Miller's Crossing: Legg Mason's Streak Holder Goes Back to Amazon

The fund world's battered heavyweight champ is betting that financial stocks, tech stocks and decked Net book peddler Amazon.com (AMZN) will help him keep his belt this year.

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After one of his worst years in recent memory, Legg Mason's Bill Miller is still the only fund manager to beat the S&P 500 in each of the last 10 years. The Baltimore-based shop filed year-end shareholder reports for his large-cap (LMVTX)Value Trust fund with regulators on Wednesday. The upshot: Miller believes the Federal Reserve's attempts to goose the economy will send an odd couple north in 2001, sleepy finanicials and life-of-the-party tech stocks. And according to a similar report for the mid-cap (LMASX)Special Investment fund, of which Miller handed the reins to co-manager Lisa Rapuano at year-end, in the fourth quarter the pair rebuilt the position in Amazon.com's sagging stock they'd dumped in the second quarter.

Yes, shareholder reports are dated, dry and drab. And Miller's Value Trust fund lost 7.1% last year, trailing most value funds and narrowly edging out the S&P 500. But his unique approach to value investing and his S&P-beating streak have earned comparisons with Andy Warhol look-alike and Fidelity guru turned pitch man Peter Lynch. He's also been right a lot more than he's been wrong, so let's hear him out, shall we?

The Streak Miller lagged his average peer in 1993 and 2000, but he's the only fund manager to beat the S&P 500 in each of the last 10 years
	Legg Mason Value	S&P 500
1991	34.7%	30.5%
1992	11.4	7.6
1993	11.3	10.1
1994	1.4	1.3
1995	40.8	37.5
1996	38.4	23
1997	37.1	33.4
1998	48	28.6
1999	26.7	21
2000	-7.1	-9.1
YTD	6.8	1.7
Source: Morningstar. Returns through Feb. 7.

Miller, who worked as a military intelligence officer and pursued a Ph.D. in philosophy before running money, isn't a traditional value manager. Most value pros, essentially Wall Street's bargain hunters, stick to cheap stocks with steady if unspectacular earnings growth in sectors like financials. He, on the other hand, chides his colleagues for their "unwillingness to try to analyze" pricier and faster-growing fare in the tech sector in his letter to Value Trust shareholders. He's publicly beaten the drum for pricey, mercurial types like Net media behemoth AOL Time Warner(AOL), Amazon.com and PC maker Gateway(GTW), all of which were in the Value Trust fund at the end of last year and all of which lost more than half their value in 2000.

Miller sees a Fed-driven sea change between last year and this one, as the Fed cuts rates to goose the economy.

"As a general rule, when the Federal Reserve is trying to encourage growth by lowering rates, it's time to play offense in the market. When they are trying to slow growth by raising rates, emphasizing defenses is the right strategy. Last year, defensive, lower-risk names were the winners: REITs, utilities, drugs, health care" and consumer cyclicals, he writes. "This year we believe that most of last year's winners should be avoided, with the exception of financials."

And so far this year his crystal ball is looking pretty accurate. Stocks like Waste Management(WMI) and HMO UnitedHealth(UNH) that grew into big weightings by the end of last year are in the red since Jan. 1.

A Top Dog's Top-Five
Legg Mason Value			Legg Mason Special Investment
Stock	% of Fund's Assets	YTD Return	Stock and Weighting	% of Fund's Assets	YTD Return
Waste Management	6.8	-10.2%	Waste Management	6.8	-10.2%
UnitedHealth	6.2	0.8	Acxiom	6.4	-15.7
Washington Mutual	5.5	-3.6	WPP Group	4.4	-1.0
America Online	5.2	38.5	Lexmark	4.1	23.5
MGIC Investment	4.4	-15.1	CareMark	4	5.1
Source: Morningstar. Returns through Feb. 7.

He thinks tech stocks, most of which were torched last year as the Nasdaq Composite fell nearly 40%, will come along for the ride.

"Technology and financial stocks have moved in opposite directions over the past 1 1/2 years since the Fed started [raising rates] in the summer of 1999. We believe that divergence will end this year," he writes to Value Trust shareholders. "The 50 basis point cut in short-term rates on Jan. 3 was the first time the Fed has moved [rates] between meetings since the global financial panic in the fall of 1998. From that rate cut until the tightening began, both groups outperformed. We think they will again."

Falling rates typically help financial stocks like banks, insurers and brokerages because, among other things, they can spur loan growth, decrease the interest paid on deposits and boost the stock market. In the report, he says his favorite financials are savings and loan bank Washington Mutual(WMI) and mortgage insurer MGIC Investment(MTG).

As for tech, he feels good about the bruised PC shops he's holding such as Gateway, Dell(DELL) and IBM(IBM), thinking they're positioned for a strong rebound if economic growth and demand for their products picks up.

"Technology shares, especially those whose current valuations reflect great skepticism about growth, such as PC makers, should also do well as the market begins to discount the resumptions of [economic] growth in the second half of this year and on into 2002," he writes, later cautioning that today's priciest tech stocks are probably still in for a rough ride.

Miller put his investors' money where his mouth is. Last year he took a beating for having a heavier tech taste than other value managers, and in the fourth quarter he didn't cut out any tech stocks. In fact, he didn't add any new names and only liquidated one position, mortgage shop Freddie Mac(FRE).

In the fourth quarter he raised the fund's share balances in Dell, Gateway and IBM. He did the same with Amazon.com, a controversial Miller fave. During the fourth quarter, the Value Trust fund's Amazon.com share balance rose from 12 million to 19.2 million according to the fund's shareholder reports. Because the stock fell more than 40% in the fourth quarter, its weighting in the fund actually dropped from 3.5% to 2.5% in the fourth quarter, despite buying more shares.

The Special Investment fund bought 1.5 million Amazon shares in the fourth quarter, which added up to a 1% weighting in the fund at year-end, according to its shareholder report. Miller and Rapuano dumped the stock in last year's second quarter, choosing a more defensive position in the company's convertible bonds. The bonds, which were nearly 2% of the fund at year-end, fell 44% in the fourth quarter, according to the fund's report.

With the unprofitable online bookseller's stock more than 80% off its 52-week high, most observers still see it as a growth stock given its speculative nature. In her letter to Special Investment fund shareholders, Rapuano lays out her and Miller's case for the company.

"We already owned [Amazon.com's] convertible bonds, and when the common stock's price plummeted into the 20s (and then the teens,) we believed the risk/reward proposition of the stock was better than the bonds," she writes. "Amazon is a highly controversial company and stock, and the level of fear and misinformation surrounding it rivals anything we have ever seen. We believe we have a solid understanding of their business model and potential profitability, and that the market's negative psychology has driven the stock to a valuation that is very compelling."

If few value purists don't agree with this move, at least they'll probably agree that it's a contrarian play. About half of the growth fund managers who owned the once hot-stock cut their losses last year. For the record, Miller and Rapuano, who has worked with Miller for some six years, have a solid record with the Special Investment fund, which beats its average peer and the S&P 500 over the last 10 years.

Special Too
	Legg Mason Special Investment	S&P 500
1-Year Return	-3.9%	-4%
5-Year Annualized Return	18.2	17.7
10-Year Annualized Return	17.5	16.8
Source: Morningstar. Returns through Feb. 7.

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