Bill Miller Sees Light at the End of the Tunnel

The most respected pro in the fund world thinks stock prices have bottomed and is buying stocks most of us wouldn't touch with rubber gloves.

Bill Miller, the only mutual fund manager to beat the S&P 500 in each of the past 10 years, says sluggish corporate earnings and the economy should revive in the second half of next year. In light of that sunny scenario, laid out in a report to shareholders of his $9 billion Legg Mason (LMVTX)Value and $1.3 billion (LMOPX)Opportunity funds filed with regulators Thursday, he listed a roster of ravaged shares that he added to the funds last quarter.

The list includes sagging telecom shops such as Lucent(LU), Qwest (Q) and Comverse Technology(CMVT), as well as the tattered credit card concern Providian(PVN). All are down more than 75% over the past year.

The upshot: Miller, who by dint of his benchmark-beating streak is acclaimed as today's Peter Lynch, thinks stock investors' pain is coming to an end. He believes that the biggest gains will be made by those willing to pick seemingly sour fruit from the market's shakiest limbs.

Benchmarking

Miller's moves are closely watched because of his track record. His streak is alive, if narrowly -- the fund's 13.5% fall so far this year tops the S&P 500 by about a percentage point. He's not infallible; the fund trails 96% of its big-cap value funds over the past 12 months. But his streak earned him Morningstar's Manager of the Decade honor for the 1990s.

A value manager who focuses more on a company's future cash flows than on traditional metrics such as price-to-earnings multiples, Miller built a reputation for picking winners such as the former America Online, now part of AOL Time Warner (AOL), when its success was far from obvious. More recently, that approach has led him to shaky online retailer Amazon.com (AOL).

The root of Miller's optimism lies in stocks' fall after last month's terrorist attacks and the government's steep interest rate cuts. His thesis is that stocks are priced for the current economic recession, and that lower rates will pave the way for higher corporate earnings, which should push stock prices higher.

"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," Miller writes. "With share prices having already declined almost 20% on top of last year's 9% drop, and hovering at levels not seen since 1998, we believe the only appropriate posture for the investor is to be bullish, and to be fully invested in equities."

Bill's Resume
Returns	(LMVTX)Legg Mason Value Trust	S&P 500
1-Year	-20.5%	-21.2%
5-Year	16.9	10.5
10-Year	17.8	12.7
Source: Morningstar. Returns through Nov. 7.

What did he buy last quarter?

He continued his controversial foray into the trounced telecom sector, where a dearth of demand and a glut of debt have crushed profits and investor optimism. Miller didn't detail the rationale behind his picks, other than noting that he believes they're undervalued and positioned to rise with the economy. In the past he's projected a rise in demand for telecom equipment in 2003, illustrating why he bought shares of Corning(GLW) and Tellabs(TLAB) in the second quarter. He added to each in the third quarter as the stocks fell 47% and 49%.

He sold the Value Trust fund's position in Level 3 Communications(LVLT) to his Opportunity Trust fund. Two troubled financial stocks are among the new names in that fund: insurer Conseco(CNC) and credit card concern Providian. Both are debt-ridden businesses, struggling to meet their obligations in a tough economy. The stocks are down 50% and 95%, respectively, over the past 12 months.

Here's Why

Miller doesn't detail what prompted his interest in these two unloved financials, but Lisa Rapuano added them to her (LMNSX)Special Investment Trust fund and explains why.

"While we believe that the credit card business has become more competitive and the Providian customer -- who tends to be lower income -- is stretched financially," she writes to shareholders, "we think that the price of Providian fully reflects this deterioration at what we believe to be only five to six times a conservative earnings forecast."

As for Conseco, she says former GE Capital chief Gary Wendt has "the company focused on the right task -- rationalizing the balance sheet by paying down debt."

Miller added an energy stock to each fund. Independent power producer AES(AES) was added to Value Trust, while oil and natural gas well operator Devon Energy(DVN) is a new face in the Opportunity fund.

Stocks cut from the funds' portfolios include manufacturer Danaher(DHR), Ames Department Stores(AMESQ), Tupperware(TUP), Storage Technology (STK) and Exodus Communications(EXDS), though the Opportunity fund still held Exodus debt on Sept. 30.

He didn't buy or sell a share of perhaps his most intriguing pick, Amazon.com, which is down 33% over the past 90 days.

The bottom line for investors is that Miller sees better days ahead. But we should all keep in mind that not all of his picks are necessarily on the money, and value managers are often early.

A Cheat Sheet Here are Miller's third-quarter moves in his two funds
Buys
Stock	Percentage of Fund Assets	1-Year Return
Level 3 Communications (LVLT:Nasdaq)*	5%	-88.2%
Providian Financial (PVN:NYSE)	3.4	-94.5
Conseco (CNC:NYSE)	2.5	-49.5
Qwest Communications (Q:NYSE)	2.2	-72.9
Devon Energy (DVN:NYSE)	2	-27.2
Lucent Technologies (LU:NYSE)	1.2	-70.7
Comverse Technology (CMVT:Nasdaq)	1.1	-81.1
AES (AES:NYSE)	1.1	-79.1
Sells
Stock	Percentage of Fund Assets on June 30	1-Year Return
Bank of America (BAC:NYSE)	1.4%	32.5%
Level 3 Communications (LVLT:Nasdaq)	0.7	-88.2
Tupperware (TUP:NYSE)	0.7	24.6
Danaher (DHR:NYSE)	0.6	-6.2
Storage Technology (STK:NYSE)	0.5	84.8
Telefonos de Mexico (TFONY:Nasdaq)	0.5	11.6
WestPoint Stevens (WXS:NYSE)	0.4	-65.9
Exodus Communications (EXDS:Nasdaq)	0.3	-99
Phoenix Companies (PNX:NYSE)	0.3	-
Ames Department Stores (AMESQ:Nasdaq)	0.1	-
Sources: Legg Mason and Morningstar. *The Legg Mason Value fund's Level 3 position was sold to the smaller Legg Mason Opportunity fund.

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