if the clients know they have always a better chance in blackjack, trump wouldnt file a bankruptcy again !!!!
please someone explain that dump sucker low p/e doesnt mean a good value... all of his holdings are going to toilet as the real problem is not the stock market but their declining margins
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Portfolio Manager Commentary
Dear Shareholder,
The credit crisis that I wrote about last quarter culminated this
quarter in the collapse and rescue of Bear Stearns, an event that I believe
(though no one knows) ended the panic phase of the credit cycle. The
economic consequences of curtailed credit, increased risk aversion,
deleveraging, lost jobs, falling house prices, and negative equity returns
remain, and are likely to take some time to play out. All of those issues
have been front-page news for some time, and I believe they are well
discounted by the market, which is why stocks have risen since Bear's
collapse.
After an awful quarter in which our fund dropped 19.7% compared to a
loss of 9.4% for the benchmark S&P 500, we have begun to perform better. In
the first few weeks of the quarter, the S&P 500 is up just over 5% and we
are up a bit more. Our lead widens if you look back to the Monday the Bear
Stearns rescue by JPMorgan was announced. While neither I nor anyone else
knows if our period of underperformance is over, it ought to be, if
valuation begins to matter more and momentum less in how the market
behaves.
To put our results in some context, in our 26-year history, we have
outperformed our benchmark 20 calendar years and underperformed 6 calendar
years. Since I assumed sole management of the fund, we have outperformed 15
years and underperformed 2 (the last 2 obviously). On a rolling 12-month
basis, we have outperformed 60% of the time since inception, and 68% of the
time since I took over. Our relative performance this past quarter was the
worst in our history, as we trailed the market by just over 1000 basis
points. We have had 3 previous quarters where we trailed by over 700 basis
points, 2 of which were in the 1989-1990 period which I have previously
likened to this in terms of the economic and market backdrop. We have had 3
worse quarters in absolute terms: the quarter the market crashed in 1987,
the 9/11 quarter, and the third quarter of 1990.
The reason this past quarter was our worst relative quarter is that we
had back-to-back months where we were more than 400 basis points behind the
market. Prior to this, we had only had 7 such months in 17 years. From the
standpoint of statistics, though, we were due. Without getting into the
details of the math, given our historical returns and average volatility,
we should have been expected to have 10 such months since 1990, instead of
the 7 we had experienced.
Why does this matter? Because when you are doing poorly, the question
always comes up: Is this normal and expected, or is something wrong and
should changes be made to the portfolio or the investment process? Every
investor goes through periods of poor relative results. Remember the
Barron's cover story on whether Warren Buffett had lost it in the
tech-driven market of the late 1990s? Statistically, our results, while
disappointing -- and few are more disappointed than the team here at LMCM,
as we are substantial investors in our products -- are consistent with what
one would expect given our process, style, and historic results.
That does not mean we are satisfied with those results, or complacent
about our investment process. We are not. We are always looking to improve
our research methodology, our analytic efforts, and our portfolio
construction process. We systematically study the methods and the
portfolios of investors with great long term records for insights, and we
scour the academic literature in finance, psychology, economics, and
decision theory to see if any new research results in those (and other)
fields can be adapted in ways that may improve our results. We study our
past decisions to see if mistakes were made that can be avoided in the
future. We do this whether we are performing well, or poorly.
One of the more common issues clients have raised during this period is
that of risk controls, given that we have had several companies suffer
dramatic and highly publicized declines, such as Countrywide Financial and
Bear Stearns. Are we taking more risk than usual, or is our research not as
rigorous as it used to be? Some insight into this can be gleaned by looking
at the 1998-2002 period. That period is instructive because it began and
ended with financial panics, similar to the credit panic today. In 1998,
Russia defaulted on its debt and the hedge fund Long-Term Capital
Management collapsed. In 2002, high-yield bonds did likewise, and fears of
deflation were rampant. During that period we had 12 stocks that declined
more than 80%, including three bankruptcies. The difference between then
and now is that we were outperforming then, and are not now. When you are
doing poorly, the scrutiny is higher and the questions more pointed, as it
should be.
