[This post originally appeared on Seeking Alpha last week. I enjoy a
wide following there, and I appreciate the opportunity to participate
in their annual series. As I note at the beginning of the interview,
this is a very valuable resource. I share the interview with readers of
"A Dash" with the permission of Seeking Alpha.
To read other pieces from Seeking Alpha's Positioning for 2013 series, click here.]
Jonathan Liss (JL): Jeff, it's great to have you closing things out again this year. For those readers less familiar with your work, how would you describe your investing style/philosophy?
Jeff Miller (JM): Hi Jonathan. Thanks for inviting me to participate again this year. I am a big fan of your annual “portfolio positioning” series. You have a good range of opinions and sharp questions. It brings out my best, as it does for others.
Our investment style emphasizes active management, a focus on risk, and attention to each client. I have no specific program that locks me into a pre-conceived viewpoint on the market. Like other fixed-fee managers, my financial interests are completely aligned with investors.
I interview each potential client and then create a blend of our six programs – something that meets the risk/reward needs for each. Readers who follow my weekly review/preview series know that I am focused on data and objective indicators. I am resistant to hype and to headlines.
Most investors are too ebullient when everything looks great, as we saw in 2000. They are also easily frightened, especially in the wake of 2008.
My most popular investment program targets an annualized absolute return of 8-9% via selected dividend stocks and selling near-term calls to enhance yield. This is working very well right now, and is a good fit as part of many programs.
I have many reasons to be bullish, but the most important is the number and quality of current opportunities. Some of my themes are similar to last year, and I invite readers to check out that article.
I was very accurate on the macro concerns about Europe as well as the highlighted stocks. (The featured collection averaged +25%). Anyone who followed me during the year also benefited from my weekly update on recession forecasting, risk (via the St. Louis Financial Stress Index), and the Fiscal Cliff, where my prediction of the outcome was almost perfect.
Last year’s developments are important for your 2013 question. Despite the favorable developments, many stocks have lagged.
JL: What are the major catalysts for global markets in 2013?
JM: This is a great question! We have a unique situation where the answer is already known, but it is mostly ignored. Many of the popularly cited economic headwinds will become less important.
Let me be quite specific about two types of catalysts:
1. The slow catalyst. This is the one we already know. The fiscal cliff decision is the final piece of the puzzle. All of the following factors will help the economy, and they are all very important:
a. Uncertainty for business --- gone! Businesses were deferring big decisions until after the election and the fiscal cliff. Any remaining issues will be clarified soon.
b. Uncertainty for consumers – gone! They were doing fine until the media blitz telling them that they should be scared witless. This concern has been resolved with the fiscal cliff decision.
c. Housing. Clearly bottoming and improving. Even the slowest-moving indicators are showing a bottom in place. There has been a lot of focus on pent-up supply. Meanwhile, we have a million households of pent-up demand.
d. Auto sales. Booming, with another great year expected.
e. Employment. Improving, especially as the drag from government job losses has slowed.
f. Energy. Good news both on natural gas and new jobs in drilling.
g. Central banks. Aggressive stimulus is now true of the U.S. and Europe. Expect China to join in.
2. The fast catalyst. This one will happen soon, but the time is a bit uncertain. The Fed is on a stated mission to create inflation, targeting 2% and tolerating 2.5% on their favorite measure (core PCE), which runs lower than the CPI.
a. Preamble – The individual investor has been reaching for yield, unwisely using past performance as a guide to future success, and therefore believing that bonds are the best investment for 2013.
b. Dénouement – Investors in bond mutual funds will learn, perhaps for the first time, that these funds can experience absolute losses! I do not know the exact time when this will happen, but when it does, we will have an accelerated chemical reaction.
JL: Which asset classes are you overweight? Which are you underweight? Why?
JM: Asset allocation for my investors is based mostly upon their individual circumstances. With this in mind, the current market offers a better risk/reward profile for stocks over bonds. There are improving real estate opportunities, but these relate dramatically to locality.
JL: To which index or fund do you benchmark your performance?
