February 5, 2014

CONSUELO MACK: This week on WealthTrack, part two of our exclusive interview with two financial champions. After last year’s winning performance, what are they doing for an encore in 2014? Wall Street’s recognized king of economists Ed Hyman joins investment superstar Bill Miller to discuss their game plan next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. This week we are continuing our conversation with two Wall Street legends. Ed Hyman, chairman of independent institutional research and money management firm, ISI Group, joins us exclusively every year with his forecasts for the New Year. Ed has been voted the number one economist by institutional investors for an unprecedented 34 years running.

He is joined by another regular WealthTrack guest, who has frequently appeared exclusively with us as well. Great Investor Bill Miller is known for his record setting 15 year winning streak with his former fund, Legg Mason Value Trust, which won him numerous accolades over the years. But what is less well known is his performance with his much smaller Legg Mason Opportunity Trust Fund which he launched in 1999. Opportunity Trust just completed a spectacular two year run, up 67% last year following a 40% gain in 2012, placing it in the number two and number one slot respectively.

Last week we talked with both Miller and Hyman about their exceptional performance last year, Ed as a forecaster and Bill as an investor and what trends they were tracking that determined their forecasts and strategies. This week we are taking a deeper dive into the forces that will shape economic and market behavior this year. I began by asking them each to identify what their analysis is telling them will be the biggest surprise of 2014.

ED HYMAN:  I think the biggest surprise is you have another big move in the stock market, but I think you’re not going to have a war in Washington. You’re going to have a synchronized global expansion. No one’s going to be great, but everybody will be positive- Europe, Japan, the United States. So I think it’ll just be another pretty good year.

CONSUELO MACK:  Bill, what do you think is going to be the biggest… you know, he said he thinks we’re going to have a good year in the market especially, so what do you think the biggest surprise could be in 2014 in the markets?

BILL MILLER: Well, for a contrarian like myself, the biggest surprise will be the bullish consensus will be right and that the consensus for about a 10 % move in the stock market, but I think the surprise would be if the stock market could be up 30% again next year instead of just eight to ten in line with earnings, so more multiple expansion.

CONSUELO MACK:  So as a matter of fact, because you had told me at one point that you think it’s possible that we could be in the midst of the greatest bull market ever? I mean, greater than the 1982, 1999 bull market? I mean, is that…?

BILL MILLER: Yeah, my point isn’t that I believe that that’s something that you can expect, but that from the 660 level on the S&P in March of ’09, it was among the lowest level after the worst financial crisis since the Depression, and coming out of that, what we’ve had is steady growth, a market which has done extremely well. Multiples are still low by historic standards in terms of really expensive markets, and if we have very low inflation and very low interest rates for years to come with the technological and energy booms that Ed has talked about, you could easily have a market that could trade at 25 times earnings and earnings go up. You know, there hasn’t been a recession in Australia in 25 years, so if earnings were to grow six percent a year for 10 years, that’ll close to double earnings, and the multiple could go up another 50%. You could have a really, really extraordinary bull market over the next 10 years or so. That’s not something that we’re positioned for and saying we expect it, but it is something in the scenarios that we’re looking at that’s certainly possible.

CONSUELO MACK:  So Ed, number one, what do you think about that scenario, that possibility?

ED HYMAN:  I think as we’ve talked about, the people that are pundits or strategists that are quoted in the news or on television, they have rosy forecasts, but investors aren’t there, and so there’s a dichotomy there. So I think the market could keep doing better, and I don’t know how you got Bill and myself on here at the same time. It’s like you’ve rigged the discussion, but I happen to agree with Bill completely, that you could, you know, the idea of having 25 times P/Es. The last time you had high P/Es was at the end of the 1990s. P/Es were 30, and they were crazy. They’re not crazy now, but if you start to probe the glass half full side of the conversation, you can get some pretty optimistic views coming out from the energy play, the technology play. These things could come into play and give you a much better stock market and a very decent economy, maybe even … see, I say decent economy. I can’t even get myself into thinking it’ll be a good economy, but maybe it will be a good economy at some point.

CONSUELO MACK:  Because people are talking about the Goldilocks economy again where you’ve got, you know, low inflation, sustainable growth. That was a pretty good period of time for Americans and for the stock market, so is that where we are now in this?

