Bill Miller 3rd Quarter Market Commentary (2001)
A month after the ghastly events of September 11, the outlines of its impact are becoming visible as the emotional shock slowly recedes. Nonessential economic activity effectively stopped as our attention was riveted by the event and its aftermath. An economy struggling to grow probably slipped into recession. If so, it will be the first time in 10 years we have experienced what once was a regular feature of the economic landscape. Prior to the long prosperity and ensuing bull market that began amidst the gloom of August 1982, recessions used to arrive about every four years or so. Their relative rarity and the lack of experience most investors have in navigating them have combined, I think, to produce an over-reaction to the news flow emanating from economic weakness.
A market that we believed was bottoming, prior to September 11, sank sharply when trading resumed, falling over 14% in the week ending September 21. The week's decline was the second worst this century, eclipsed only by one of almost 16% during the Great Depression. The major indices hit levels not seen since the autumn of 1998 during the panic surrounding the collapse of Long Term Capital Management.
We believe that although one consequence of the terrorist attacks was to deepen and prolong a profits decline, another was to catalyze a bottom in the stock market. Markets bottom when things appear bleakest. The headline in The New York Times on Thursday, October 4, "Only Certainty to Economist is Dire Outlook," reminds me of the famous "Dark Days on Wall Street" headline the Sunday before the greatest bull market of the century got underway.
The most important investment question is always, "What is discounted?" It is only when what happens is different from what is expected that prices undergo significant change. I think the poor economic and profits outlook was fully captured by the declines of the week ending September 21, and that the low that day is likely to be the low for this bear cycle. Not only has the broad market action since then been positive, but the reaction of individual stocks to earnings announcements is evidence that late in September the market had discounted results worse than those likely to be reported. The strongest companies have already recovered to levels higher than they were trading before the attacks. Some significant technology companies have been reporting in line with consensus estimates, and their shares have rallied sharply, again indicating that the market's expectations were for even worse results than consensus estimates.
The clear negative economic implications of the attacks have also galvanized policymakers and resulted in a strong fiscal and monetary response. Stimulus packages have already been approved for over $60 billion of federal spending, and additional tax cuts appear imminent. The Fed has cut rates 100 basis points since September 11, bringing short rates to their lowest levels in almost 40 years. I believe the combination of these actions and those to come set the stage for a solid recovery no later than the second half of next year. With the Producer Price Index falling relative to the Consumer Price Index, and with energy prices falling, inflation looks set to decline to somewhere between 1% and 1.5% over the next year.
By the second half of 2002 the economy should be growing, inflation should be falling, earnings should be rising, and interest rates will likely be at or below today’s levels. With share prices having already declined almost 20% on top of last year's 9% drop, and hovering at levels not seen since the lows of 1998, we believe investors can be bullish, and can be fully invested in equities.
I am aware that many experienced investors and strategists have advocated caution in the aftermath of the terrorist attacks, noting correctly that we have never seen anything like this before, that confidence has been severely shaken and without it the economy will remain weak, that there are no guarantees that the fiscal and monetary stimulus packages will work, and that this was a different kind of economic difficulty we were in, one driven by poor business fixed investment, and thus one not as easily susceptible to traditional remedies such as rate cuts.
I agree with all of the premises, but disagree with the conclusion that investment caution is the proper posture. (This is inductive, not deductive reasoning.) In my opinion, caution is called for when share prices are high, profits are peaking, interest rates are rising, inflation is moving up, and stocks are at all-time highs and are overpriced according to intellectually respectable valuation models. That was the case in March of 2000. That was when caution was appropriate.
When profits and the economy are bottoming, when interest rates and inflation are falling, when volatility and pessimism are high, when share prices are at multi-year lows and valuation models indicate stocks are undervalued, then being bullish, not cautious, may be the proper investment posture.
- Bill Miller
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