Miller Wagers Gundlach’s Bearish Housing Position Loses
Gundlach, the chief executive officer of DoubleLine Capital LP, and Zell, chairman of landlord Equity Residential, predict fewer young people will buy homes, further driving down the U.S. ownership rate. Miller, the stock picker who beat the Standard & Poor’s 500 Index for a record 15 years, said he’s so confident lending and housing will rebound that he’s betting on mortgage insurers, homebuilders and subprime servicers.
“Anytime there’s a cataclysm, people always say it’s never going to come back,” said Miller, 64, sitting outdoors at a table overlooking Baltimore’s harbor. “I don’t believe there’s been a secular change in demand for housing. People may just rent longer than they otherwise would have before eventually buying.”
Miller, portfolio manager since 1999 of the $2.1 billion Legg Mason Opportunity Trust (LMOPX) at LMM LLC, is bullish on housing even as Federal Reserve Chair Janet Yellen raises concerns about the economic impact of slowing sales. U.S. mortgage lending contracted to the lowest level in 17 years in the first quarter, and sales of lower-priced existing homes plunged 12 percent in March compared with a year earlier.
Since 2011, when homebuilder executives started talking about their improved outlooks, Miller has been adding to his real estate and financial holdings, which now make up 33 percent of the fund. Legg Mason Opportunity Trust, which Miller has co-managed with Samantha McLemore since 2008, returned 23 percent over the past 12 months, ahead of 97 percent of similarly managed funds, according to data compiled by Bloomberg.
Miller, who can recall how the stock market performed on many days as far back as the 1980s, said he remains upbeat on housing because banks are beginning to ease lending requirements.
In March, credit standards were the loosest in at least two years, according to a Mortgage Bankers Association index. The measure, based on underwriting guidelines, rose to 114 from 100 when it started in 2012. Wells Fargo & Co. (WFC), the largest U.S. home lender, last month cut its minimum credit score for borrowers of Fannie Mae and Freddie Mac-backed loans to 620 from 660. And earlier this week, the Federal Housing Finance Agency, which oversees the two government-backed mortgage companies, unveiled plans to spur lending by reducing the risk to banks of having to buy back loans that default.
“The housing recovery is far less robust right now than it’s ever been historically coming out of a recession,” which means there’s so much room for improvement, said Miller. “That’s the opportunity and also what gives rise to the confusion” among investors, he said.
Housing starts climbed 13.2 percent to a 1.07 million annualized rate following March’s 947,000 pace, the Commerce Department reported today in Washington. The median estimate of 79 economists surveyed by Bloomberg called for 980,000.
Earlier this month at the Sohn Investment Conference in New York, Gundlach recommended betting against an exchange-traded fund that tracks an index of homebuilders because declining affordability will reduce housing demand. Gundlach said in an e-mail May 14 that he doesn’t expect a significant increase in housing starts.
Gundlach’s $32.7 billion DoubleLine Total Return Bond Fund (DBLTX), which invests in mortgage-backed securities, returned 1.8 percent over the past year, ahead of 83 percent of rivals.
“You have a huge fraction of 18- to 34-year-olds who are unemployed and they also are much less interested in homebuying,” Gundlach said May 6 during an interview with Matthew Winkler, editor-in-chief of Bloomberg News, in New York. “Most of these people have been scarred by the housing collapse.”
The share of Americans who own their homes was 64.8 percent in the first quarter, the lowest since 1995, according to a Census Bureau report last month. That’s down from 65.2 percent in the previous three months and 69.2 percent at its peak in 2004.
Zell said in April at the Milken Institute Global Conference in Beverly Hills, California, that the rate may fall to as low as 55 percent as Americans postpone getting married and having children.
“The deferral of marriage has such a staggering impact on real estate and I just don’t think people focus on it,” Zell said at the conference.
Terry Holt, a spokeswoman for Zell, declined to comment for this story.
This isn’t the first time Miller has bet heavily on an optimistic outlook. His 15-year streak leading the Legg Mason Value Trust to better returns than the S&P 500 ended in 2006. His performance worsened as he wagered on financial stocks during the credit crisis, prompting a 55 percent decline in his fund in 2008. In 2012, Miller stepped down from the Value Trust, while staying on as the manager of the Opportunity fund.
“Legg Mason Opportunity Trust is in the top 1 percent in good times and the bottom 1 percent in bad,” said Todd Rosenbluth, director of mutual-fund research for S&P Capital IQ in New York. “It will do well in a strong economic environment and continuation of the housing recovery, but when markets get choppy or flat, it won’t have other kinds of securities to provide an offset.”
The fund delivered an annual 22 percent return over the past five years to beat 95 percent of rivals, according to data compiled by Bloomberg. In 2011, it fell 35 percent as the S&P 500 rose 2.1 percent.
Miller’s largest stake is insurer Genworth Financial Inc. (GNW), at 3.9 percent of the portfolio as of March 31, according to Legg Mason Inc.’s website. The Richmond, Virginia-based firm’s stock doubled to $15.53 in 2013 as rising home prices helped its mortgage insurance unit post its first profit since 2007.
As home prices climb, mortgage insurers like Genworth will benefit as housing values support insurance claims and originate new business, according to Miller. U.S. home prices increased 12.9 percent in the 12 months through February, according to the S&P/Case-Shiller index of 20 cities.
Miller started ramping up his Genworth holding in 2012 when shares were about $5 as mortgage insurers were reimbursing lenders for losses stemming from a wave of defaults. Genworth shares closed at $17.81 in New York yesterday.
Homebuilders such as PulteGroup Inc. (PHM) and Lennar Corp., both among Miller’s top 30 holdings, have been discounted because of their weak earnings. Miller said they are poised to grow 20 percent to 25 percent a year for as long as the next five years, and will outperform the S&P 500. They’ve both increased their share of the market and reduced costs to boost profits, he said.
A sustained rise in interest rates could delay the housing rebound for about a year, Miller said. Borrowers would eventually get used to the higher rates and return to the market, he said, pointing to the housing boom in the late 1990s when people purchased homes even as rates averaged about 6 percent.
Now Miller is setting his sights on mortgage servicers, betting he’ll profit from changes in government policy. Servicers, who collect mortgage payments, are grabbing market share from banks, which face regulations limiting the amount of capital they can risk on servicing rights. More than $1 trillion in servicing rights have changed hands in the last two years.
“Anytime the government makes a major change, it usually creates a big opportunity,” said Miller. The transfer of servicing rights is similar to when firms had to sell junk bonds about 25 years ago following new regulations, he said.
Nationstar Mortgage Holdings Inc. (NSM), which is majority owned by Fortress Investment Group LLC, benefited during the boom in refinancing and then suffered as mortgage rates rose. It will again profit as originations return and it buys more servicing rights from banks, according to Miller.
In March, Benjamin M. Lawsky, New York’s top bank regulator, asked Nationstar for information about the “explosive growth” in its mortgage-servicing business, citing hundreds of consumer complaints about the company’s practices.
Miller started buying shares of the Lewisville, Texas-based servicer at the end of last year. The move damaged his fund’s performance since Nationstar shares, hurt partly by the state probe, are down 14 percent this year. Miller said he has long-term confidence in the stock and has been steadily increasing exposure whenever the shares are at $30 or below.
“We’re optimistic in that we’re long-term investors,” Miller said. “Two thirds to three quarters of the time the market goes up, so if you’re longer term oriented, you have to be bullish.”
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