ED HYMAN:  Well, because I spend so much time talking to people, people are deeply concerned.


ED HYMAN:  For sure. They’re concerned about the political situation in the United States, the income disparities, the elevated levels of profit margins, the end game on quantitative easing, what’s going to happen in Europe. Is it really fixed?  Of course not, and there’s China over there with lack of transparency.  So there’s plenty but by the time those are all resolved, if they are resolved, then the market is where Bill’s saying it’s going to be.

CONSUELO MACK:  So what are you worried about, and we haven’t even talked in part one and now part two of our conversation about what’s going on overseas either, but what are you worried about?

ED HYMAN:  So I think there are two worries. One is that rates spike up to five percent in some sort of boom. Bond yields are now three and a half or…

CONSUELO MACK:  For the 10-year.

BILL MILLER: The 10, they’re three, just over three.

CONSUELO MACK:  Three, right.

ED HYMAN:  So they go to five, and the other would be that oil spikes to 150 or 200 dollars.

CONSUELO MACK:  So what are the odds of either of those happening?

ED HYMAN:  In the case of bond yields going up, I’d say one in three.

CONSUELO MACK:  Within a year.

ED HYMAN:  Yeah, and energy, it’s just a powder keg. It depends on what happens in the Middle East. Those are the two things that I worry about the most.

CONSUELO MACK:  Right.  So Bill, you’re a stock guy, and so give me a couple of stories that you’re really excited about in the market. I mean, what are a couple of the companies that you’re invested in and tell us why you’re enthusiastic about them.

BILL MILLER: Well, our stuff falls into a variety of different buckets. The one that I mentioned earlier from the previous show was housing, so last year we did about 900,000 housing starts.  The equilibrium is about 1.4 million from the decade of 2010 to 2020, so we still printed a 500,000 shortage last year of potential housing units, so we’re going to have a housing cycle which is going to be very long and extended by historic standards. We’re only a couple years into it, and every long cycle, whether it be the emerging markets boom or the energy boom or the tech boom from the early 1990s, the stocks don’t get all their gains in year one and then just die the rest of the time. They usually have a big year one which the housing stocks did in 2012. Then they get ahead of themselves. They consolidate which they did in 2013, and then they get going again which we think is going to happen in 2014.

So we sold a chunk of our housing stocks direct to builders, Pulte, Lennar, KB, those kinds of things in the spring, and we began buying them back into the spike in rates that happened over the summer, but right now we still think those are among the best places to be. So Pulte’s around 19 or 20. Lennar is in the high 30s. KB is around 18. Taylor Morrison is 21. Pulte back at the peak of the housing cycle was 50. Lennar was 80.  So those things still have a long way to go, and we think that housing starts will get back to the level that they did during the housing bubble but that that won’t be a bubble at that time. That will still be just catching up. So we think there’s a long way to go in the housing stocks, just one example.

CONSUELO MACK:  Okay, and I’ve got to ask you about Apple because, of course, I remember you telling me that Apple was one of the misunderstood stories ever at one point.  So what’s your take on Apple right now?

BILL MILLER: Yeah, I think I said when Apple was around 400 it was one of the greatest no-brainers I had ever seen, and now it’s only the second and third greatest no-brainer I’ve ever seen. It’s around 550 right now. But yeah, so with Apple everybody’s obsessed with what’s Apple’s next new hot product going to be? Are margins going to come down? All this again, I’ll say, the waves and the not current with Apple.

And so what you have with Apple is a company which is among the cheapest companies in the market. It’s the most profitable company in the world. It’s got the biggest buyback in the history of the world. It trades at a huge discount to the market with returns on equity and capital which are among the best in the overall market. It’s got an impregnable balance sheet. It’s got a dividend yield that’s pushing three percent, and they’ll raise the dividend significantly we think in the spring or early summer, so it’s one of these things where it’s like, what’s not to like with this thing if you actually care about valuation? Now, if what you care about is the next story and the next item on the tape, and are they going to beat the quarter, actually the answer is, yes, they’re probably going to beat the quarter.

