Bill Miller & The Coming Equity Bubble
January 30, 2018
Edit
There is currently a to a greater extent than ofttimes than non held sentiment that 1 of the biggest risks global equity markets human face upwards at acquaint is that involvement rates ascension to a greater extent than chop-chop than expected (perhaps triggered past times inflation stirring). I have, to some extent, shared that view. However, Bill Miller - an investor I charge per unit of measurement really highly* - has exactly posted his 4Q letter to investors, in addition to inwards it, he weighed inwards on this number amongst an interesting perspective:
"There is growing describe of piece of work organization that the keen bond bull marketplace that began inwards belatedly 1981 is over (this is sure enough right inwards my view), but departure on what that mightiness hateful for stocks. In the Barron's Roundtable, several commented that rising rates could compress valuations if yields went inwards a higher house 3% in addition to that stocks could halt the twelvemonth down. I retrieve that is wrong. I believe that if rates ascension inwards 2018, taking the 10-year treasury inwards a higher house 3%, that volition propel stocks significantly higher, every bit money exits bond funds for alone the 2nd twelvemonth inwards the past times 10, in addition to moves into stock funds every bit happened inwards 2013. Stocks that twelvemonth were upwards 30%, mostly every bit a resultant of that shift inwards fund flows".
In ordinary circumstances, I would consider this declaration to hold upwards a fallacy of composition. If investors sell bond funds to purchase stock funds, the bond fund managers volition indeed demand to sell bonds to fund redemptions, in addition to the stock managers volition indeed demand to purchase stocks amongst novel subscription monies. However, who buys the bonds off the liquidating bond managers? Bond prices volition accept to autumn in addition to yields ascension to a market-clearing storey that attracts an equivalent number of buyers from somewhere. And those novel buyers may accept to liquidate other assets - possibly including private stock holdings - to finance those bond purchases. Net net, on a system-wide Blue Planet these portfolio adjustments ought non to comport upon overall liquidity weather condition materially.
However, every bit I accept discussed inwards past times spider web log posts, nosotros create non alive inwards normal times. What is different this wheel is that key banks accept conjured upwards an enormous amount of fresh liquidity from the ether through experimental quantitative easing/money printing operations. They accept - for the most role - bought bonds off individuals, funds, in addition to institutions amongst newly printed cash, in addition to the cash received past times these sellers has ended upwards parked inwards excess depository financial establishment deposits (held, inwards turn, past times banks every bit excess key depository financial establishment reserves). These accounts proceed to earn fiddling to no involvement (indeed, some depositors inwards some parts of the Blue Planet are fifty-fifty beingness charged negative involvement rates for the privilege of having their money custodised).
Risk aversion has prevailed inwards the post-GFC years, in addition to thus a lot of this newly printed money held inwards depository financial establishment deposits has been hesitant to catamenia into equities, in addition to also - to a grade - into the bond market, given the depression yields on offering (and key banks - through their bond buying activities - deliberately priced them out inwards club to purchase them out). Consequently, a lot of the funds accept remained idly parked inwards cash. Stock prices accept risen over the past times decade non through euphoria in addition to bullish brute spirits, but through investors beingness dragged ever so like shooting fish in a barrel - kicking in addition to screaming - into stocks through financial repression in addition to its persistently depression rates. This is why nosotros accept seen - at to the lowest degree until lately - none of the behavioural factors commonly associated amongst stock marketplace tops (outside of Bitcoin), despite valuations beingness high. This bull marketplace has indeed been different.
Because in that location is so much newly printed money sitting idle inwards depository financial establishment accounts, Bill Miller mightiness really good hold upwards right inwards his assessment that rising rates could really serve to propel equity markets much higher. If bond funds get down to disappoint investors, piece at the same fourth dimension confidence levels some the outlook for equities continues to recover, a sizable reallocation from bond funds to stock funds is quite possible, in addition to importantly, due to all the past times QE that has occurred, the bonds beingness sold past times bond funds might hold upwards purchased past times some of the mountains of idle cash currently sitting in that location doing nothing, coaxed inwards past times rising yields. Were this to occur, it would effectively resultant inwards the strength of past times accumulated QE efforts beingness channelled indirectly but inwards total strength into the stock market. This could human activity every bit rocket fuel to a bull marketplace that is already start to get together some serious momentum.