What makes things difficult is that when you look at performance you
are observing the results of price changes in the securities held in our
portfolio. You are not observing the value of the businesses whose shares
you own, merely how the market is pricing those shares at a point in time.
Price and value are not only different, it is precisely that they can
differ widely that creates the opportunities for value investors to earn
excess returns. The greater the difference, the greater the potential
return.
My friend Jeremy Hosking, who has delivered around 400 basis points per
year of excess return over two decades at Marathon (in London), corrected
me recently when I spoke about our underperformance. "You mean, your
deferred outperformance," he said. I thought it a clever line, but it
contains an important point. For investors who are trend followers, or
theme driven, or who primarily build portfolios around forecasts, or who
employ momentum strategies, price is dispositive. When they do badly, it is
because prices moved in a direction different from what they thought. For
value investors, price is one thing, and value is another. When prices move
against us, it usually means that the gap between price and value is
growing, and our future expected rates of return are higher.
This is especially the case in momentum-driven markets, such as we have
been in for the past two years. In such markets, price trends persist, and
wide gaps open up between price and value. That is why fertilizer stocks
such as Potash can go from the $20s to the $200s in two years, and why
Microsoft can bid over 60% more than where Yahoo! was trading and still be
getting a great deal.
We looked at when momentum does well, and when valuation does well.
Momentum strategies typically dominate when there is perceived distress,
such as the past year or so in credit and financials and this year in
equities globally (in the first quarter, not a single S&P sector was up),
or there is euphoria, such as tech in the late 90s or commodities and
materials today, or when valuation spreads between industries are narrow,
as has been the case for most of the past two years. So it's been a great
time for momentum and a lousy time for value. According to Birinyi
Associates, the single worst strategy you could have followed in the first
quarter would have been to buy the worst stocks of 2007. Momentum in
action, just negative momentum.
I am often asked, how long do we have to wait before the fund starts to
do better? The real answer here is the same as it is about most such
forecasts: no one knows. I am reminded of the story Nobel Prize winner Ken
Arrow tells about his experience trying to make long-range weather
forecasts for the military during World War II. He told his superiors that
his forecasts were so unreliable as to be useless. The word came back that
the General knew his forecasts were useless, but needed them anyway for
planning purposes.
For planning purposes, here is my forecast: I think we will do better
from here on, and that by far the worst is behind us. I think the credit
panic ended with the collapse of Bear Stearns, and credit spreads are
already much improved since then. If spreads continue to come in, the
write-offs at the big financials will end, and we may even have some
write-ups in the second half instead of write-downs. Valuations are
attractive, and valuation spreads are now about one standard deviation
above normal, a point at which valuation- based strategies usually begin to
work again, and momentum begins to fade (there is no evidence of the latter
yet, as the old leaders continue to lead). Most housing stocks are up
double digits this year despite dismal headlines, a sign the market had
already priced in the current malaise. I think likewise we have seen the
bottom in financials and consumer stocks, but not necessarily the bottom in
headlines about the woes in those sectors. Although the economy is likely
to struggle as it did in the early 1990s, the market can move higher, as it
did back then.
The wild card is commodities. If commodities break, or even just stop
their relentless rise, equity markets should do well. If they continue to
move steadily higher, they have the potential to destabilize the global
economy. We are already seeing unrest in many countries due to the soaring
prices of rice and other grains. Oil has rallied $30 per barrel in the past
8 weeks on no fundamental news, save only the same stories about fears of
supply disruptions. The typical fundamental drivers at the margin, such as
global economic growth, miles driven, and seasonality, would all suggest
prices similar to those that prevailed in early February. But none of that
has mattered. I agree with George Soros that commodities are in a bubble,
but it also appears he is right when he describes it as one that is still
inflating, and we still have the summer driving and hurricane season with
which to contend.
