Current market has rich rewards in longer term

Published March 19, 2008

Current market has rich rewards in longer term

By GENEVIEVE CUA


LEGG Mason Capital Management chairman Bill Miller is often likened to Warren Buffett in his conviction in value. Here is an excerpt from his commentary for Q4 2007:

'In the 25 years since we started the Value Equity mandate, we have had six calendar years of underperformance. Despite that 19-6 record against the market, all losses are painful. They are also unavoidable and unpredictable. It would be great if we could figure out how to never underperform. No one has been able to do that, but that does not make it any less painful.

About the only advantage of being old in this business is that you have seen a lot of markets and sometimes market patterns recur that you believe you have seen before. It is not an accident that our last period of poor performance was in 1989 and 1990, and I think there is a reasonable probability the next few years will look like what followed those years.

All the poorest performing parts of the market, housing, financials and the consumer sector - with the exception of consumer staples - are at valuation levels last seen in late 1990 and early 1991, an exceptionally propitious time to have bought them. The rest of the market is not expensive, but valuations cannot compare with those in these depressed sectors.

What took us into this malaise will be what takes us out. Housing stocks peaked in the summer of 2005 and were the first group to start down. Now housing stocks are one of the few areas in the market that are up for the year. They were among the best performing groups in 1991, and could repeat that this year. Financials appear to have bottomed and the consumer space will get relief from lower interest rates.

Investors seem to be obsessed just now over the question of whether we will go into recession or not, a particularly pointless inquiry. The stocks that perform poorly entering a recession are already at recession levels. If we go into recession we will come out of it. In any case we have had only two recessions in the past 25 years, and they totalled 17 months. As long-term investors we position portfolios for the 95 per cent of the time the economy is growing, not the unforecastable 5 per cent when it is not.

I believe equity valuations in general are attractive now, and I believe they are compelling in those areas of the market that have performed poorly over the past few years. Traders and those with short attention spans may still be fearful, but long-term investors should be well rewarded by taking advantage of the opportunities in today's stock market.'

Published March 19, 2008

The contrarian strategy

Going against the crowd does lead to long-term results, GENEVIEVE CUA finds out


A VALUE investor who makes a call to pick up stocks now may be ridiculed as a fool - even if he or she has had a long track record of success.

Portfolio manager Mary Chris Gay of Legg Mason Capital Management, who works with legendary investor Bill Miller, says the time to buy is at the point of 'maximum pessimism' - and that applies particularly to financial stocks in which the fund is currently overweight.

This is a time, however, when bank strategists are calling an underweight in equities, even as the market is expecting the US Federal Reserve to cut interest rates by 100 basis points.

Ms Gay says: 'What we try to do is to maximise the discount between the underlying value of companies and what we believe they're worth on a risk adjusted basis. The potential upside of our portfolio today is as great as it has ever been.'

Ms Gay is referring to the firm's flagship Value Fund, run by Mr Miller himself, with US$40 billion in assets. Mr Miller has been variously described in the US media as one of the world's greatest investors. BusinessWeek, for instance, named him as one of the heroes of value investing, thanks to a 15-year winning streak by the Value Fund against the S&P500, after fees.

The fund, however, suffered a rout in 2006 and 2007, underperforming the S&P500 by about 2,000 basis points. This, as Mr Miller himself wrote in his fourth quarter commentary published last month, was the worst showing since 1989 and 1990, when the fund underperformed by 2,500 basis points.

The current rout, blamed partly on having missed out on commodities' meteoric rise, has spurred redemptions of some US$3 billion, according to Fortune magazine.

Ms Gay says: 'No manager has been able to avoid underperforming. Being contrarian means to go against the crowd. The crowd now wants commodities and things that have been going up. But we believe with fairly strong evidence that a strategy of going against the crowd does lead to long-term returns.

'Right now the contrarian view would be to sell energy and buy financials. . . Whether we're at the bottom, we're not smart enough to know. We're trying to populate the portfolio with things that reflect a very very difficult environment. We're definitely going to see more writedowns, but the changes in management in some of the big firms, their willingness to take the pain now - we think that's very healthy and may help set up a recovery at a faster rate.'

She says the firm passed on commodities in 2003, which was a mistake. But she likens buying resources now to buying Internet stocks in 1998 and 1999. 'There is a long term fundamental case for commodities, but their prices reflect and carry substantial risk. Overall, buying cheap assets and getting out of expensive ones is the way to go.'

But here's some background. The Value Fund invests in US large cap equities. It is a concentrated portfolio - as at end-December, it had less than 50 stocks. Its holdings may defy what many believe to be value, with names like Amazon.com, Google, Yahoo and Exxon Mobil.

Says Ms Gay: 'What we try to do is to buy at the point of maximum pessimism which is where we believe we're at for financials today. And if we truly believe in the underlying value and the price falls further, it increases the future rate of return and we average down.'