As I accept discussed inwards past times articles, marketplace valuations, in addition to dispassionate risk/reward assessments past times equity portfolio managers, create non drive markets. Market liquidity factors drive markets, in addition to if stock funds (and passive ETFs) have rising inflows, they volition accept no choice but to maintain buying, irrespective of valuation. If Miller is right, in addition to so absent a major geopolitical or otherwise unexpected shock, in addition to so a bond-to-stock reallocation could good proceed to propel stocks into the stratosphere.
As I accept argued inwards past times spider web log entries, given the unprecedented grade of monetary printing nosotros accept seen this cycle, it ought to non hold upwards a surprise if this wheel ends upwards rivalling or exceeding the valuation excesses nosotros saw during the dot-com era, where mature low-growth blueish flake stocks similar Coca-Cola got every bit high every bit 40x earnings (Coke currently trades at almost 25x). The leading horseman of the 1990s tech bubble (Microsoft, Cisco Systems, etc), traded every bit high every bit 80x earnings - twice the levels many of today's tech leaders such every bit Facebook in addition to Google merchandise at (closer to 30-40x). Mature Japanese blueish chips got every bit high every bit 80-100x earnings inwards the belatedly 1980s. We are far, far away from the storey of valuation excesses that are really possible inwards markets.
As Miller also argues, the path of to the lowest degree resistance for markets remains higher, amongst the alone major caveat beingness that this momentum volition hold upwards disrupted if something comes completely out of left champaign that investors are totally ill-prepared for, which is want to occur from fourth dimension to fourth dimension (e.g. a nuclear country of war amongst North Korea). The 'known unknowns' volition non create it - it volition accept to hold upwards an 'unknown unknown'. Absent such a shock, also much money is currently sitting on the sidelines hoping in addition to waiting for a push clit dorsum to enter, for markets to materially decline. Markets volition almost ever become upwards when this is the case. They alone become downwards when everyone is all of a abrupt in addition to unexpectedly forced to sell or deleverage due to a major shock, or where an unknown unknown causes investors to panic.
An unexpected recession would also probable create it, in addition to many investors proceed to await 1 inwards the U.S. of America but because it has been a long fourth dimension since nosotros concluding had one. However, developed marketplace corporate investment has been extremely weak inwards the post-GFC years, in addition to the economical recovery from the GFC far from vigorous (particularly inwards Europe, where the unemployment charge per unit of measurement is soundless 11%). For this reason, it is quite possible that nosotros are non yet every bit belatedly inwards the U.S. of America economical wheel every bit many assume (economic cycles create non boot the bucket of onetime age, every bit the proverb goes), because the prior absence of corporate investment way that the overcapacity in addition to accompanying slump inwards both profits in addition to corporate investment that usually emerges belatedly inwards the wheel in addition to triggers a recession is soundless quite unlikely to occur for some time. Indeed, amongst taxation cuts in addition to 'America first' policies, U.S. of America corporate investment looks probable to accelerate from here. A pregnant increment inwards the financial deficit volition also induce the U.S. of America economic scheme this year, in addition to M&A activity soundless has a long trend to become to recover to prior peaks every bit well.
I rest really concerned that nosotros are soundless inwards the fairly early on stages of a historic bull marketplace that eventually turns into an all out speculative mania. I really much promise I am incorrect - an extended bull marketplace carrying markets to extremely overvalued levels is a value investor's worst nightmare. However, markets are notoriously uncooperative in addition to impervious to one's wishes, in addition to create non render the opportunities you lot would similar exactly because they are needed or desired, in addition to amongst global markets upwards 5% YTD already, things are non looking good, I'm afraid.
