The Wall Street Panic of 2008

Panic: In economics, acute financial disturbance, such as widespread bank failures, feverish stock speculation followed by a market crash, or a climate of fear caused by economic crisis or the anticipation of such crisis.
-- Britannica Online

Make no mistake -- by this definition, what we've witnessed so far in 2008 is nothing less than a global market panic.

Acute financial disturbance? Freddie Mac and Fannie Mae imploded. Bear Stearns got "rescued" along with AIG (NYSE: AIG  ) , but somehow Lehman Brothers wasn't saved. Money markets "broke the buck," and there was a formal bank run on IndyMac.

Feverish speculation followed by a crash? Our housing bubble fueled excessive borrowing and risky lending practices, resulting in the credit crisis we're now dealing with. The S&P 500 is down 31% year to date, erasing the past five years of market gains.

Climate of fear? U.S. investor sentiment is at record lows, and the CBOE Volatility Index (the "fear index") has posted all-time highs in recent days. No one seems to know where the next shoe will drop.

The list, sadly, could go on.

Don't panic
Of course, no one wants to call this a market "panic." Instead, in most places it's been labeled a "crisis." In fact, the term "panic" hasn't been widely used to describe a market since the Panic of 1907 -- which is unfortunate, because understanding this as a panic has something to teach us.

In the 19th century (the high time for market panics), Yale professor William Graham Sumner defined a panic as:

... a wave of emotion, apprehension, alarm. It is more or less irrational. It is superinduced upon a crisis, which is real and inevitable, but it exaggerates, conjures up possibilities, takes away courage and energy.

In other words, the subprime and credit mess is the "crisis," and the "panic" is the exaggerations and doom-and-gloom language that come with it. We've seen plenty of that in recent months. Three of the world's major financial publications have likened our current economy to the Great Depression more than 250 times so far this year. So please, let's call this market by its proper name: the Panic of 2008.

Fortunately, "a panic," Sumner continued, "can be partly overcome by judicious reflection, by realization of the truth, and by measurement of facts."

Let us be judiciously reflective
So what do the panics of the early 20th century tell us about how we might overcome this one?

The last official panic -- the Panic of 1907 -- shook the U.S. economy to its core. Wall Street brokerages failed, depositors ran on banks, well-known companies went under, and the market's liquidity was in question. (Sound familiar?) In this instance, J.P. Morgan and friends famously put together $25 million to keep the market afloat -- a role now occupied by the Federal Reserve. By 1909, the Dow Jones index had more than recovered from pre-panic highs.

In 1914, the year the Great War began in Europe, the U.S. stock markets actually closed for nearly four months after foreign investors began pulling their money out of U.S. equities en masse to support the war effort. When it reopened, the market was devalued about 30%, but sustained rallies doubled that opening by the end of 1916.

Then, of course, came the Great Depression -- the single most important economic event in U.S. history -- which began with the Crash of 1929 and lasted arguably until the U.S. entered World War II in 1941. In 1932, unemployment hit 24.9%, and more than 9,000 banks failed during the 1930s. And there were no federally insured deposits until the Banking Act of 1933 created the FDIC, so when the bank failed, your money went with it. In fact, Wall Street's very future -- not to mention the economic model of capitalism -- was in question.

For those investors who had both the money and the courage to invest in the 1930s, it paid off. One man famously borrowed money to buy 104 U.S. stocks trading for less than $1 a share in 1939. Talk about investing at the point of maximum pessimism! Four years later, though, his money had quadrupled. His name, of course, was John Templeton.

OK, what's your point?
Judicious reflection, realization of the truth, and measurement of facts all say the same thing: We've seen markets like today's before -- and some far worse. And in every case, the point at which the market has turned irrational or overly pessimistic is precisely the time we long-term investors should have bought equities.

Despite the headlines proclaiming the next Great Depression, this is no Great Depression -- only a panic helped along by the short-term mind-set of the financial industry. Financial media's job is to attract readership by sensationalizing news events, and financial institutions, which are built on commissions and fees, want to keep money moving in and out in order to bulk up their own revenues. So both fan the flames of panic.

