Why Now's Not the Time to Panic

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Ever since the financial crisis more than three years ago, many investors have been waiting for the next shoe to drop. A number of events since then, including the return of $100 oil, the rise of gold prices to almost $2,000 per ounce, the European sovereign debt crisis, and more recently the slowdown in emerging-market growth, have all stoked fears of a new move down for the global economy.

But for six months now, the stock market has largely ignored the growing set of fears about the world's economic future. And even as warning signs mount that suggest froth in the market, you shouldn't use the situation as an excuse to make big panic-driven moves in your portfolio -- even after the huge gains stocks have seen.

Storm clouds gathering?
Recently, bearish analysts have pointed to several indicators that they see as overly exuberant:

Apple's (Nasdaq: AAPL  ) market cap is now approaching $600 billion, reminding some of when tech rivals such as Microsoft (Nasdaq: MSFT  ) briefly supported half-trillion market caps during the dot-com boom before coming crashing back down to earth.

As earnings season begins, the strong growth that we've seen ever since the huge losses of 2008 and early 2009 is beginning to plateau. With projected earnings growth of 3.2% for the S&P 500 this quarter coming in far slower than the 19% growth rate at this time last year, many companies will face much harder comparisons in 2012 than they have in years past. Alcoa (NYSE: AA  ) leads off earnings tomorrow, and it's projected to post its second straight loss in the first quarter because of weak aluminum prices and slackening demand.

The Federal Reserve's reluctance to add more monetary easing led to a spike in interest rates. The effects of higher rates -- ranging from higher government borrowing costs to consumers having disposable income to spend -- could bring the already-fragile economic recovery in the U.S. to a standstill.

Geopolitical and economic issues present many challenges. Already, the Chinese stock market has plunged, and Europe may face major problems if bailout plans turn out not to work.

With the market arguably overdue for a correction, all these fears seem justified. But before you jump to conclusions and sell all the stocks you own, you have to put the current situation into a broader context.

Where we were and where we are
The most dangerous words in investing are "this time it's different." But there are some big differences between current and past conditions that should reassure you that a huge crash isn't imminent.

For one thing, even though the stock market hasn't made much progress since 2000, earnings definitely have. Looking at data compiled by market researcher Aswath Damodaran, overall S&P 500 earnings jumped from their then-high of $56 in 2000 to more than $97 last year. So even if earnings do start to grow more slowly, the slowdown comes from a higher base level.

The same idea holds for individual stocks. At certain points in early 2000, Cisco Systems (Nasdaq: CSCO  ) traded at more than 200 times trailing earnings. Intel (Nasdaq: INTC  ) peaked at above 60 times earnings, while Microsoft sported an earnings multiple of nearly 80. Those valuations practically promised a bearish shakeout at some point. By contrast, Apple's current market cap reflects an earnings multiple of just 18 -- and if you take out the drag that nearly $100 billion in cash has on the earnings power of the company, you get an even less extreme figure.

Looking ahead
Of course, the stock market won't move straight up forever. Last week's modest drop was the worst of 2012 so far, but you can count on it getting worse before the year is out -- even if nothing particularly extraordinary happens between now and then.

Moreover, the threat of more serious problems arising is constant. On top of all the concerns around the world that we know about, the unknown next shoe to drop might be the most catastrophic in terms of what it could do to stocks.

But unless you think that huge earnings drops like what we saw in 2008 are doomed to repeat themselves, the biggest positive that stocks have going for them is that valuations aren't crazily high. So while being prepared for potential trouble always makes sense, panicking now would be the worst move you could make.

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Fool contributor Dan Caplinger isn't panicking even if a guy named Bubba won the Masters yesterday. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Apple, Cisco Systems, Intel, and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft, Intel, and Apple, as well as creating bull call spread positions in Microsoft and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never panics.

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  • Report this Comment On April 09, 2012, at 12:11 PM, steveat wrote:

    The next shoe is Spain.

    You add in people that dropped out trying to look for a job, you're looking at 35-40% unemployment.

    No one cares about Greece anymore. They are responsible for 2% of the EU's economy..they need to does Spain. However, Spain is something like 12% of the EU economy, so it's going to hit harder and the ripple effect will hit the US hard and probably for 6-12 months.

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