Bill Miller, Legg Mason Inc.'s top money manager and self-described contrarian investor, said yesterday that downtrodden housing and financial stocks may soon replace today's high-flying energy, materials and industrial stocks as the market's top performers.
Miller, whose record-setting Legg Mason Value Trust lags behind the market for a second year, said fear has driven the precipitous decline in financial, housing and consumer stocks, which make up a large chunk of his portfolio.
Those sectors have been particularly hard hit by the credit crisis gripping Wall Street.
But in a quarterly letter to shareholders, Miller compared those stocks to the now-popular energy, industrial and non-U.S. stocks that hit bottom in 2002 before rebounding to post spectacular five-year returns.
"Just as the right thing to do in 2002 was to buy what everyone was panicked about, I think the greatest gains over the next five years will be made in those securities people are panicked about today," Miller said.
Miller's Value Trust became renowned for beating the Standard & Poor's 500 stock index for 15 consecutive years. "The Streak," as it came to be known, ended in 2006 and shows no sign of making a comeback so far this year.
The contrarian strategy Miller outlined yesterday has worked in his favor in the past. For example, AES Corp., one of the largest energy producers and the No. 2 holding in Value Trust, was trading at less than $1 per share in 2002. Today, it is up 20 times over its 2002 lows, Miller noted.
But it's too early to say whether beleaguered housing and financial stocks will follow a similar pattern, as Miller predicts. The subprime loan crisis has produced billions of dollars in losses for major lenders and shows little sign of abating.
Financial stocks were the biggest losers in the market yesterday, with Merrill Lynch & Co. and JPMorgan Chase & Co. leading the way.
JPMorgan, Miller's sixth-largest holding, fell $1.17, or 2.6 percent, to $43.15 in trading yesterday, while shares of Citigroup Inc., his 15th-largest holding, fell 2 percent to $37.73. (Overall, U.S. market indexes were up yesterday, but less than 1 percent.)
Miller said in September that he was retooling the fund to include more large U.S. companies, which he said are a better value right now relative to the rest of the market.
In yesterday's letter, he said he would sell off some of his top 10 holdings to free up cash to diversify the portfolio. Miller has historically held fewer stocks in his fund relative to others in the market.
"He's often been a contrarian investor," said Greg Carlson, a fund analyst with Morningstar Inc. "In some cases, he bought too early, such as housing stocks. But he believes they're significantly undervalued now."
Miller began investing in housing-related stocks more than a year ago, when valuations were high. Among them was Countrywide Financial Corp., a mortgage lender that has seen its shares fall 66 percent this year. He also placed bets on builders Pulte Homes and KB Home - both of which have seen business fall off with the housing slump.
In his letter, Miller noted that recent big swings in Countrywide's share price have been driven by emotion, rather than sound analysis of the company's long-term business value. He values its shares in the $40 range, compared with yesterday's close of $14.35, down 8 cents.