Bill Miller Is Bullish

The current credit crunch is "much more serious" for the U.S. financial system than the 1987 stock market crash was, warns Legg Mason's Bill Miller in a conference call with analysts. "The mortgage market is bigger than the whole U.S. economy, and that market is effectively shut down."

But once the immediate crisis has passed, Miller thinks stocks will head higher. And he predicts that the industry sectors that have led the market in recent years, such as energy and basic materials, will become laggards. "The leadership is likely to change," says Miller, whose Legg Mason Value (symbol LMVTX) beat Standard & Poor's 500-stock index a record 15 straight years until 2006.

Even assuming the crisis is resolved quickly, Miller says, "Markets are readjusting their outlook globally for growth." He expects growth to slow, and that emerging markets stocks -- "the high-beta trade on global growth" -- will be hard hit. But with slower growth, earnings growth (where you can find it) will be all that much more valuable a commodity.

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So what's Miller buying? He says financials are the most attractive stocks because they're trading at cheap multiples to earnings and cash flow -- and because the yield curve is steepening, meaning that longer-term bonds are finally paying higher yields than shorter-term bonds. The "big guys" -- Citigroup (C), J.P. Morgan Chase (JPM), Bear Stearns (BSC), Lehman Brothers (LEH), Goldman Sachs (GS) -- trade at "spectacularly low multiples of current earnings." While "earnings may not rise that much, they're not going to drop that much either."

It's a classic Miller move. He sees panic in a market sector -- in this case financials -- and he plunges right in. (To be sure, he already had 14% of Value in financials on June 30.) It has paid off for him many times in the past. He loaded up on Tyco International (TYC), for instance, when its stock was in single digits and skeptics thought it would go the way of Enron and WorldCom. It's still his second largest holding. He already owned Countrywide Financial (CFC) going into the mortgage mess and predicts it will recover and thrive.

Miller is plainly worth listening to. An eclectic thinker, he has piloted Valueto an annualized 14% return over the past 15 years -- four percentage points per year better than the S&P 500. It ranks in the top 10% over the past ten years among large-company funds that combine value and growth characteristics. His newer fund, Legg Mason Opportunity (LMOPX), a member of the Kiplinger 25, ranks tenth over the past five years among more than 550 funds specializing in stocks of midsized growth companies.

He's a contrarian to the core. Miller isn't excited by healthcare or other defensive areas. "The market has already shifted to those," he says. In addition to financials, Miller sees big gains ahead for technology. He owns Amazon (AMZN), Google (GOOG) and Yahoo (YHOO) among others. He also still holds several homebuilders, which he concedes he bought much too early. One lesson he says he has learned from the recent selloff in homebuilders: Don't try to be early "into areas of excess."

Still a huge crisis

The credit crunch still strikes Miller as extremely dangerous to the economy and the stock market. If the credit markets don't unfreeze in the next 30 to 60 days, he predicts "a much darkened economic outlook." He notes that it's "a global credit problem," not one just limited to the U.S.

Much more needs to be done. "The entire investment environment has changed" with the Federal Reserve Board's decision on August 17 to lower the discount rate on loans it makes to banks, he says. Yet the Fed's move "wasn't anywhere near enough." He wants to see the Fed cut the federal funds rate -- a more powerful tool that is the rate banks charge each other for loans -- and to take other actions. "The Fed's job one is to return the short-term credit markets and the mortgage markets to normalcy," says Miller. "If that doesn't happen, this will spread and ultimately take the equity markets down with it and stop the economy dead in its tracks. If people can't buy and sell homes, they will stop buying completely."

But Miller is optimistic. After the crisis is resolved, he sees the market rising. Stocks are cheap relative to earnings and other measures. "Once the market gets wind that this is over, the path of least resistance is higher."

Consequently, in Legg Mason Opportunity, Miller's smaller and more aggressive fund, he's selling his "safe names" and buying riskier stocks.

Legg Mason Value, he concedes, had a lousy 2006, returning just 6%, and is doing worse than that this year. The fund was down 2% through August 22. But don't write Miller off. He's proven to be one of the most gifted fund managers working today.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.