JM: Each of our programs has a different standard. In our bond ladder, for example, we inform investors about the returns we are currently able to get while staying shorter than seven years and using only investment grade bonds. In our enhanced yield program we target an absolute return of 8-9%. In our trading program we might only equal the market return, but do so with less risk. (We are sometimes out of the market or using inverse ETFs). Our “Great Stocks” program is benchmarked to the S&P 500 since we gain our edge via active management and thematic investing in known names.
JL: There’s a lot of confusion out there regarding the proper use of inverse and leveraged ETFs. As a seasoned portfolio manager, it would be very interesting to know how you use these funds. What are the buy and sell triggers? What sort of holding period is typical? What position size is necessary to offer true downside protection without the risk of significant drag on overall performance?
JM: We use the inverse ETFs as part of our most active trading programs, named “Oscar” and “Felix” to reflect the basic approach of each model. Our use is not designed as a hedge, but as a way to profit in a down market. The holding period varies based upon the market trend. If we were to hit a 2008-type situation, for example, Felix would first go to bonds and gold and eventually to the inverse ETFs. We do not use any leveraged ETFs.
Individual investors need considerable trading skill to use these ETFs successfully. The leveraged versions track the market in short time intervals, but the relationship breaks down with time. If you wanted to emphasize your stock-picking in a neutral market, you could add some portion of the inverse ETFs to your portfolio. You could also use them as a hedge if you had an increase in an objective indicator of risk (like the SLFSI).
Long-term ownership is just like reducing your position size, so it is a drag on performance most of the time.
JL: As we are now a week into 2013, what is your highest conviction pick for the remainder of 2013?
JM: My basic thesis is that the improving economy will clarify where we are in the business cycle – an extended, gradual move from a sharp decline. The market looks very different once you realize that we are only in the third or fourth inning of this recovery. Let me offer a few specific stocks that fit the themes of where we are in the business cycle, as well as other macro influences. I like to move from a general theme, to a sector, and then to specific stock selection.
Caterpillar (CAT) – A great early-cycle stock and one that will benefit from the improvement in China. Costs have been kept under control. If it traded at the PE multiple common for the last decade, it would trade at 130 or so.
AFLAC (AFL) – A conservative way to play the rebound in Europe. It is unloved by many on the Street, leading to an attractive valuation. It has a single-digit multiple with earnings growth of over 14%.
JPMorgan Chase (JPM) – Stumbled this year after the “whale trading” incident. If you think this incident represents an overall failure of control, you might not like the company or the stock. If you are a contrarian, value-oriented investor, your best picks are often flawed in the eyes of many. One aspect of upside: European banks will be disgorging distressed assets under Basel III. Banks with great balance sheets will be able to take advantage. This stock could easily be 65-70 in 2013.
Technology – both PC stocks and Apple (AAPL). Apple will benefit from the expected rebound in consumer confidence. Current prices reflect a multiple in single digits of forward earnings, once you adjust for cash holdings. The PC is not dead. As corporate investment resumes, there will (finally) be the upgrade cycle to Windows 8.
Some of these themes are second-half plays. The challenge will be the first-quarter earnings reports, which will still show weak growth.
Best short ideas include the over-owned sectors:
Bonds – Bond mutual funds are dangerous. Shorting iShares Barclays 20+ Year Treasury Bond ETF (TLT) is a possibility.
Utility stocks are popular as dividend plays. People are buying yield without looking at value. These stocks will trade like 100-year bonds when rates start to rise.
JL: Any consideration of shorting an ETF like the Utilities Select Sector SPDR ETF (XLU) – or is this just a sector you’re avoiding for the time being?
JM: Good question, and thanks for helping me to respond clearly. I think TLT and XLU are over-valued and dangerous holdings, so they are good short ideas. None of our current programs involves shorting stocks or ETFs except via the inverse ETFs, so it is not something that I can implement.
JL: Where have you been having retirees turn for income in this record low rate environment?
JM: We provide income to retirees through our Enhanced Yield program. This combines conservative dividend stocks with yield enhancement via selling short-term calls. The call sales capture the rapid part of the time decay curve and also provide some cushion against market volatility. The program has less risk than merely owning dividend stocks, and works well even in a sideways market.
