Bill Miller made his formidable name as a value manager by drubbing the benchmark S&P 500 index for a remarkable 15 consecutive years.
By 2006, though, his failure to climb on the commodity bandwagon caught up to his results. And in 2008, a disastrous bet on deeply wounded financials caused his multi-billion-dollar Value Trust fund to plunge 55 per cent and left his reputation in tatters.
But 2009 marked a strong comeback. And the 59-year-old chairman and chief investment officer of Legg Mason Capital Management is extremely bullish on prospects for this year.
You believe this is going to be an outstanding year for U.S. equities, the economy and the currency. What's the source of that confidence?
We looked at the valuation of the U.S. equity market. We looked at the earnings revisions and the estimates. We looked at GDP. It still looks to us like the consensus numbers are too low.
I would say that we're certainly more optimistic than most, but that's supported by the data. You're looking at earnings growth in the first couple of quarters of 2010 being greater than 30 to 35 per cent, on a year-over-year basis. That would translate into GDP growth in the 5- to 6-per-cent range.
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I would not be surprised to see [U.S. economic]growth north of 4 per cent in 2010.
What about the bear arguments that housing remains feeble and that much of the economic growth stems from stimulus spending, which is going to be shrinking?
Certainly there are cross currents here, and those are two of them. The stimulus program was absolutely necessary to counteract the big drop in aggregate demand. But the program was only maybe 10 per cent under way by the third quarter. And we had economic growth beginning already.
So the key to growth was?
It's the normalization of credit and the cost of credit throughout the economy. That's been due to the Fed.
And housing?
It has to be closely watched. The Case-Shiller index shows about an 8.5 per cent move in prices off the bottom in the last five months. If that continues, the year-over-year price declines in housing will be over in March.
What about the consumer?
People continually underestimate the impact of a rising stock market and rising financial asset prices. Those go a long way towards repairing consumer net worth.
Let's turn to your investing record. What led you to underestimate the severity of the crisis when you were loading up on financials?
What I did not count on was that there would be very dramatic policy errors.
That was simply an error on my part. because when you go back and look at the Depression, the errors that the economists focus on are the errors of the Fed, in terms of monetary policy. But there were also policy errors.
But broadly speaking, the politics of the Depression were in the right direction: good fiscal policies, bad monetary policy. In this particular case, political policy was bad and monetary policy was good, although too slow.
What lessons have you taken away from the debacle?
Investors have to be extremely sensitive to government policy and react quickly when that policy is not capital friendly.
[Also]crises come in many forms. The standard form is a liquidity problem [the trigger for the 1987 market crash] which can easily be solved by the Fed or the Treasury. The other, more insidious form is a balance sheet problem or an asset value problem. And that can only be solved by shoring up asset values and balance sheets. ... That's a much bigger problem. So it's imperative for investors to recognize the difference.
Besides being more sensitive to policy ramifications, have you made any changes to your investment strategy?
Not as a result of the crisis. The crisis was one of trying to understand what the risks were and how one should position portfolios in the face of different kinds of risks.
We have made some changes to our portfolio construction process as a result of the 2006-2007 experience that we had with a lack of commodities and industrial exposure. That change is relatively modest.
How so?
What we did was put an overlay into our process, whereby if any industry sector gets in the bottom decile of its historic price-to-book relationship, relative to the market, then we will have a position in it and probably at least a market weight. As value investors, we're going to make sure that we're exposed to any sector which is trading at very depressed valuations.
Did you ever consider quitting when people were booing you at Baltimore Orioles baseball games?
I never considered walking off the field during the financial crisis, when we were doing badly. Earlier than that, when we were doing well, especially after that 15-year run - a nice number - [that would have been the time to leave] Like Ted Williams announcing his retirement after he hit that home run in his last at-bat. But I didn't do that.