Legg Mason’s Bill Miller released his first quarter investment commentary on Wednesday, and it was optimistic. Some highlights:
I think we will do better from here on, and that by far the worst is behind us. I think the credit panic ended with the collapse of Bear Stearns, and credit spreads are already much improved since then. If spreads continue to come in, the write-offs at the big financials will end, and we may even have some write-ups in the second half instead of write-downs.
Valuations are attractive, and valuation spreads are now about one standard deviation above normal, a point at which valuation-based strategies usually begin to work again, and momentum begins to fade (there is no evidence of the latter yet, as the old leaders continue to lead).
Most housing stocks are up double digits this year despite dismal headlines, a sign the market had already priced in the current malaise. I think likewise we have seen the bottom in financials and consumer stocks, but not necessarily the bottom in headlines about the woes in those sectors. Although the economy is likely to struggle as it did in the early 1990s, the market can move higher, as it did back then.
The wild card is commodities. If commodities break, or even just stop their relentless rise, equity markets should do well. If they continue to move steadily higher, they have the potential to destabilize the global economy. We are already seeing unrest in many countries due to the soaring prices of rice and other grains. Oil has rallied $30 per barrel in the past 8 weeks on no fundamental news, save only the same stories about fears of supply disruptions. The typical fundamental drivers at the margin, such as global economic growth, miles driven, and seasonality, would all suggest prices similar to those that prevailed in early February.
But none of that has mattered. I agree with George Soros that commodities are in a bubble, but it also appears he is right when he describes it as one that is still inflating, and we still have the summer driving and hurricane season with which to contend.
The weak dollar is another culprit in the commodity cycle. Oil began to rise in earnest when the dollar index broke down sharply in February. The Fed could help a lot by halting its interest rate cuts. Real short rates are now negative. It is not the price of credit that is the problem, it is its availability. If the Fed stopped cutting rates, that would help the dollar, which in turn ought to stall the commodity price rises, and thus also help the inflation picture. More technically, the Fed, in my opinion, needs to focus on the value of collateral and not on the price of credit. It appears they are beginning to do this, which is a very healthy sign.
Despite moving higher over the past month, the U.S. market and most others around the world are down for the year, and fear and risk aversion still predominate. Yet valuations in general are not demanding, interest rates are low, and corporate balance sheets, especially in the U.S., are in excellent shape.
That sets the stage for what should be an improving environment for investors in stocks and in spread credit products, if not in government bonds where risks are high and opportunities low, in my opinion. With most investors being fearful, I think it makes sense to allocate some capital to the greedy side of that pendulum, and that means putting cash to work in equities.
The Kelly Letter agrees, which is why we’ve made nine stock purchases so far this year.