LT3000
*Bill Miller achieved fame at Legg-Mason for trouncing the S&P 500 for xv consecutive years - an unheard of feat - earlier experiencing a disastrous 2008, where he bet heavily in addition to unsuccessfully on beaten-up financials (he reversed course of written report in addition to shut out his positions inwards September 2008, but alone afterwards sustaining heavy losses). His reputation has been forever tarnished. Whenever I scream that I am a fan of Miller, I am at 1 time asked 'didn't he blow upwards his fund inwards 2008?'
Since his 2008 blow up, he has relaunched his ain outfit Miller Value Partners, in addition to has 1 time again been slaughtering the marketplace twelvemonth afterwards year. Even including 2008 - and, past times the way, if Lehman had non gone under, he would accept made an absolute fortune - he has outperformed the marketplace past times almost 500bp per twelvemonth afterwards fees for approaching 30yrs - an incredible feat. I run across Miller every bit the perfect embodiment of Keynes' admonition that "experience teaches that it is improve for reputation to neglect conventionally than to succeed unconventionally".
My honor for Miller derives every bit much from the character of his thinking in addition to ideas every bit his rails record, however. He is an innovative in addition to genuinely independent thinker. He was really early, for instance, into the airline merchandise (US airline stocks accept increased past times 4-5x inwards recent years), recognising good earlier the balance of the investment community the significance of a consolidating marketplace construction in addition to a alter inwards administration incentives towards profitability in addition to away from over-investment.
The vast bulk of value investors missed this opportunity, because "Warren Buffett said you lot should never invest inwards airlines". Interestingly enough, several years in addition to several hundred percentage afterwards Miller entered, Buffett emerged every bit a buyer of U.S. of America airlines, surprising the investment community. This highlights an of import truth inwards markets - you lot demand to hold upwards an innovative, independent thinker to succeed inwards markets. That's how Buffett did it. Would-be Buffett copycats neglect to empathise that. Buffett is to hold upwards admired in addition to learned from, but messianic, uncritical hero-worship in addition to simulated demonstrates, at a deep level, a failure to empathise why Buffett succeeded inwards the foremost place.
"There is growing describe of piece of work organization that the keen bond bull marketplace that began inwards belatedly 1981 is over (this is sure enough right inwards my view), but departure on what that mightiness hateful for stocks. In the Barron's Roundtable, several commented that rising rates could compress valuations if yields went inwards a higher house 3% in addition to that stocks could halt the twelvemonth down. I retrieve that is wrong. I believe that if rates ascension inwards 2018, taking the 10-year treasury inwards a higher house 3%, that volition propel stocks significantly higher, every bit money exits bond funds for alone the 2nd twelvemonth inwards the past times 10, in addition to moves into stock funds every bit happened inwards 2013. Stocks that twelvemonth were upwards 30%, mostly every bit a resultant of that shift inwards fund flows".
In ordinary circumstances, I would consider this declaration to hold upwards a fallacy of composition. If investors sell bond funds to purchase stock funds, the bond fund managers volition indeed demand to sell bonds to fund redemptions, in addition to the stock managers volition indeed demand to purchase stocks amongst novel subscription monies. However, who buys the bonds off the liquidating bond managers? Bond prices volition accept to autumn in addition to yields ascension to a market-clearing storey that attracts an equivalent number of buyers from somewhere. And those novel buyers may accept to liquidate other assets - possibly including private stock holdings - to finance those bond purchases. Net net, on a system-wide Blue Planet these portfolio adjustments ought non to comport upon overall liquidity weather condition materially.
