With the Dow reaching a 20% decline from its October peak and officially entering "Bear Market" territory, it's natural to feel beaten and broken. More depressing, globally, stocks had their worse first six months in 26 years and with direct correlation, there wasn't a venture backed IPO for the entire quarter for the first time in 30 years. General Motors, which was once and maybe again the proxy for the welfare of America ("how GM goes so goes the country"), fell to a market cap level it hadn't seen since Gerald Ford was passing out W.I.N. (whip inflation now) buttons and at one point on Thursday, was at a price it hadn't seen since Dwight Eisenhower was President.

Core inflation - just 1% 18 months ago - has reached 4.4%. Non-core inflation including energy and food is up 8% (only an economist could rationalize how energy and food weren't "core"). Moreover, oil is up over 40% year-to-date and commodities are up over 30%. The flat world is getting pumped up with 60% of the countries world-wide experiencing 10% or greater inflation in 2008. It's no mystery that gold is surging at over $900 an ounce and the dollar has fallen 40% in the past five years.

As bad as it seems in the real world, on Wall Street it's even worse with 5% of the employees fired in the past year or approximately 100,000 people; a major bank Bear Stearns going "poof" over a weekend and hundreds of billions of dollars written off from bad debt and many billions more to come. The "it's recession if it's your neighbor and depression if its you" definition is definitely at work contributing to the doom and gloom. Together with the media, you could easily be convinced we'll be seeing legions of people selling apples on the corner any day.

While seemingly EVERYBODY is in the camp that we are heading into the bear infested woods, I'm much more optimistic. Two truisms come to mind; "if it's in the papers, it's in the prices" and "the time to be fearful is when everybody is greedy, and greedy when others are fearful"—these have provided an accurate compass in the past that I'm counting on today.

One of the characteristics of great investors is they make complex things simple. How do you make the best returns in the stock market long-term? Find the fastest growing companies, with the 4Ps, close your eyes, take a deep breath and hold on for the ride.

Simple, and theoretically correct, but back on planet earth we have to be at least aware of the short-term realities of the stock market. Or as John Maynard Keynes said - "Markets can remain irrational longer that you can remain solvent." Ben Graham's voting machine versus a weighing machine is a great analogy to understand how the market works in the short-term and how it works in the long-term.

In the short-term, the market is like a voting machine which reflects the mood of the moment. What's popular, and what's not. Market sentiment, and the conventional wisdom of the day. In the long-term, the market is like a weighing machine and it measures is one thing: earnings. We win by identifying and investing in companies that generate the most earnings and earnings growth, but we have to be alive to collect.

In order to help understand the near-term influences for stock price movement, I track six variables I call the 6 Is. These 6 Is could effectively be viewed as a weather report before I was going to play a round of golf. It's helpful for me to know if it's windy, rainy or cold so I know what I'm going to face and be prepared. If the weather is so bad that it's impossible to go out and play, I can wait in the clubhouse until playing conditions get better. But in the end, all that matters is what the scorecard says after 18 holes!

#1 Inflation

Inflation is an increase in the general level of prices and a fall in the purchasing power of money. Given that the lion's share of value for growth companies is based on its future earnings, inflation, which makes these future earnings less valuable today, has an outsized negative impact for growth companies. Going back to the concept of "discounting" future earnings, the rate of inflation is a primary driver of the appropriate discount rate.

Inflation also has a direct impact on company profitability. In a low inflation environment, or in deflationary environments, the risk for companies making longer-term investment decisions lessens. True growth companies should have disproportionate advantages in low-growth and/or low-inflation environments. Conversely, in periods of high or accelerating inflation, the risk of profitability eroding increases as does the difficulty in calculating long-term investment outlays.

Accordingly, monitoring inflation trends is the most useful in understanding short-term risk for emerging stock prices.

Currently the #1 negative for growth companies doing well in this environment is the high level of inflation. With the CPI currently tracking at 4.4%, investors need to be compensated for future earnings versus near-term destruction of purchasing power. The long term Megatrends of Globalization, Outsourcing, and the Internet should keep inflation in check from a secular standpoint, but the cyclical inflation pressures caused from the demand imbalance for energy and food in emerging countries creates a short- to intermediate-term negativity.

#2 Interest Rates

It makes intuitive sense that the higher the "here and now" interest on CDs or yields on bonds are, the less growth companies' future earnings are worth today. Of course, the reverse is also true, the lower the interest rates are the more valuable future earnings are today.

Academically, interest rates in their own right don't reflect anything more than the present value of future payments. Sometimes, the relationship between interest rates and stock performance can provide a false picture, if for example, economic growth was accelerating - which is usually good for stocks - interest rates could rise due to interest payments.

While the perception of risk with higher interest rates may be overblown somewhat, the fact remains that the bulk of its earnings to be received by stock investors are much farther out into the future. The net result of this is that growth companies are more severely impacted by fluctuating interest rates than the overall market.

By looking inside the current level of interest rates, we can better understand whether interest rates reflect inflationary concerns that have yet to materialize or a rise in equity risk-aversion.

Using our matrix with a T-Bill rate of 4%, it would suggest that a company growing at 25% for the next three to five years should sell at 32 times the twelve month forward P/E. A company projected to grow at 35% should sell at 44 times twelve month forward P/E in a 4% ten-year T-Bill environment.