In fact, we’ve got e-mail from like Gazelle which is a site where you turn in cell phones and things like that to trade them in, and they said that they were behind because the trade-ins on Apple products were so high that they were running late, in other words, because the demand for the new Apple products, that’s why people were trading in their existing Apple products. But can you think of another company where, when they introduced the iPhone 5S, the line out the door at the Regent Street store in London was over a mile long waiting to get that. During that same time in Tokyo, there was a typhoon, and people wouldn’t leave the line outside the Apple store, so they had to take them off the streets and put them in the store until the typhoon passed, because they wouldn’t leave. So I mean, I think it’s an extraordinary… we think it’s basically a consumer brand that’s masquerading as a technology company, and so while people are focused on things like Nokia’s collapse, Blackberry’s collapse, what I think they’re not focusing on is this is like Chanel or it’s like Hermes or something like that.

CONSUELO MACK:  Kind of a must-have aspirational product.

BILL MILLER: Yeah, I mean, if Nike can trade at 22 times earnings, it doesn’t seem to be odd if Apple could trade at how about 15 times instead of 11 times. So it’s our biggest position, it and Genworth are the two biggest positions in the portfolio.

CONSUELO MACK:  And why Genworth, and then I’m going to get back to Ed, but what’s the story with Genworth?

BILL MILLER: So I mentioned earlier in a previous program that last year you could buy companies that were so cheap that you could easily see them doubling or tripling. Genworth is one of the last of the Mohicans in that it doubled last year, but it still trades at less than half of tangible book value. It’s got a new CEO in there who’s revamping their long-term care business which has been a very poor business, but they’re the leader in that business. So we think with Genworth, which is around $16 today, we think that their return on equity is going to gradually improve to 10 to 12% over the next three to four years. That will easily get a trading at book value, and book value by that time will probably be 35 or 36, so we see, again, very little downside in the company because you have book value protection. You have great capital adequacy there. You’re probably going to get share buybacks beginning in the next six months to a year. So I think it’s a low risk double in the next three years.

CONSUELO MACK:  Ed, do you have any stock stories that you want to share with us from ISI Group?

ED HYMAN:  I’m going with Bill.

CONSUELO MACK:  You know, I want to ask you about the China story, because I know that ISI many years ago hired Don Straszheim who was a China expert, and you identified that. That was going to be a major force for better or worse in the world economy, in the world markets. So what’s your analysis now of China, which a lot of people are worried about?

ED HYMAN:  We’re pretty grumpy on China. The economy is doing well by any Western standard. It’s growing seven percent. The economy has doubled in the past seven years, so seven percent a day is the same as 14% seven years ago in terms of the basis effect on growth, but we’ve sort of moved on. There are three areas I wanted to mention to you. First, I mentioned last year I thought was a free pass on the U.S. market because of the Fed doing QE. This year, it’s Japan. The Japanese market’s up 50% last year, and the Bank of Japan is definitely going to increase their balance sheet a trillion dollars. The second space I like is a synchronized global economy as I mentioned last show, and I think Citibank is a way to play that, and the third space I like…

BILL MILLER: We have a big position in Citi, by the way.

CONSUELO MACK:  Oh, you do?  In the Opportunity Trust Fund?


ED HYMAN:  And I like a sister to Apple, but I like the technology sector, and I think Amazon is a very exciting play on that. So those are the three areas that I’m looking at right now.

CONSUELO MACK:  So let me dive a little bit deeper into each one of those. So let me ask you about China. When you say you’re grumpy on China, what does that mean?

ED HYMAN:  We’re just not sure if the transparency is there and what the leadership wants to do, and there’s been a transition in the leadership, and they’re trying to feel what their new priorities are, growth versus environmental issues, growth versus income disparities, growth versus getting the mix between consumption and investment changed around. So we’re just sort of waiting on those for now, and I’m more interested in the U.S. and in Japan and in the companies that benefit from a synchronized global expansion. China’s going to grow. Japan’s going to grow. U.S. is going to grow. Europe’s going to grow, and it’s been a while since you could look around the world and see that every place is going to be green, be a little bit of a plus.

CONSUELO MACK:  And forgive me for doing this, but I know that China has been such a focus of conversation and consternation. A couple of years ago only, people were talking about China as being the driver of global growth and that it was surpassing the U.S., and certainly the economy had surpassed Japan a couple of years ago in its GDP and contribution to world growth. So what’s China’s role now in global growth?