The most highly touted sources of yield all represent crowded trades. The valuations of many dividend stocks are stretched. Other investments return principal in the guise of income – a trap for the unwary!
JL: Are there any parts of the fixed income space currently offering the prospects of decent ‘total return’ to investors?
JM: I strongly endorse the total return concept. That is the point of “enhancing” yield. Every time I take a deep look at a high-yield investment, I find either a disguised return of principal or hidden risks. You can achieve good total returns by including some stocks in your portfolio – a little octane in the tank, as I often say.
JL: Turning to younger investors, what is the ideal asset allocation for someone with a long-term horizon (greater than a decade) and no need to touch their investments? Can investors continue to rely on stocks for the bulk of their capital appreciation?
JM: There is a special challenge for young people – and a corresponding opportunity. Starting early in saving and investing is crucial. Stocks provide the chance to be a business owner as well as a worker. Those focused on the last ten years have a negative outlook. I suggest that any young person look at a long-term chart of U.S. stock prices. Right now, actual risk is lower, stock prices are more attractive and economic growth is improving.
JL: How bad is the current gridlock in Washington and the uncertainty it breeds for investors? How closely do you watch political developments when formulating an overall investing thesis/asset allocation mix?
JM: Given my background as a former college professor specializing in public policy formation, I embrace these controversies. The recent political issues in Europe and the U.S. are a special opportunity. Most of the coverage of these issues drifts rapidly into opinion instead of analysis. There is little real understanding of how multi-party bargaining works in practice.
Take the term “gridlock.” In the end, for the issues most important to the market there was not really gridlock. A final compromise was reached. It happened at the last minute. It was messy and unloved by all. This was all very predictable and quite typical.
It is a great opportunity for me, and profitable both on Europe issues and the fiscal cliff. But let us look to the future.
The fiscal cliff story was great for the financial media. They want to keep the momentum going. Already there is a new campaign to characterize the deficit negotiations as a “crisis.” You cannot make good headlines by simply reporting the facts: Leaders are posturing before the bargaining even starts. We will not know much for at least another six weeks.
Here is a specific example. I do not believe that defense spending will be slashed through the budget sequestration. However in the next two months you will hear many claims to the contrary. The result is that a number of these stocks are quite attractively priced, including Northrop Grumman (NOC), Lockheed Martin (LMT), and Raytheon (RTN). It is possible that prices will go lower before moving higher, but the time frame is about two months.
JL: Do you believe gold and other precious metals are a genuine hedge in uncertain markets? If so, how much exposure do you have? If not, where are you turning for potential downside diversification?
JM: Gold rallies with fears of hyperinflation or deflation from systemic collapse. Since I do not see near-term prospects for either, I am not enthusiastic about gold.
The only really good method for hedging tail risk is to buy puts or perhaps do a more complex put spread. This is not easy for most investors. I prefer to control for risk by downsizing positions when necessary. Recession forecasting indicators and measures of financial stress are very good for this purpose. I report on these each week in my WTWA series.
JL: Finally, what advice would you give to a ‘do-it-yourself’ investor in the present investing environment?
JM:
JM: The biggest mistake for most investors is inaction. They may suspect that they should be adjusting their portfolio, but they do not know how to proceed. They might be disorganized, with many different accounts. These investors should make a New Year’s resolution for action. If you are doing nothing, it is cheaper to get some help than to stick in bad investments. Investment managers are used to creating order from chaos!
Thanks again for inviting me to participate. In reviewing my answers I realize that I am taking a contrary viewpoint on many issues. When you are looking for significant investment edge, this is often the result.
By Oldprof
To read other pieces from Seeking Alpha's Positioning for 2013 series, click here.]
Jonathan Liss (JL): Jeff, it's great to have you closing things out again this year. For those readers less familiar with your work, how would you describe your investing style/philosophy?
Jeff Miller (JM): Hi Jonathan. Thanks for inviting me to participate again this year. I am a big fan of your annual “portfolio positioning” series. You have a good range of opinions and sharp questions. It brings out my best, as it does for others.
