prove to be a strength over the next ten years.
Commodities closely linked to global growth, such as copper and platinum should do well. Oil and gas exploration businesses should also pay off longer term, particularly those drilling successfully in Africa. Gold should maintain its value if inflation grows and may play a part in the new global reserve currency that could emerge in the coming years.
Many UK companies have significant overseas earnings – particularly industrial and engineering businesses with a focus on infrastructure work and mining services. Many British groups could be attractive targets for overseas predators, particularly if the Pound remains low. The trend of loss of ownership of British national treasures could accelerate. There will be risks in chasing the environmental trend but the decade will see many more nuclear power stations built around the world. There will also be some opportunities in technology as demand for wireless chips grows.
Comment: Nothing very startling or original here, but the emphasis on resources and the Far East is very much in line with the strategic themes that form the basis of my own current thinking.
Markets: The equity markets got off to a powerful start yesterday, with rises in nearly all the major markets. Gold was also a notable feature, rising more than 2%. Nothing yet to disprove the Miller hypothesis so far, in any event. This is the S&P 500 index over a three year period with 50 and 200 day moving averages, and the relative strength indicator.
This is the gold chart on the same basis. If the trend in gold is still higher, as I believe it is, this looks a good trading opportunity, as the metals all look oversold.
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