However, every bit I accept discussed inwards past times spider web log posts, nosotros create non alive inwards normal times. What is different this wheel is that key banks accept conjured upwards an enormous amount of fresh liquidity from the ether through experimental quantitative easing/money printing operations. They accept - for the most role - bought bonds off individuals, funds, in addition to institutions amongst newly printed cash, in addition to the cash received past times these sellers has ended upwards parked inwards excess depository financial establishment deposits (held, inwards turn, past times banks every bit excess key depository financial establishment reserves). These accounts proceed to earn fiddling to no involvement (indeed, some depositors inwards some parts of the Blue Planet are fifty-fifty beingness charged negative involvement rates for the privilege of having their money custodised).
Risk aversion has prevailed inwards the post-GFC years, in addition to thus a lot of this newly printed money held inwards depository financial establishment deposits has been hesitant to catamenia into equities, in addition to also - to a grade - into the bond market, given the depression yields on offering (and key banks - through their bond buying activities - deliberately priced them out inwards club to purchase them out). Consequently, a lot of the funds accept remained idly parked inwards cash. Stock prices accept risen over the past times decade non through euphoria in addition to bullish brute spirits, but through investors beingness dragged ever so like shooting fish in a barrel - kicking in addition to screaming - into stocks through financial repression in addition to its persistently depression rates. This is why nosotros accept seen - at to the lowest degree until lately - none of the behavioural factors commonly associated amongst stock marketplace tops (outside of Bitcoin), despite valuations beingness high. This bull marketplace has indeed been different.
Because in that location is so much newly printed money sitting idle inwards depository financial establishment accounts, Bill Miller mightiness really good hold upwards right inwards his assessment that rising rates could really serve to propel equity markets much higher. If bond funds get down to disappoint investors, piece at the same fourth dimension confidence levels some the outlook for equities continues to recover, a sizable reallocation from bond funds to stock funds is quite possible, in addition to importantly, due to all the past times QE that has occurred, the bonds beingness sold past times bond funds might hold upwards purchased past times some of the mountains of idle cash currently sitting in that location doing nothing, coaxed inwards past times rising yields. Were this to occur, it would effectively resultant inwards the strength of past times accumulated QE efforts beingness channelled indirectly but inwards total strength into the stock market. This could human activity every bit rocket fuel to a bull marketplace that is already start to get together some serious momentum.
As I accept discussed inwards past times articles, marketplace valuations, in addition to dispassionate risk/reward assessments past times equity portfolio managers, create non drive markets. Market liquidity factors drive markets, in addition to if stock funds (and passive ETFs) have rising inflows, they volition accept no choice but to maintain buying, irrespective of valuation. If Miller is right, in addition to so absent a major geopolitical or otherwise unexpected shock, in addition to so a bond-to-stock reallocation could good proceed to propel stocks into the stratosphere.
As I accept argued inwards past times spider web log entries, given the unprecedented grade of monetary printing nosotros accept seen this cycle, it ought to non hold upwards a surprise if this wheel ends upwards rivalling or exceeding the valuation excesses nosotros saw during the dot-com era, where mature low-growth blueish flake stocks similar Coca-Cola got every bit high every bit 40x earnings (Coke currently trades at almost 25x). The leading horseman of the 1990s tech bubble (Microsoft, Cisco Systems, etc), traded every bit high every bit 80x earnings - twice the levels many of today's tech leaders such every bit Facebook in addition to Google merchandise at (closer to 30-40x). Mature Japanese blueish chips got every bit high every bit 80-100x earnings inwards the belatedly 1980s. We are far, far away from the storey of valuation excesses that are really possible inwards markets.
As Miller also argues, the path of to the lowest degree resistance for markets remains higher, amongst the alone major caveat beingness that this momentum volition hold upwards disrupted if something comes completely out of left champaign that investors are totally ill-prepared for, which is want to occur from fourth dimension to fourth dimension (e.g. a nuclear country of war amongst North Korea). The 'known unknowns' volition non create it - it volition accept to hold upwards an 'unknown unknown'. Absent such a shock, also much money is currently sitting on the sidelines hoping in addition to waiting for a push clit dorsum to enter, for markets to materially decline. Markets volition almost ever become upwards when this is the case. They alone become downwards when everyone is all of a abrupt in addition to unexpectedly forced to sell or deleverage due to a major shock, or where an unknown unknown causes investors to panic.
