Image Source: Mike Cohen

By Brian Nelson, CFA

Investors are building in near worst-case scenarios for future free cash flow expectations across our coverage universe in most cases, and it may not make a lot of sense, in our view, given the resilient nature of the global economy through thick and thin. Within the discounted cash flow model that we use to derive the fair value estimates for companies in our coverage, we apply a 10-year baseline (discount) Treasury rate of 4.5%, which is still meaningfully above the current 10-year Treasury rate that is now hovering around 3.5%.

What that means is that there still remains an adequate margin of safety within our analytical framework before we might grow concerned about rising interest rates and their impact on fair value estimates (rising interest rates generally mean lower equity values, all else equal), and whether, more specifically, we need to think about raising that benchmark (discount) rate within our valuation framework. We still believe that the current high levels of inflation will be managed effectively by policy makers and that equity investing remains a very attractive proposition over the long haul. 

Stocks Still Attractive Long-Term Assets

The stock market, as measured by the total return of the S&P 500 is up 70% since the March 2020 COVID-19 panic bottom. It's important to keep this level in context, too. The March 2020 COVID-19 bottom, which dealt a lot of pain to speculators, represented a three-fold increase in long-term investor capital for the bargain hunter that scooped up shares of the S&P 500 index at the March 2009 bottom of the Great Financial Crisis.

For the intelligent investor that understands the importance of long-term compounding to equity returns, we don’t think they’ll be shaken out of this market. Still-single digit levels of inflation and little sign that it ever will accelerate from here coupled with still-modest moves in the interest rates to the upside (within a historical context) suggests to us that panic selling is in full force, exacerbated by the slide in crypto prices, which has damaged speculative holdings and household wealth, to varying degrees, in our view.

Keeping Things In Perspective

Based on our calculations, using YahooFinance data: From the last trading close, the simulated Best Ideas Newsletter portfolio is outperforming the S&P 500, as measured by the SPY, by about 5 full percentage points so far this year in 2022, despite being fully invested, and without including the consideration of dividends. The year 2022 comes after strong absolute hypothetical performance during this massive bull market cycle, too. What's not to like?

Facebook, now Meta Platforms (META), PayPal (PYPL), and Alphabet (GOOG) have been disappointing so far in 2022, but that’s why we don’t have a simulated portfolio of just three stocks, but rather one of 15-20 securities. Some of our recent adds to the simulated newsletter portfolio, namely Exxon Mobil (XOM) and Chevron (CVX), coupled with the contributions from the Energy Select SPDR (XLE) and Vertex Pharma (VRTX) have cushioned the simulated Best Ideas Newsletter portfolio nicely to drive relative outperformance.

Don’t Fear the Bear Market in Stocks

We’ve seen all of this fear before, and the markets have come roaring back to new all-time highs again, and again, and again. First Trust concluded in their work “History of U.S. Bear & Bull Markets,” that the average bear market period during the post-World War II era was about 11.3 months, while the average bull market lasted 4.4 years. Average bear market drawdowns were 32%, while average total cumulative total returns averaged 154.9%. In this historical context, it's just hard to say that 2022 is out of the ordinary.

Don’t fear the bear!

We’re keeping a level-head in this market environment. Sure, the S&P 500 has come in a lot during the first half of 2022, but the simulated Best Ideas Newsletter portfolio is outperforming the S&P 500 by an estimated 5 percentage points, even though it is down by a mid-teen percentage. Stocks will continue to be volatile, but frankly, there isn’t much that we see right now that is too concerning. The media plays on your fears to drive clicks and eyeballs, so be cognizant of this as you're watching television or reading the latest from well-known perma bears. 

What we think we’re witnessing in equity markets is merely deleveraging in the crypto space (some forced selling) and a myopic focus on Fed activity, which while very important, isn’t as important with benchmark rates, namely the 10-year Treasury, hovering at just 3.5%. We think many investors are getting too worked up over what might be ahead of the markets, but it’s important to keep things in the here-and-now, too, at times.

More Upside Potential Than Downside Risk for Investors with Long-Enough Time Horizons 

Clearly, the 10-year is not at 13.5%, but rather at 3.5%, and while it has moved aggressively higher in recent months, it is still near all-time lows, and very few are actually calling for the return of double-digit interest rates like that of the 1980s either. That said, of course, there will always be things to be worried about – whether it is the war in Ukraine, rising inflation rates, the Fed, consumer confidence, business spending, or name your metric.

It’s actually quite easy to find this data point or that data point or this correlation or that correlation to be worried about, but the reality is that the simulated Best Ideas Newsletter portfolio is down an estimated 16.6% so far in 2022 after huge hypothetical gains the past many years. We think speculators are getting too far ahead of themselves.

From our perch, the market behavior in 2022 is all part of a normal stock market cycle, and while it's hard to call a bottom amid the selling pressure that we've witnessed, there is considerable upside potential in the stock market versus downside risk for investors with long-enough time horizons, in our view.

Concluding Thoughts 

Investors should be looking for opportunities today, while others around them are panicking, especially those that leveraged into crypto many months ago near the peak.

We continue to be huge fans of the areas of large cap growth and big cap tech as these areas not only are flush with entities that have strong cash-based sources of intrinsic value but also have been beaten down unfairly in recent months, in our view. 

It may be hard to believe amid all of this selling pressure, but we’re staying the course with our newsletter portfolios. We like stocks for the long haul, and we don’t expect anything like what happened during the COVID-19 meltdown or the Great Financial Crisis.

This is but a "normal" bear market in our view, and we still believe stocks could make a huge rebound in the near term.

Don't forget to read, "Cash Is A "Terrible Long-Term Asset," and why we think the market may be due for a huge rally here.

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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson's household owns shares in HON, DIS, HAS, NKE. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.

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