Individual investors like us do not have the advantage versus Wall Street when it comes to short-term trading, but we do have longer time horizons. Wall Street focuses on minutes, hours, and days, while we focus on years and decades. And that's what makes their panics a good time for us to buy.

Let's take the most modern example of market irrationality -- the dot-com bubble and subsequent burst -- and see what's happened to some quality names since the S&P 500 was near its low in September 2002.

Company

Returns (9/30/2002-Present)

Cisco Systems (Nasdaq: CSCO  )

80%

Oracle (Nasdaq: ORCL  )

113%

Schlumberger (NYSE: SLB  )

264%

CVS Caremark (NYSE: CVS  )

139%

Baxter (NYSE: BAX  )

127%

Adobe Systems (Nasdaq: ADBE  )

201%

Data provided by Capital IQ. Returns adjusted for dividends.

You didn't need to be a market genius to invest in these names in 2002. They were all well-known to both consumers and investors. All six had been beaten down considerably by the bear market, though, and that downturn presented investors with excellent opportunities to buy great companies at great prices.

Ironically enough, however, the third quarter of 2002 had the fewest equity-based mutual fund assets of the entire post-dot-com bust. Put simply, investors bailed on the market at exactly the wrong time.

It's still scary
Don't get me wrong -- some of the financial headlines we've seen over the past few months are downright frightening. But it's important to not join the panic and to keep a long-term perspective on market panics, booms, crises, and everything in between. In this market, that means you should keep investing, and make sure you're diversified.

At our Motley Fool Stock Advisor investing service, Fool co-founders Tom and David Gardner had a lot of success picking up great companies during the post-dot-com bust. Their long-term focus helped them add names like Amazon.com at a time when the market wanted nothing to do with them -- and their picks are subsequently beating the market by 30 percentage points on average.

They're taking a similar approach now, and count top brand names such as Starbucks among their "best buys" right now. To see what else they're recommending, take a free, 30-day trial. Click here to get started -- there's no obligation to subscribe.

This article was originally published on Sept. 4, 2008. It has been updated.

Todd Wenning panics at the sight of clowns, but at little else. He does not own shares of any company mentioned. The Fool, on the other hand, owns shares of Starbucks, which is a Stock Advisor and an Inside Value pick. Amazon is a Stock Advisor recommendation. The Fool's disclosure policy keeps a steady hand.


Read/Post Comments (13) | Recommend This Article (79)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 08, 2008, at 5:30 PM, sadifooled wrote:

    I think we have had enough of this smooth talk by self declared and teflon coated experts. All this talk of glorifying 'investing for future' in stocks is nothing short of duping people (making us 'fools') and fleecing their money so that commission and fees may be earned. What we are seeing is the 'house of cards' of capitalism showing its true face. Let buyers be beware and just rest easy with hard earned money and be happy with dollar for dollar, No need to gamble anymore!

  • Report this Comment On October 08, 2008, at 7:15 PM, crayonmonitor wrote:

    Folks. Listen.

    Just turn off the computers and see if your actual thought processes will cause such a panic. This is 99% caused by automated trading tools running in a sliding market. There are more shares traded in a second now than in the first year of real people actually buying and selling shares. The "safety settings" for day traders are multiplying the speed of the effect by factors of thousands. And don't think "pro traders" use any other settings. They simply sold thier settings to the "trading software" companies.

    This is not panic. This is a few houses on Long Island at risk.

    And if you don't sell, you won't lose. Keep the stock. the companies are still there. Buy them if you like them. The big banks certainly will be. For peanuts.

    Don't let journalists make up news for their own sake. Some days there is no news.

  • Report this Comment On October 09, 2008, at 5:24 AM, manuelj76 wrote:

    The market is the market. Things go up and they can equally come down. If this is really as bad as it seems then buy puts. Make money hands over fists shorting big household names. Now is the time. If things are really so bad then why hold on to your cash? Buy gold! You think people take paper money in the middle of a depression? This is quite needed in our economy. We need to recycle our thought process and realize the harm that unrestrained capitalism can have.