Our investment style emphasizes active management, a focus on risk, and attention to each client. I have no specific program that locks me into a pre-conceived viewpoint on the market. Like other fixed-fee managers, my financial interests are completely aligned with investors.
I interview each potential client and then create a blend of our six programs – something that meets the risk/reward needs for each. Readers who follow my weekly review/preview series know that I am focused on data and objective indicators. I am resistant to hype and to headlines.
Most investors are too ebullient when everything looks great, as we saw in 2000. They are also easily frightened, especially in the wake of 2008.
My most popular investment program targets an annualized absolute return of 8-9% via selected dividend stocks and selling near-term calls to enhance yield. This is working very well right now, and is a good fit as part of many programs.
JL: As 2013 gets underway, are you generally more bullish or bearish?
JM:
This year represents a special opportunity for long-term investors.
Nearly everyone should be nudging stock allocations higher. Those who
are recently retired need to think about inflation. A reasonable stock
allocation is the best inflation fighter.I have many reasons to be bullish, but the most important is the number and quality of current opportunities. Some of my themes are similar to last year, and I invite readers to check out that article.
I was very accurate on the macro concerns about Europe as well as the highlighted stocks. (The featured collection averaged +25%). Anyone who followed me during the year also benefited from my weekly update on recession forecasting, risk (via the St. Louis Financial Stress Index), and the Fiscal Cliff, where my prediction of the outcome was almost perfect.
Last year’s developments are important for your 2013 question. Despite the favorable developments, many stocks have lagged.
JL: What are the major catalysts for global markets in 2013?
JM: This is a great question! We have a unique situation where the answer is already known, but it is mostly ignored. Many of the popularly cited economic headwinds will become less important.
Let me be quite specific about two types of catalysts:
1. The slow catalyst. This is the one we already know. The fiscal cliff decision is the final piece of the puzzle. All of the following factors will help the economy, and they are all very important:
a. Uncertainty for business --- gone! Businesses were deferring big decisions until after the election and the fiscal cliff. Any remaining issues will be clarified soon.
b. Uncertainty for consumers – gone! They were doing fine until the media blitz telling them that they should be scared witless. This concern has been resolved with the fiscal cliff decision.
c. Housing. Clearly bottoming and improving. Even the slowest-moving indicators are showing a bottom in place. There has been a lot of focus on pent-up supply. Meanwhile, we have a million households of pent-up demand.
d. Auto sales. Booming, with another great year expected.
e. Employment. Improving, especially as the drag from government job losses has slowed.
f. Energy. Good news both on natural gas and new jobs in drilling.
g. Central banks. Aggressive stimulus is now true of the U.S. and Europe. Expect China to join in.
2. The fast catalyst. This one will happen soon, but the time is a bit uncertain. The Fed is on a stated mission to create inflation, targeting 2% and tolerating 2.5% on their favorite measure (core PCE), which runs lower than the CPI.
a. Preamble – The individual investor has been reaching for yield, unwisely using past performance as a guide to future success, and therefore believing that bonds are the best investment for 2013.
b. Dénouement – Investors in bond mutual funds will learn, perhaps for the first time, that these funds can experience absolute losses! I do not know the exact time when this will happen, but when it does, we will have an accelerated chemical reaction.
JL: Which asset classes are you overweight? Which are you underweight? Why?
JM: Asset allocation for my investors is based mostly upon their individual circumstances. With this in mind, the current market offers a better risk/reward profile for stocks over bonds. There are improving real estate opportunities, but these relate dramatically to locality.
JL: To which index or fund do you benchmark your performance?
JM: Each of our programs has a different standard. In our bond ladder, for example, we inform investors about the returns we are currently able to get while staying shorter than seven years and using only investment grade bonds. In our enhanced yield program we target an absolute return of 8-9%. In our trading program we might only equal the market return, but do so with less risk. (We are sometimes out of the market or using inverse ETFs). Our “Great Stocks” program is benchmarked to the S&P 500 since we gain our edge via active management and thematic investing in known names.
