Market Commentary
The second quarter was relatively uneventful across markets, with both bonds and commodities largely unchanged according to the +0.07% and +0.55% performances from the Bloomberg Agg and the Commodities Research Bureau indices, respectively. The bond market anticipated a respite from inflationary pressures in the US, correctly for now, with expectations for inflation over the next two years falling from 3% in April to just over 2% at quarter-end. This dynamic has historically benefitted large capitalization stocks to the detriment of small caps, and last quarter proved no exception – the more economically sensitive S&P Small Cap 600 index generated a -3.11% return while the S&P Large Cap 100 index advanced 7.07%. Equity volatility remained low, especially so in June, which saw realized equity market volatility approach that of bonds, a rare dynamic which has historically not lasted long.
The other dynamic that has historically not lasted indefinitely is the extent to which large cap stocks have beaten smaller cap stocks. Over the past two calendar quarters, the aforementioned large cap index has outperformed the small cap index by a cumulative 19.9%. Markets have not seen this level of calendar quarter outperformance in twenty-five years, since just prior to the tech bubble bursting. Clearly, there is no causal driver preventing large caps from continuing to outperform small caps by another 19% over the next two quarters. However, history often rhymes, and large caps now trade at their biggest valuation premium to the small cap index since 2001, with small caps producing aggregate outperformance of 78.4% versus large caps from the end of 2001 through 2010. The premium valuations placed on some of the largest companies now require the highest levels of sustained growth to generate a return for investors, even though scale and sustainable growth potential do not always correlate. Increasingly narrow constituencies benefit from mega-cap stocks with huge revenues per employee growing at above-market rates, a trend that likely cannot continue indefinitely.
Of course, none of this changes what we do every day – turn over rocks to find attractive prospective investments and compare them to what we own in an effort to construct a portfolio of good businesses that have a high probability of trading at better prices in the future. At the margin, we are finding some of the most compelling opportunities in energy and financials, whose prices appear to discount a much worse future than we anticipate. Many names in the space are well-run, growing with improving returns on capital while breaking out to new multi-year highs despite mid-single-digit multiples of earnings power.
Our portfolios are very different from their benchmarks (with the exception of MVPL). Names and sector weights are a by-product of our bottom-up process, which means that our performance will differ meaningfully from the benchmarks’, especially over short periods of time. That is a feature, not a bug. We look to concentrate in securities tied to aligned capital allocators who we think are likely to enhance equity value per share over the long term. In light of the aforementioned dynamics, we find our portfolios to be an especially compelling opportunity today for investors looking to diversify away from the market’s concentrated skew towards growth, technology, and elevated expectations for sustained growth from some of the world’s largest entities.
As always, we remain the largest investors in our funds and appreciate your partnership.
Bill Miller IV, CFA, CMT
July 1, 2024
Fund Highlights
The Miller Income Fund returned -1.09% versus a positive 1.11% return for the unmanaged ICE BofA High Yield index. The passive strategies tracking the index each did approximately 40 basis points worse than the index, with the SPDR Bloomberg High Yield Bond ETF (JNK) returning 0.70% and iShares iBoxx High Yield Corporate Bond ETF (HYG) returning 0.74%. This is an ongoing and meaningful performance discrepancy dynamic we have highlighted in the past owing to a combination of the index’s illiquidity and ETF fees, both of which provide stronger headwinds than they do among more liquid equity indices.
| Annualized Performance as of 6/30/24 | Quarter | 1-Year | 3-Year | 5-Year | 10-Year |
| LMCLX | -1.09% | 26.05% | -0.91% | 6.59% | 4.27% |
| ICE BofA Merrill Lynch High Yield Master II | 1.11% | 10.52% | 1.70% | 3.76% | 4.23% |
This quarter’s “top-contributor” list included a new holding, Hoegh Autoliners (HAUTO NO) a car-shipping company seeing rates skyrocket in a high demand / supply-constrained environment. While we understand the cyclicality of the rates, the stock still looks too cheap at 3.7x this year’s earnings, minimal debt and an aligned management team. Some of our financials continued to perform well for us, including Bread Financial (BFH) and Lincoln National (LNC), both of which we think have compelling prospects to continue leading.
Some of last quarter’s best performers were this quarter’s biggest detractors, including automaker Stellantis (STLA), building products maker Boise Cascade (BCC) and MicroStrategy’s 0.75% convertible bonds of 2025, which were recently called, effectively requiring holders to convert the bonds into shares. After its pullback, Stellantis now trades at an EV/EBIT multiple of 1.6x the consensus analyst estimate for this year’s operating profit, while Boise Cascade trades at a low double-digit free cash flow yield for a quality player in a critical business with a long secular runway; both have fortress balance sheets with cash levels above debt. We have written extensively about Bitcoin and still find the technology undervalued, though a wider array of vehicles to invest in Bitcoin appeared to weigh on MicroStrategy’s valuation during the quarter.
The portfolio saw some minor changes this quarter. We no longer own Encore Wire (WIRE) after it was bought out. We eliminated IHeart bonds after they continued to underperform our expectations, and we sold GEO stock after it reached a level that we deemed fairly valued relative to other opportunities; our GEO bonds were called. We initiated a starter position in the common stock of Build-a-Bear Workshop (BBW), an experiential retailer with a capital-light growth plan trading at less than 5x this year’s EBITDA estimate.