Bill Miller Sees a 'V'

The Peter Lynch of the digital age thinks stocks have seen their lows, but he isn't scheduling any parades just yet.

Bill Miller, manager of the (LMVTX Quote - Cramer on LMVTX - Stock Picks)Legg Mason Value Trust fund, is about to become the only active fund manager to top the S&P 500 11 years running. At a Thursday press briefing he laid out his vision of how the next year will play out for investors. The good news: He believes that interest rates won't rise, paving the way for a sharp, "V-shaped" recovery in the economy and corporate profits. The bad news: He thinks today's steep valuations will keep stock gains modest.

The upshot for investors is that one of Wall Street's savviest vets sees a light at the end of the tunnel. Though he doesn't expect a return to the late '90s glory days anytime soon, Miller believes tech, telecom and financial services stocks -- along with junk bonds -- will prosper in the new year.

Winston Churchill

"Our view is that we'll get a V-shaped recovery," Miller told a room full of reporters over lunch in midtown Manhattan. "We've had a V-shaped decline in corporate profits and we believe they'll surprise to the upside in the second half of next year."

Given that outlook, he says stock prices bottomed on Sept. 21 and that "the path of least resistance will be higher." But Miller is also quick to dash hopes of a blowout market rally, given stocks' valuations.

"It's very unlikely we'll get multiple expansion from here next year," he said. His advice for investors trying to figure out what returns to expect is to simply add a stock's dividend to what you think its earnings growth will be over the next year. The conservative formula is borrowed from value legend John Neff and works out like this: A stock paying a 1% dividend and growing its earnings by 6% might see its shares rise by 7% or so, assuming it's not trading at a sky-high valuation already.

Why You Care

While just about every fund company trots out road-weary fund managers at this time of year, there's good reason to pay attention to Miller's musings. Of all the thousands of stock-fund managers out there, he's the only one to compile such a consistent index-beating streak. His Value Trust fund averages a 19.4% annualized gain over 10 years, beating the S&P 500 by more than 5 percentage points and topping all value funds. He also runs the (LMOPX Quote - Cramer on LMOPX - Stock Picks)Legg Mason Opportunity fund, which is about to beat the index for the second straight year since its launch at the end of 1999.

The Streak Going on 11 years for Bill Miller

Source: Morningstar. Returns through Dec. 11.

Miller's distinct track record is the product of an equally distinct style. Unlike managers who focus on a stock's price tag or earnings growth, Miller fuses the so-called value and growth approaches by weighing valuation vs. cash flow growth two or three years down the road. That has led him to nontraditional picks that look pricey or dicey or both, like Amazon.com(AMZN Quote - Cramer on AMZN - Stock Picks), Lucent (LU Quote - Cramer on LU - Stock Picks) and Conseco (CNC Quote - Cramer on CNC - Stock Picks). His funds continue to hold all three stocks.

"We think value and growth is a distinction without a difference," he said.

Bookworm

In acting on his outlook, he says he put nearly all of his fund's cash to work in the week beginning Sept. 21, when stocks began trading again after the terrorist attacks on Sept. 11. As usual, he focused on unloved stocks where he saw the chance for the most upside given an economic recovery next year.

That led him to add to the ravaged telecom stocks he started buying in last year's third quarter, Lucent, Corning (GLW Quote - Cramer on GLW - Stock Picks) and Qwest (Q Quote - Cramer on Q - Stock Picks), which he believes is particularly cheap. Each has lost more than half of its value over the past 12 months. Despite a bounce in telecom stocks since Sept. 21, Miller is in the black only with his Lucent shares. That said, he still believes telecom equipment spending, which tumbled sharply over the past two years, will rise in 2003 and buoy these companies' earnings.

He's also sticking with his massive stake in online retailer Amazon.com. Between Miller's funds and those of his colleagues, Legg Mason is the largest holder of both Amazon's stock and its bonds. On Sept. 30, Legg Mason's funds owned 16% of the company, according to Lionshares.com, with half of its shares held in Miller's Value Trust fund.

A public proponent of the stock, which is down 53% over the past 12 months, Miller says the company will grow sales by 12% next year and should be cash-flow positive. Miller expects the company to pay down debt or buy its own shares with its cash after that, pointing to a dearth of Amazon bond sellers as an illustration of the company's rising stability.

Bonding Experience

In closing, Miller made the case for financial stocks and high-yield bonds being good performers next year.

He believes interest rates, which have fallen from 6.5% to less than 2% over the past year, won't head north next year. That should stimulate loan growth, while also boosting stock prices in general and financial stock prices in particular. On Sept. 30, his biggest financial-stock holdings in Value Trust were insurer UnitedHealth Group (UNH Quote - Cramer on UNH - Stock Picks) and bank Washington Mutual(WM Quote - Cramer on WM - Stock Picks). His financial faves in Opportunity Trust were insurer UnumProvident(UNM Quote - Cramer on UNM - Stock Picks) and troubled credit card concern Providian Financial(PVN Quote - Cramer on PVN - Stock Picks).

The high-yield bond market has sputtered for nearly four years, most recently due to the telecom sector's collapse. But over the next year Miller sees room for recovery as survivors pay off their debt. He's owned bonds from Amazon, Level 3 Communications and Exodus Communications in the Opportunity fund.

Throughout his presentation, Miller reminded reporters that he's had plenty of misses, using the now-bankrupt Enron as a recent example. Then again, he can still point to his streak, one that even Peter Lynch never equaled.