An unexpected recession would also probable create it, in addition to many investors proceed to await 1 inwards the U.S. of America but because it has been a long fourth dimension since nosotros concluding had one. However, developed marketplace corporate investment has been extremely weak inwards the post-GFC years, in addition to the economical recovery from the GFC far from vigorous (particularly inwards Europe, where the unemployment charge per unit of measurement is soundless 11%). For this reason, it is quite possible that nosotros are non yet every bit belatedly inwards the U.S. of America economical wheel every bit many assume (economic cycles create non boot the bucket of onetime age, every bit the proverb goes), because the prior absence of corporate investment way that the overcapacity in addition to accompanying slump inwards both profits in addition to corporate investment that usually emerges belatedly inwards the wheel in addition to triggers a recession is soundless quite unlikely to occur for some time. Indeed, amongst taxation cuts in addition to 'America first' policies, U.S. of America corporate investment looks probable to accelerate from here. A pregnant increment inwards the financial deficit volition also induce the U.S. of America economic scheme this year, in addition to M&A activity soundless has a long trend to become to recover to prior peaks every bit well.
I rest really concerned that nosotros are soundless inwards the fairly early on stages of a historic bull marketplace that eventually turns into an all out speculative mania. I really much promise I am incorrect - an extended bull marketplace carrying markets to extremely overvalued levels is a value investor's worst nightmare. However, markets are notoriously uncooperative in addition to impervious to one's wishes, in addition to create non render the opportunities you lot would similar exactly because they are needed or desired, in addition to amongst global markets upwards 5% YTD already, things are non looking good, I'm afraid.
LT3000
*Bill Miller achieved fame at Legg-Mason for trouncing the S&P 500 for xv consecutive years - an unheard of feat - earlier experiencing a disastrous 2008, where he bet heavily in addition to unsuccessfully on beaten-up financials (he reversed course of written report in addition to shut out his positions inwards September 2008, but alone afterwards sustaining heavy losses). His reputation has been forever tarnished. Whenever I scream that I am a fan of Miller, I am at 1 time asked 'didn't he blow upwards his fund inwards 2008?'
Since his 2008 blow up, he has relaunched his ain outfit Miller Value Partners, in addition to has 1 time again been slaughtering the marketplace twelvemonth afterwards year. Even including 2008 - and, past times the way, if Lehman had non gone under, he would accept made an absolute fortune - he has outperformed the marketplace past times almost 500bp per twelvemonth afterwards fees for approaching 30yrs - an incredible feat. I run across Miller every bit the perfect embodiment of Keynes' admonition that "experience teaches that it is improve for reputation to neglect conventionally than to succeed unconventionally".
My honor for Miller derives every bit much from the character of his thinking in addition to ideas every bit his rails record, however. He is an innovative in addition to genuinely independent thinker. He was really early, for instance, into the airline merchandise (US airline stocks accept increased past times 4-5x inwards recent years), recognising good earlier the balance of the investment community the significance of a consolidating marketplace construction in addition to a alter inwards administration incentives towards profitability in addition to away from over-investment.
The vast bulk of value investors missed this opportunity, because "Warren Buffett said you lot should never invest inwards airlines". Interestingly enough, several years in addition to several hundred percentage afterwards Miller entered, Buffett emerged every bit a buyer of U.S. of America airlines, surprising the investment community. This highlights an of import truth inwards markets - you lot demand to hold upwards an innovative, independent thinker to succeed inwards markets. That's how Buffett did it. Would-be Buffett copycats neglect to empathise that. Buffett is to hold upwards admired in addition to learned from, but messianic, uncritical hero-worship in addition to simulated demonstrates, at a deep level, a failure to empathise why Buffett succeeded inwards the foremost place.