JL: There’s a lot of confusion out there regarding the proper use of inverse and leveraged ETFs. As a seasoned portfolio manager, it would be very interesting to know how you use these funds. What are the buy and sell triggers? What sort of holding period is typical? What position size is necessary to offer true downside protection without the risk of significant drag on overall performance?
JM: We use the inverse ETFs as part of our most active trading programs, named “Oscar” and “Felix” to reflect the basic approach of each model. Our use is not designed as a hedge, but as a way to profit in a down market. The holding period varies based upon the market trend. If we were to hit a 2008-type situation, for example, Felix would first go to bonds and gold and eventually to the inverse ETFs. We do not use any leveraged ETFs.
Individual investors need considerable trading skill to use these ETFs successfully. The leveraged versions track the market in short time intervals, but the relationship breaks down with time. If you wanted to emphasize your stock-picking in a neutral market, you could add some portion of the inverse ETFs to your portfolio. You could also use them as a hedge if you had an increase in an objective indicator of risk (like the SLFSI).
Long-term ownership is just like reducing your position size, so it is a drag on performance most of the time.
JL: As we are now a week into 2013, what is your highest conviction pick for the remainder of 2013?
JM: My basic thesis is that the improving economy will clarify where we are in the business cycle – an extended, gradual move from a sharp decline. The market looks very different once you realize that we are only in the third or fourth inning of this recovery. Let me offer a few specific stocks that fit the themes of where we are in the business cycle, as well as other macro influences. I like to move from a general theme, to a sector, and then to specific stock selection.
Caterpillar (CAT) – A great early-cycle stock and one that will benefit from the improvement in China. Costs have been kept under control. If it traded at the PE multiple common for the last decade, it would trade at 130 or so.
AFLAC (AFL) – A conservative way to play the rebound in Europe. It is unloved by many on the Street, leading to an attractive valuation. It has a single-digit multiple with earnings growth of over 14%.
JPMorgan Chase (JPM) – Stumbled this year after the “whale trading” incident. If you think this incident represents an overall failure of control, you might not like the company or the stock. If you are a contrarian, value-oriented investor, your best picks are often flawed in the eyes of many. One aspect of upside: European banks will be disgorging distressed assets under Basel III. Banks with great balance sheets will be able to take advantage. This stock could easily be 65-70 in 2013.
Technology – both PC stocks and Apple (AAPL). Apple will benefit from the expected rebound in consumer confidence. Current prices reflect a multiple in single digits of forward earnings, once you adjust for cash holdings. The PC is not dead. As corporate investment resumes, there will (finally) be the upgrade cycle to Windows 8.
Some of these themes are second-half plays. The challenge will be the first-quarter earnings reports, which will still show weak growth.
Best short ideas include the over-owned sectors:
Bonds – Bond mutual funds are dangerous. Shorting iShares Barclays 20+ Year Treasury Bond ETF (TLT) is a possibility.
Utility stocks are popular as dividend plays. People are buying yield without looking at value. These stocks will trade like 100-year bonds when rates start to rise.
JL: Any consideration of shorting an ETF like the Utilities Select Sector SPDR ETF (XLU) – or is this just a sector you’re avoiding for the time being?
JM: Good question, and thanks for helping me to respond clearly. I think TLT and XLU are over-valued and dangerous holdings, so they are good short ideas. None of our current programs involves shorting stocks or ETFs except via the inverse ETFs, so it is not something that I can implement.
JL: Where have you been having retirees turn for income in this record low rate environment?
JM: We provide income to retirees through our Enhanced Yield program. This combines conservative dividend stocks with yield enhancement via selling short-term calls. The call sales capture the rapid part of the time decay curve and also provide some cushion against market volatility. The program has less risk than merely owning dividend stocks, and works well even in a sideways market.
The most highly touted sources of yield all represent crowded trades. The valuations of many dividend stocks are stretched. Other investments return principal in the guise of income – a trap for the unwary!
JL: Are there any parts of the fixed income space currently offering the prospects of decent ‘total return’ to investors?