  • Report this Comment On October 09, 2008, at 4:31 PM, lilsu wrote:

    I am new to The Motley Fool. I am disappointed to find such misinformation as the U.S. having the largest oil reserves in the world. It is well known that Saudi Arabia still has more oil in the ground than the U.S. ever had! Most people suspect that Iraq has more than the Saudis. If I am being misled by this kind of misinformation, can I trust anything on this site?

  • Report this Comment On October 09, 2008, at 4:51 PM, jcktman wrote:

    There's only one thing to do - HOLD ON TO YOUR SHORTS!

    If you cash is already invested close your eyes and take your hands off the wheel and open them in 2yrs.

    If you still have some cash. Buy equities now!

  • Report this Comment On October 09, 2008, at 5:03 PM, SusieQ213 wrote:

    I smell a bargain! It's interested to sit back on the sidelines knowing my automated investments continue averaging my cost basis down. People will continue to need drugs, consumer goods, etc., so I will sit back, put away my 401k statement, and prepare for a bumpy ride. I have the time and the fortitude for both...

  • Report this Comment On October 09, 2008, at 6:38 PM, zygnoda wrote:

    TMFPhila

    I think he/she is refering to the silly invesment promos.

  • Report this Comment On October 09, 2008, at 9:18 PM, davidn46 wrote:

    Why is Chesapeake Energy (CHK) still rated as

    a five cap stock (i.e. highly recommended by

    the fool community) when it has lost over

    50% of its value over the last 4 weeks?

    In part,based on the 5 cap rating, and my trust of the Fool Site ,I've been

    holding on to my 200 shares of CHK

    thinking that if it weren't good it would have

    been down graded by the community

    to at best 4 caps. But no, it's still

    a highly rated five capper.

    Why?

    I am really beginning to feel fooled,as in

    mislead, and deceived. This is not a good thing. Losing capital is one thing,

    but losing trust, that can't be replaced,

    is in some ways a greater disappointment.

    Please clarify this situation for me,and let me know what you recommend . Thank you.

  • Report this Comment On October 09, 2008, at 11:14 PM, lilsu wrote:

    Todd,

    It was one of those investment ads. The webmaster should monitor these ads for truthiness!

  • Report this Comment On October 10, 2008, at 1:26 PM, borneofan wrote:

    TMFPhila....

    The real question is economic recovery cost. US and Canada have fantastic reserves of oil shales, coal, natural gas and offshore deposits. However the recovery cost has always been well above $50/bbl, whereas some of the arab world can easily extract hydrocarbons at less than $5/bbl.

    There is no lack of oil. There is a lack of oil that can be cheaply accessed. And there is a real shortage of private oil fields (almost 90% of oil is held by gubmints and not harvested at all, or very inefficiently).

    Witness our own political folly with ANWR: we have been politically unwilling to responsibly use 1000 acres of a several 100,000 acre plot of uninhabitable land for oil and natural gas exploration.

  • Report this Comment On October 10, 2008, at 5:47 PM, vb123 wrote:

    Hope this will go down in history as the "not so great depression" ...

  • Report this Comment On October 11, 2008, at 1:06 AM, Scales7 wrote:

    I like the attempt to blame capitalism for the "free markets" crashing. Bla Bla Bla.

    First of all it was the political pressures from Washington bearing down on these markets that started the spiral and kept the spiral going that got us here. Shame on Washington for doing that to us. Shame on the Corporations buckling under pressure and shame on the "investors" for jumping on board. My money is invested in a company with great management and long term profit potential and I have lost a dime. This has been our biggest an most profitable year. The company is MINE and I am a Capitalist and love Free Markets. It is so easy to make money when I compete with SO MANY idiots.

  • Report this Comment On October 14, 2008, at 5:14 PM, starzagazin wrote:

    Times of panicky selling are opportunities for judicious buying. There is a silver lining in the market right now for those who keep there eyes open for undervalued stocks. I think Crayonmonitor's comments about automated trading tools exacerbating the market slide are spot on. Don't be "fooled" into selling online or otherwise. Stay diversified, stay the course and reap the rewards in 2-3 years. Seeking permanent solutions (selling out) to a temporary problem is just asking for a good pocket cleaning.

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