Bill Miller: Leadership Will Shift to U.S. Large Cap Financials, Consumers
This market has been remarkably serially correlated. In plain talk, what has gone up keeps going up, and what has not, does not. Valuation has not mattered at all. What has mattered is price momentum. This is very similar to what we saw with tech, telecom, and internet names in 1999. It is not yet that extreme, but it is pretty extreme.
The best quintile of stocks based on traditional valuation factors such as price to earnings, price to book, price to sales, and dividend yield, has underperformed the market by over 1000 basis points this year. The best quintile on price momentum alone, using 3 and 9 month price trends, has outperformed by 1400 basis points. Coming at it somewhat differently, if you took the 50 best-performing stocks for the 3 year period ended December 31, 2006, and made that your portfolio for 2007, you would have returns over double that of the S&P 500 this year(5)...
If credit is becoming harder to come by, if spreads are widening, if growth is slowing, then it seems to me the leadership is about to change... Where will the new leadership come from? The same place it usually does: the old laggards. I think the new leadership will be US, large-cap, dollar-based, and grow to encompass what no one wants to own today, especially financials and consumer. I also think so-called growth stocks will continue to do fine. When growth becomes scarcer and the discount rate becomes lower, growth becomes more valuable.
More particularly, 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 5 years will be made in those securities people are panicked about today. For specific names, consult the 52-week new low list.
Miller's full letter is available via Legg Mason's site (.pdf).
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