Looking at the ThinkGrowth Index - the 300 fastest growing companies in the US market - the index has a projected growth of 25.4% and is selling at just 20 times 2009 earnings. Based on our P/E to growth matrix, we think a fair value is closer to 32 times earnings - suggesting that growth stocks are significantly undervalued.

Currently with earnings yield for the S&P 500's earnings yield at 7% and the 10-year note of 4%, equities are 73% undervalued to stocks

#3 Indices (Market Valuation)

Understanding the relative valuation of the market versus historic data and in context with the current growth and interest rate environment helps put perspective on the near-term risk and opportunity.

Historically, the P/E for the S&P 500 is 14x and earnings have grown at 7% with a 3% dividend yield, and inflation of about 3%. So for example, if the P/E for the S&P 500 was 20x and EPS growth was expected to be 5% and inflation was 8%, I would be very worried about the near-term vulnerability of the market. On the flip side, if the P/E was 10x, the EPS growth was 20% and inflation was 1%, I'd be backing up the truck.

As mentioned in our interest rate section above, on a PE to growth basis and a simple earnings yield basis, growth stocks and the market overall are significantly undervalued.

#4 Investor Sentiment

Valuation levels by definition reflect investors' sentiment but leave much to be desired in explaining market moves in absence of fundamental changes. A classic way to gauge investor sentiment is to simply ask them - are they bullish or bearish?

Investor Sentiment polls are fraught with issues, but they are somewhat useful to get a general sense of investor optimism/pessimism with the usefulness driven as a contrarian indicator.

When investors are at bullish extremes, it's generally a warning signal to be cautious and when investors are at negative extremes, it's generally a good time to get more opportunistic. We find put/call ratios, short interest and cash ratios in mutual funds all more useful than sentiment polls because it reflects what investors are doing as opposed to what they are saying. Again, the value of analyzing these ratios are as a contrarian sentiment indicator - i.e. heaving shorting in market bullish, low levels of cash in mutual funds bearish, etc.

Currently, investment sentiment polls show that 31.3% of investors are bullish, while 52.3% are bearish. This shows an extreme level of bearishness, which as a contrarian indicator is very positive for the market. Moreover, put-to-call ratio is at 1.2 and the short interest ratio is approximately 14% - both indicating very high levels of bearishness providing stocks the "wall of worry" they need to climb.

#5 Inflows (Outflows) to Equity Funds

At the end of the day, the stock market, like all markets, is a function of supply and demand. Inflows into equity mutual funds are critical to understand the supply and demand fundamentals of the stock market.

Demand is created by cash inflows into equity mutual funds, corporate stock buybacks, and mergers and acquisitions done in cash. Supply is mainly the stock manufactured by Wall Street in the form of IPOs and secondaries. Cash inflows or outflows into funds could be looked at as a contrarian sentiment indicator, but it needs to be balanced with the supply-demand effects of this as well.

Looking at the inflows into equity mutual funds as potential firepower or outflows to sap demand is extremely valuable to understand near-term influences on the market.

Last week, outflows of $13.4 billion is bullish as a contrarian sentiment indicator, but is bearish from supply demand standpoint. Moreover, while there has been $26 billion of outflows into equity mutual funds this year, corporate stock buybacks and the minimal equity supply created by Wall Street have created a modest positive demand imbalance for stocks.

#6 IPO Pricing

One of the most useful week-to-week indicators of true investor sentiment is IPO pricing relative to a company's filing range. Unlike an "Are you a Bull or a Bear" survey, investor sentiment is a real-world indicator of how investors are actually voting—with their cash. Historically, IPO pricing has been an effective tool for measuring the relative strength and health of investor sentiment, by not only capturing how investors are monetizing their sentiment, but also whether they are becoming excessively optimistic or pessimistic.

In a normal market environment we would anticipate that roughly 20% of new IPOs price above the filing range; 60% within the range and the remaining 20% below. Additionally, we would expect an IPO to have a "pop" - trading up 10-15%. In a frothy market, 50% or more of IPOs may price above the filing price. The IPO "pop" may be 25% or more. In a very pessimistic market, IPO pricing is weak where very few if any IPO's price above the filing range, there is a minimal IPO pop, and in fact, many new issues trade down. When the market gets too "hot," something always happens to cool it down and this is the greatest risk with high multiple, high octane growth companies.

Year to date, there have been a remarkably low 27 IPOs, which if this pace continued would be a lower issuance than even the dark, dark days of 2002. Moreover as we mentioned before, there were zero venture-backed IPOs, which hasn't happened since 1978. While the $27 billion total capital raised in IPOs year-to-date isn't horrible, when you ex- out the fact that Visa accounts for $18 billion of this, we are back into the pathetic territory. Additionally, looking at the last 10 IPOs that have been priced, seven of the ten are trading below their IPO price. While this is not good news for a growth investment bank such as Think, it is very bullish for the outlook for equities, as it indicates that we are getting very close to a time when growth stocks will come back into fashion.

While I'm reminded of Peter Lynch's observation that "it's always darkest before it turns pitch black," I believe the current environment is outstanding to buy the best growth companies in the world at discount prices. I'm not sure when the sun will rise in the East again, but I know it will and when it does, investors are going to be well rewarded by the fastest growing companies on "sale". I love the education stocks which are great companies in an economic downturn including Devry, K12, American Public University and Capella Education. Google and Apple, in my view the two best growth companies in world, are selling at substantial discounts to the future earnings power.