Miller vs. Whitney: Bank stocks showdown
The returns on Legg Mason's Value Trust mutual fund depend on Bill Miller being right about bank stocks and Meredith Whitney being wrong.
By Michael Tsang
Bloomberg News
The returns on Legg Mason's Value Trust mutual fund depend on Bill Miller being right about bank stocks and Meredith Whitney being wrong.
Miller, who beat the Standard & Poor's 500 index for a record 15 straight years before stumbling in 2006, says financial companies are his favorite investment for the rest of the decade.
Whitney, the former Oppenheimer stock analyst who became one of Wall Street's first bears when credit markets started to freeze in 2007, said banks are "grossly overvalued" after government evaluations of their financial health.
The stakes are greater for Miller, who lost more money in the past three years than 99 percent of rival managers by owning Bear Stearns, Freddie Mac and American International Group, according to data compiled by Bloomberg and Morningstar.
Whitney proved prescient by telling her clients to avoid Citigroup, Wachovia and UBS, which lost at least two-thirds of their value last year.
"It could be Bill is right and the vast majority of banks will earn their way out of this," said William Stone, chief investment strategist at PNC Financial Services Group's wealth-management unit, which oversees $96 billion in Philadelphia.
"But if the economy takes another nose dive and the adverse feedback loop begins again with a vengeance, then maybe it's Meredith."
Miller declined to comment; Whitney didn't return phone calls or an e-mail message seeking comment.
Miller, a so-called value investor who seeks the cheapest companies relative to earnings or assets, posted the worst returns within his fund's category in the past three years, data compiled by research firm Morningstar show.
The fund lost 55.1 percent in 2008 after Miller underestimated the magnitude of the worst financial crisis since the Great Depression.
In April last year, a month after Bear Stearns collapsed and was taken over by JPMorgan Chase, he wrote in a letter to fund shareholders that "we have seen the bottom in financials."
The S&P 500 has tumbled 36 percent since then, with a measure of banks plummeting 53 percent.
He boosted his stake in Freddie Mac, once the second-largest U.S. mortgage-finance company, to 17.7 million shares from 5.9 million shares in the first half of 2008, Securities and Exchange Commission filings show.
Miller's holdings in AIG, once the world's biggest insurer, also increased to 9.68 million shares from 8.45 million shares at the end of 2007. Both companies were taken over by the government in September.
"He's made massive bets in institutions that were wiped off the face of the exchange," said Frederic Dickson, who helps oversee $20 billion as chief market strategist at D.A. Davidson in Lake Oswego, Ore.
This year, Miller's fund has gained 8.1 percent, putting him among the top 10 percent in his category, according to data compiled by Morningstar.
"Financials have the biggest potential to outperform," he said last week, naming his favorite picks as Wells Fargo, Capital One Financial, and American Express.
Miller's bets hinge on U.S. home prices stabilizing this year and an economy that performs better than projections from the Federal Reserve. The central bank said in January that gross domestic product will shrink by 0.5 percent to 1.3 percent in 2009. Miller projects U.S. equity markets will rise 20 to 30 percent in 2009.
More than 19 percent of the Value Trust was invested in financial stocks at the end of the first quarter, according to Legg Mason's Web site, greater than their 12.8 percent share of the S&P 500 now.
In the first three months of 2009, Miller bought about 3.77 million shares of Wells Fargo, the largest U.S. mortgage originator, and almost quadrupled his position in credit-card company Capital One, according to data compiled by Bloomberg and Legg Mason's Web site. Miller also increased his stake in American Express, the biggest U.S. credit-card company by purchases, by about 22 percent, the data show.
Since March 31, Wells Fargo has gained 70 percent. Capital One rose 96 percent, while American Express added 77 percent.
"When you get past the two-to-three-year horizon where they work through their problems, the valuations today are exceptionally cheap," said Scott Minerd, chief investment officer at Guggenheim Partners Asset Management, which manages $30 billion. "Survival for banks is not a question anymore."
While Miller is beating the S&P 500 for the year, anyone who bought shares of the Value Trust between July 1997 and October 2008 and never sold them has lost money, according to monthly data compiled by Bloomberg and Morningstar. During that period, the index returned more than 20 percent, including dividends. The fund has given up about $17.7 billion of its assets under management since May 2007, or 82 percent.
Whitney says bank stocks will decline because the gains aren't matched by improvements in their businesses.
"The underlying core earnings power of these banks is negligible," Whitney, who quit Oppenheimer in February to start her own firm, Meredith Whitney Advisory Group in New York, said in a May 11 interview with CNBC.
U.S. banks will likely return to "negative earnings" after posting first-quarter profits, she said last month. The largest companies must sell assets after expanding at an unsustainable pace in the past two decades.
Home prices are likely to be down 50 percent from peak levels, Whitney said. A recovery in consumer spending, which accounts for 70 percent of the U.S. economy, may be undermined as banks and card companies slash $2.7 trillion in credit lines by the end of 2010, she wrote in a report e-mailed Tuesday.
That may dampen revenue at lenders such as Capital One and American Express. She's sticking by her call even as financials lead the S&P 500's 31 percent rally from a 12-year low in March.
Whitney, who is married to John "Bradshaw" Layfield, a former World Wrestling Entertainment champion, graduated with honors from Brown University, and began her career as a research analyst in 1993.
Whitney predicted in October 2007 that Citigroup would have to cut its dividend, which the bank did in January 2008, by 41 percent. Her recommendation triggered what was at the time the steepest tumble in Citigroup shares since September 2002.
In December 2007, she lowered her rating on UBS because earnings estimates for the largest Swiss bank by assets were "unrealistic." Last year, the Zurich-based lender reported a per-share loss of 6.92 Swiss francs, 25 percent worse than analysts anticipated. The U.S. shares fell 65 percent, while the local stock declined 68 percent in 2008.
Dickson says Whitney's accuracy has made him more skeptical the gain in financial stocks is sustainable.
"I'm pretty much in Meredith Whitney's camp on this one," Dickson said. "She's been dead-on in identifying the problems in the banks. I'm hoping for the economy's sake and banking's sake that I'm wrong."
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