The fund's largest allocations are to consumer discretionary stocks (23 per cent); IT (22 per cent) and financials (18 per cent). She adds: 'Maybe we are in a recession; if we are it's too late to be defensive. The time to be offensive is when there is uncertainty, which is the time when the greatest opportunity presents itself.'

One of the metrics the group's analysts scrutinise is a stock's return on invested capital. To be considered attractive, a company must generate earnings above its cost of capital. Otherwise, it is destroying value. After all, the market is a discounting mechanism; and the snapback can be swift. Those who stay out of the market in troubled times may find that they are unable to get back in.

Ms Gay cites the record of financial stocks, which also slumped in the early 1990s with the savings and loan crisis. 'If you bought Citi stock in 1991, at that same year the stock was up 74 per cent. The market was up 30 per cent, but JP Morgan rose 100 per cent. Over a five-year period from 1991, financial stocks were up five times as much as the market.

'The bottom line is that for long-term investors, buying at a point of great uncertainty - especially for financials, buying at book value or below - has proven historically to be a very good strategy.' US financial stocks are trading at five to seven times earnings, and the S&P 500 at about 18 times. Based on consensus estimates for next year's earnings, the latter's multiple falls to about 11 times.

She tells investors to keep their eyes on their objectives, which typically comprises a long-term savings goal spanning 10 or even 20 years. And tune out the noise. 'Aligning yourself with someone who has an investment process that is also long-term oriented and focused on value leads to good returns over a long period. But the price of that is the willingness to withstand the volatility.

'Sometimes a good process leads to a bad outcome. That doesn't mean you have done anything wrong. Sometimes a bad process leads to a good outcome, and that's what you often see in trends and momentum. But over a long period of time a good process does lead to a good outcome.'

Bankruptcies sneak back despite good times

Situation could worsen if economy slows and people start losing their jobs

By SIOW LI SEN


(SINGAPORE) Despite full employment and robust economic growth, the number of people facing financial ruin has begun to rise.

After falling from a high in 2004, the number of bankruptcy petitions and orders has begun to flatten and the delinquency rate for credit card holders has started to go up.

Lawyers and those involved in bankruptcy counselling say new bankrupts tend to be younger and are mainly men. Also showing up are parents who acted as guarantors for their children.

While the upward trend is far from alarming as it springs from a very low base, the situation could turn bleaker if the economy slows down and some people lose their jobs.

'As far as I am aware, 99.9 per cent of the people made bankrupt are holding jobs; they complain that their salary is too low to pay (the debt) and that they have a family to feed,' said Aaron Chan, Advent Law director.

The economy expanded 7.5 per cent last year and the unemployment rate was 2.1 per cent - a 10-year low. The National Trades Union Congress (NTUC) said retrenchments hit a 14-year-low, while unionised firms paid out the fattest bonuses in 18 years.

Yet people seem to be living beyond their means.

'When the country is doing well, there's a feel-good factor and people just want to spend,' said Mr Chan, who has been a banking litigation lawyer for some 15 years.

He said the weekly list which comes out for bankruptcy hearings includes professionals such as lawyers and doctors.

But these professionals usually pay up at this stage as they would not be allowed to practise if they were made bankrupt, Mr Chan said.

Creditors can petition for a person to be made bankrupt once the debt exceeds $10,000.

Leong Sze Hian, president of the Society of Financial Service Professionals, volunteers at the Official Assignee's office. He said the number of bankrupts could be even higher as creditors are holding back.

In January this year, there were 292 petitions for bankruptcy and 215 bankruptcy orders were passed. In 2007, the average monthly bankruptcy petitions stood at 268 and the orders at 230, according to the Insolvency & Public Trustee's Office.

In the works is a debt repayment scheme to help debtors avoid bankruptcy.

Since he began counselling debtors two years ago, Mr Leong said he noticed that a number of new bankrupts seem younger, and are overwhelmingly men.

Bankrupts include those who have problems paying rent for their HDB shops as well as those who cannot pay the bank loans for their HDB homes.

In addition, quite a few are parents who acted as guarantors for the unsecured credit taken out by their children, Mr Leong said.

There was also one case of a man who did not own a car but was bankrupted for his certificate of entitlement (COE) bid.

He had bid $8,000 for the COE but found his application for a car loan rejected by a bank, said Mr Leong. With fees and charges, his debt snowballed to over $10,000, he said.

Credit Bureau (Singapore) Pte Ltd data shows that the number of delinquent credit card holders began rising steadily from July last year.

In December, there were 14,379 delinquent credit card holders representing a delinquency rate of 1.42 per cent against 11,346 or 1.16 per cent in July.

Said Credit Bureau general manager Mark Rowley: 'I agree that we are seeing some early signs that delinquency is trending upwards although arguably off a low base. The numbers over the next few months will be interesting.'

Credit Bureau's data also shows that a majority of those having payment problems are between 21 and 44 years old, and men make up almost 70 per cent.

Some 80 per cent have credit cards with at least two banks. In most cases, the delinquent owes less than $5,000.