Leverage Bites For Banks And Even Bill Miller

I was saddened, even surprised, to read Bill Miller is taking retirement as manager of Legg Mason�s Capital Management Value Fund.

Never met him, but watched at some distance as he logged year after year of outperformance stretching over two decades.  I�d pull up the fund�s portfolio from time to time to see what�s what, concluding this is a guy who ain�t afraid to stand alone, take oversized positions in specific stocks and double-weight major sectors of the S&P 500 Index.

You couldn�t ever accuse Miller of closet indexing or even reckless stock selection in peripheral industries or overindulging in small capitalization ragamuffins.

This fund�s current portfolio reads like a who�s who of big capitalization properties covering the financial sector, energy, technology, healthcare and non-durables properties like PepsiCo and Philip Morris International.

The only portfolio positions I�d characterize as peripheral investments in an iffy economic setting are United Continental and Annaly Capital Management.  Now is not the time to own airlines and leveraged money managers unless you believe in America (and Euroland) 365 days out of the new year coming up.

I could quarrel with specific positions like Texas Instruments, Teva Pharmaceutical, PepsiCo and General Electric, but that�s not why Miller�s portfolio is underwater.  The heart of the matter is the fund�s near double weighting in the financial sector.

I count up to approximately 21 percent of assets spread over banks, insurance underwriters, asset managers, credit card purveyors and brokerage houses like Morgan Stanley.  Recently eliminated financials embraced non performers like Bank of America, Goldman Sachs and Capital One.  Bank of America topped out near $20 and trades now at five bucks. It�s nearly a full retracement going back to the darkest days of 2009.  I own the preferred stock which trades around $20, yielding over 7 percent.  The bank may need to raise serious capital, diluting itself to meet the Fed�s draconian stress test benchmarks next year.

When banks belched black blood in 2008-�09, Citigroup narrowly escaped nationalization and needed to dilute equity unmercifully.  Its capitalization ballooned from 5.5 billion shares to a 30 billion share count.  If you x-out Citigroup�s 1 for 10 reverse split it trades at two bucks and change.

I like Citigroup as a great value play currently trading at 50 percent of net tangible assets per share.  JPMorgan got my money, too, but I would never dream of seriously overweighting bank stocks in any portfolio construct.  The reason is simplistic.  Banks remain leveraged properties.

Years ago, the leverage factor was 25 to 1.  Same goes for brokerage houses.  With new financial regulation, leverage is now below 15 to 1 and declines further as Volcker-inspired regulation comes into play next couple of years.  Ask Jon Corzine if leverage is a killer when you make a serious mistake in judgment.  There are still more banks than bankers in the world.