The weak dollar is another culprit in the commodity cycle. Oil began to
rise in earnest when the dollar index broke down sharply in February. The
Fed could help a lot by halting its interest rate cuts. Real short rates
are now negative. It is not the price of credit that is the problem, it is
its availability. If the Fed stopped cutting rates, that would help the
dollar, which in turn ought to stall the commodity price rises, and thus
also help the inflation picture. More technically, the Fed, in my opinion,
needs to focus on the value of collateral and not on the price of credit.
It appears they are beginning to do this, which is a very healthy sign.
This is a topic for another letter, but anyone interested in it should
consult the work of John Geanakoplos, a distinguished economics professor
at Yale and an external faculty member at the Santa Fe Institute, who has
written extensively on this issue, and presented to the Fed on it as well.
He and Chairman Bernanke were grad students together at MIT.
Despite moving higher over the past month, the U.S. market and most
others around the world are down for the year, and fear and risk aversion
still predominate. Yet valuations in general are not demanding, interest
rates are low, and corporate balance sheets, especially in the U.S., are in
excellent shape. That sets the stage for what should be an improving
environment for investors in stocks and in spread credit products, if not
in government bonds where risks are high and opportunities low, in my
opinion. With most investors being fearful, I think it makes sense to
allocate some capital to the greedy side of that pendulum, and that means
putting cash to work in equities.
Our portfolio, in my opinion, is in excellent shape, despite, or more
accurately because of, its performance. Prices have declined substantially
more than business values. On the Monday Bear Stearns opened for trading
after its sale to JPMorgan, the stock of the latter increased in value by
the rough difference between the price agreed to (then $2 per share) and
the mark-to- market book value of Bear Stearns, about $90 per share
including the value of their building. While the price of Bear was around
$2, the market understood the tangible value was about $90, all of which
accrued to JPMorgan's shareholders. While the press focused on our
ownership of Bear Stearns, our position in JPMorgan was nearly three times
larger. Many of our top 10 holdings sell at less than half our assessment
of their intrinsic business value (defined as the present value of their
future free cash flows), an unusually wide discount.
It is this assessment that makes us confident our, and your, investment
will deliver results more consistent with the past 26 years than with the
past two.
As always, we appreciate your support and welcome your comments.
Bill Miller
April 23, 2008
All investments are subject to risk including possible loss of
principal. Past performance is no guarantee of future results.
Top Ten Holdings as of March 31, 2008
Amazon.com Inc. (6.5%), The AES Corp. (6.4%), JPMorgan Chase and Co.
(5.0%), Aetna Inc. (4.9%), UnitedHealth Group Inc. (4.5%), Yahoo Inc.
(4.4%), eBay Inc. (4.2%), General Electric Co. (4.0%), Sears Holding Corp.
(4.0%), and Federal Home Loan Mortgage Corporation (3.5%). These holdings
do not include the Fund's entire investment portfolio and may change at any
time.
The views expressed in this commentary reflect those of Legg Mason
Capital Management, Inc. (LMCM) as of the date of the commentary. Any views
are subject to change at any time based on market or other conditions, and
LMCM, Legg Mason Value Trust, Inc., and Legg Mason Investor Services, LLC
(LMIS) disclaim any responsibility to update such views. These views may
differ from those of portfolio managers and investment personnel for LMCM's
affiliates and are not intended to be a forecast of future events, a
guarantee of future results or investment advice. Because investment
decisions for the Legg Mason Funds are based on numerous factors, these
views may not be relied upon as an indication of trading intent on behalf
of any Legg Mason Fund. The information contained herein has been prepared
from sources believed to be reliable, but is not guaranteed by LMCM, Legg
Mason Value Trust or LMIS as to its accuracy or completeness.
An investor should consider a Fund's investment objectives, risks,
charges and expenses carefully before investing. For a free prospectus,
which contains this and other information on any Legg Mason Fund, visit
http://www.leggmason...vidualinvestors. An investor should read the
prospectus carefully before investing.
Legg Mason Capital Management, Inc. and Legg Mason Investor Services,
LLC are Legg Mason, Inc. affiliated companies.
Legg Mason Investor Services, LLC distributor, Member FINRA, SIPC
Edited by A-ha, 26 April 2008 - 05:31 PM.
