We believe that today, financial advisers who are deeply convicted in the value they bring to their clients have the opportunity of a lifetime.
In today’s environment they can do one of three things: They can bury their head in the sand and simply say this too will pass.
Or they can also follow the crowd and sell great businesses at steep discounts and “go to cash” as we call it.
The third choice is the best choice, in our opinion: They can lead their clients by engaging with a money manager who seeks to use market sell-offs as a beneficial long-term opportunity.
We believe astute advisers have been brought – literally on a silver platter – a healthy and much needed valuation reset on equity prices.
While we enter a so-called ‘bear market’ that appears to be disruptive while immersed in it, when viewed through the appropriate lens, this market cycle can be hugely beneficial.
As legendary investor Shelby Davis is credited with saying: “You make most of your money in a bear market, you just don’t realize it at the time.”
View it as an opportunity
Warren Buffet best answered this question by saying: “A market downturn doesn’t bother us because it is an opportunity to increase our ownership of great companies with great management at good prices.”
Benjamin Graham a mentor to both Davis and Buffet, said: “The intelligent investor is a realist who sells to optimists and buys from pessimists.”
At Nepsis, we firmly believe that all three gentlemen are spot on and suggest that a deeply rooted conviction in a consistent process is ultimately what leads to progress. It is “Process Before Progress” as we say at Nepsis.
Looking at the data
The two gigantic pieces of data investors were given date back to April 20, 2020 when WTI Crude traded down to -$40.32 per barrel and August 4, 2020 when the US 10-YR Treasury Yield yielded 0.51%.
We felt that energy companies that had wide economic moats, strong management, consistently grew their dividend, and had disciplined their exploration process, had deeply sold-off.
Crude Oil could simply not trade at a negative price. We purchased several great energy-related businesses in Q3 of 2020 and still hold them today.
When the 10-YR Treasury dipped to 0.51% we believed it reflected undue fear in the underlying economy, and we believed rates needed to significantly rise.
We sought companies with sound earnings and solid dividends in the Large-Cap Value space with modest valuations that could weather a nearly 7x rise in rates to 3.45%.
We continue to own many of those businesses today as we believe this valuation reset is generational in nature.
Where do we go from here?
Before we answer this question, we want to reiterate that predictions and prognostication are a fool’s game. This being said, a prudent research and investment process can provide insight as to what the future may bring.
In our estimation, two things that cannot be dismissed are higher prices of goods and services, and higher interest rates.
A combination of many subcomponents leads us to this conclusion including the re-shoring of operations from overseas, and a declining workforce, causing higher wages – both of which will lead to a sustainable inflation rate of 3-4% and not the 1-2% from which we have been accustomed.
Historical analysis would suggest in this environment, that several conclusions can be made regarding the metrics one would want to entertain.
They include businesses with high free-cashflow, wide economic moats, dividend growth, revenue and EPS growth coupled with low debt-to-equity ratios and strong managements.
These “Quality Factors” give investors a margin of safety that allows for sustainability in times of peril.
Process and clarity
Due to higher inflation and interest rates, the days of speculative, highly-levered growth stocks being given a free-pass are behind us.
Individual security selection as opposed to market-cap weighted index collective ownership products, and an active, tactical management versus cookie-cutter solutions will provide investors with far better opportunities.
Lastly, although we believe that this secular bull market is only in its 6th inning or so and it looks like the bottoming process has slowly begun in this cyclical bear market, better days are ahead.
Moreover, our world as money managers and advisers has changed and we need to adapt by being highly-selective in how we advise our clients going forward.
At Nepsis, we hold to this statement: Investment process and clarity – which to us means that clients know what they own and why – is paramount, now more than ever.
Chuck Etzweiler is senior vice president of research at Nepsis, Inc.