ED HYMAN:  As I mentioned, it’s doubled in the past seven years. So when it grows seven percent, it’s like growing 14% back then in terms of the amount of iron ore it uses or energy it uses or cotton it uses. So it’s still a major force, but we’re waiting for this sort of a clarity in terms of what their goals are, and I also say the stock market acts like death, and so I’m just sort of waiting until it looks a little clearer. In contrast, Japan looks like a very clear shot.

CONSUELO MACK:  So let’s… you said you get a free pass with Japan, so what kind of a free pass are we getting?

ED HYMAN:  They’re going to increase their balance sheet by a trillion dollars, about what we did last year.

CONSUELO MACK:  The Bank of Japan.

ED HYMAN:  The Bank of Japan, but their stock market is a quarter the size of the U.S., so they’re really putting it on, and the market’s acting pretty well, and the yen is weakening. Like today, it was weaker which means it’s more attractive to buy their goods, so that looks like a good shot.

CONSUELO MACK:  So from an investment point of view, I mean, should I be buying a Japan fund?



ED HYMAN:  And you have to short the yen and long the stock market.

CONSUELO MACK:  And you think that the Abe transformation has legs, and that this is not just a short-term phenomenon.

ED HYMAN:  Well, I’m always like Bill here. You’re always looking for the easier shot, and the easy shot is that the Bank of Japan will give Abe the financial cover to try and get these third arrow initiatives in place, and if the economy weakens in the spring when they increase the VAT, then the Bank of Japan will accelerate their buying. It’s a little bit like the government shutdown here in ’13 when the economy looked like it might weaken. The Fed kept doing QE, so I’m really focused more on what the Bank of Japan is doing and its impact on the stock market, but…

CONSUELO MACK:  I see.  Just as you said, the Fed was your partner last year.

ED HYMAN:  And then I’ll see how the Abe thing works out. I’ve been to Tokyo 41 times, so I’ll show you my mileage account, so I know it pretty well, not knowing much about it, but they’re pretty excited, and they have the Olympics coming up, but in the meantime you have a free pass.

CONSUELO MACK:  So this concept of a synchronized global expansion, you know, we’ve talked about the fact that you’re seeing some real issues in peripheral Europe, in southern Europe for instance. We see labor unrest in France. I mean, I’m looking at what the inflation… the emerging markets, number one, have sold off, have really significantly. I’m looking at inflation that you covered ISI in Brazil and Indonesia.  So talk to me about this synchronized global expansion, because I’m seeing pockets that I’m not seeing the expansion.

ED HYMAN:  Well, Europe will probably grow less than one percent, but a year ago it was possibly going to collapse.

CONSUELO MACK:  Right, right. I see. So there’s the difference.

ED HYMAN:  And a year ago or a little more than a year ago, China was having a hard landing, and Abe was not elected. So in that sense it’s not a mature concept, but I can see that you now have the most synchronized growth we’ve had in a long time.

CONSUELO MACK:  So the improvement that you’re seeing is really what’s so striking.

ED HYMAN:  And no place is booming. We might boom, but we’re not booming now, and Europe definitely isn’t booming. Japan isn’t booming, but everybody is in a better place than they were.

CONSUELO MACK:  Bill, one of the hallmarks of your approach that you’ve written about is that you look for where you’re seeing inefficiencies in the market that you’re taking advantage of that stem also from human behavior, I mean, from institutional investors, individual investors.  Where are you seeing the biggest inefficiencies in the market right now?

BILL MILLER: We touched on it earlier. The asset allocation of individuals and institutions is extraordinarily conservative this far into a bull market with a current economic situation and economic outlook being quite positive. So the lingering effects, the fear that was engendered and the fear of losses engendered by the 2008 collapse is still with us. Michael Goldstein, one of the better quantitative people or one of the best quantitative analysts out there said that the public is information-centric and volatility-phobic to a manic degree, meaning that they’re worried about the next news item that might cause whatever they own to go down a little bit, and I think that’s the biggest inefficiency in the market today. Ed and I were talking earlier. The hedge fund business back in the old days when we were younger was people like Mike Steinhardt and George Soros and Stan Druckenmiller, and their job was to make money, and now the job of the hedge fund is not to lose money, and the institutions want…

CONSUELO MACK:  Right, it’s to hedge.