JM: I strongly endorse the total return concept. That is the point of “enhancing” yield. Every time I take a deep look at a high-yield investment, I find either a disguised return of principal or hidden risks. You can achieve good total returns by including some stocks in your portfolio – a little octane in the tank, as I often say.
JL: Turning to younger investors, what is the ideal asset allocation for someone with a long-term horizon (greater than a decade) and no need to touch their investments? Can investors continue to rely on stocks for the bulk of their capital appreciation?
JM: There is a special challenge for young people – and a corresponding opportunity. Starting early in saving and investing is crucial. Stocks provide the chance to be a business owner as well as a worker. Those focused on the last ten years have a negative outlook. I suggest that any young person look at a long-term chart of U.S. stock prices. Right now, actual risk is lower, stock prices are more attractive and economic growth is improving.
JL: How bad is the current gridlock in Washington and the uncertainty it breeds for investors? How closely do you watch political developments when formulating an overall investing thesis/asset allocation mix?
JM: Given my background as a former college professor specializing in public policy formation, I embrace these controversies. The recent political issues in Europe and the U.S. are a special opportunity. Most of the coverage of these issues drifts rapidly into opinion instead of analysis. There is little real understanding of how multi-party bargaining works in practice.
Take the term “gridlock.” In the end, for the issues most important to the market there was not really gridlock. A final compromise was reached. It happened at the last minute. It was messy and unloved by all. This was all very predictable and quite typical.
It is a great opportunity for me, and profitable both on Europe issues and the fiscal cliff. But let us look to the future.
The fiscal cliff story was great for the financial media. They want to keep the momentum going. Already there is a new campaign to characterize the deficit negotiations as a “crisis.” You cannot make good headlines by simply reporting the facts: Leaders are posturing before the bargaining even starts. We will not know much for at least another six weeks.
Here is a specific example. I do not believe that defense spending will be slashed through the budget sequestration. However in the next two months you will hear many claims to the contrary. The result is that a number of these stocks are quite attractively priced, including Northrop Grumman (NOC), Lockheed Martin (LMT), and Raytheon (RTN). It is possible that prices will go lower before moving higher, but the time frame is about two months.
JL: Do you believe gold and other precious metals are a genuine hedge in uncertain markets? If so, how much exposure do you have? If not, where are you turning for potential downside diversification?
JM: Gold rallies with fears of hyperinflation or deflation from systemic collapse. Since I do not see near-term prospects for either, I am not enthusiastic about gold.
The only really good method for hedging tail risk is to buy puts or perhaps do a more complex put spread. This is not easy for most investors. I prefer to control for risk by downsizing positions when necessary. Recession forecasting indicators and measures of financial stress are very good for this purpose. I report on these each week in my WTWA series.
JL: Finally, what advice would you give to a ‘do-it-yourself’ investor in the present investing environment?
JM:
- Don’t expect too much. It is not as easy as brokerage commercials make it seem.
- Decide upon a systematic approach that you know will work. If you do not do this, you will bail out the first time something seems to go wrong.
- Control your risk. Do not determine size by what you want to make, but with what you can afford to lose.
- Expect to spend a lot of time on research. If you think you can achieve good results in a couple of hours a week, you will be disappointed.
- Do not get caught up in unquantifiable headline risk and political arguments. Focus on what you expect to happen, not what you think should happen.
- Exploit free resources (like Seeking Alpha) for ideas and information like conference call transcripts, but make your own decisions.
- Be willing to pay for some information. I don’t mean stock tips or those who claim to time the market. I mean data that is well organized and easy to use – something that will save you time and let you work efficiently. For fundamental investors, Chuck Carnevale’s FAST Graphs product is essential. It saves me hours of work.
JM: The biggest mistake for most investors is inaction. They may suspect that they should be adjusting their portfolio, but they do not know how to proceed. They might be disorganized, with many different accounts. These investors should make a New Year’s resolution for action. If you are doing nothing, it is cheaper to get some help than to stick in bad investments. Investment managers are used to creating order from chaos!
Thanks again for inviting me to participate. In reviewing my answers I realize that I am taking a contrary viewpoint on many issues. When you are looking for significant investment edge, this is often the result.
By Oldprof