BILL MILLER: Yeah, they want low volatility, and they don’t want to take much risk, so the hedge funds are, in an up 30% market, they’re up five or six or seven, and so I think that’s again a very important change in the way that institutions are behaving, individuals are behaving, and so I think it opens up an opportunity for people to actually try and make money. I mean, our fund was up 68% last year not because we did something wild and crazy. We were just right down the middle of the fairway looking at really cheap stocks. So I think that’s the thing which is unusual is that you can get, at least you could have got in the last couple of years really good results by doing nothing terribly outside of the consensus.

CONSUELO MACK:  What should we expect this year from the Legg Mason Opportunity Trust? And I’m thinking reversion to the mean. You’ve had what would be called a hot streak for two years now, so …

BILL MILLER: It’s a lucky streak. It’s a lucky streak for two years.

CONSUELO MACK:  Whatever it is, you know, aren’t you worried about people coming into the fund at the possible highs?

BILL MILLER: Well, the history of money management, there’s one thing that’s for sure is that people buy high and sell low, so that’s what they do, so the fact is we’re seeing inflows into the fund, but they’re modest. I mean, they’re 500,000, a million dollars a day, nothing like what they were back in the 2005, ’06, or back in the late 1990s.

CONSUELO MACK:  And that’s one of the inefficiencies that you’re seeing as well.  I need to ask you, One Investment for long-term diversified portfolio. Ed Hyman, what would you have us all own some of?

ED HYMAN:  Amazon.

CONSUELO MACK:  Amazon, and the reason is…

ED HYMAN:  I think this tech thing is really a big deal. There are two billion people on the Internet today, and in four years it’ll be four billion people globally, and I’m reading the book by Bezos about Bezos on Amazon right now, and I just got a feel.

BILL MILLER: It’s a great book, even though Jeff really doesn’t like that book.

ED HYMAN:  I can see why he doesn’t, too.  But I’m reading this book, and then the presents didn’t come at Christmas. This thing has really taken off.

CONSUELO MACK:  Okay, in one minute, Bill, what’s your One Investment for a long-term diversified portfolio?

BILL MILLER: Well, I wouldn’t do one. If I had to do one, I’d only do one anytime, but I’d say housing, financials and airlines would be three things I’d have in every portfolio. We talked about housing. Financials, I mean, Citibank trades below tangible book value, one of the great franchises in the world. Steeped in yield curve is good for banks. The regulatory environment, we kind of know what that is. The banks have started out the year strong. Airlines have consolidated. They had a great year last year. Delta was the leader, but United Airlines has the same rough revenues. We own Delta, United and American, but it has the same rough revenues as Delta does, but Delta’s got a 10 billion more market cap because United has 14,000 more employees and 500 more planes. They will get that rationalized over the next several years, so we think there’s a lot more money to be made in the airlines.

CONSUELO MACK:  All right, so we’re going to fly away on that note. So Bill Miller, so great to have you here from Legg Mason Opportunity Trust.

BILL MILLER: Thank you.

CONSUELO MACK:  Ed Hyman from ISI Group, thank you for your annual appearance on WealthTrack.

ED HYMAN:  My pleasure.

CONSUELO MACK:  Happy New Year to both of you.

BILL MILLER: Great, thank you.

CONSUELO MACK: At the close of every WealthTrack, we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is look for consistency, discipline, ceaseless effort and honesty from your investment professionals. Financial Thought Leaders and Great Investors like Ed Hyman and Bill Miller “eat, pray, love” investing, as the  bestselling book put it. Their passion for their craft, their endless research, analysis and effort and their willingness to admit when they are wrong separates them and other successful long term investors from the pack. You want those qualities working for you.

Next week we will talk to another Great Investor who has all of those characteristics. So much so that he spent several years convincing his boss, legendary small cap pioneer Chuck Royce, to allow him to launch a large cap fund in the small cap firm. Royce’s Charlie Dreifus will tell us why he is thinking large. In the meantime to see this week’s program and others again plus our exclusive web-only segments with this week’s guests, please go to wealthtrack.com and for those of you reaching out to us on Facebook and Twitter, we look forward to connecting with you. Have a great weekend and make the week ahead a profitable and a productive one.

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