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Related topics: Freeport McMoRan, China, stocks, financial crisis, Jim Jubak

The stock market is haunted by ghosts of the bear market of 2000 and the financial crisis of 2008.

Every time oil tumbles or silver plunges I can feel the icy fingers of 2008 creep down my spine and I can read fear in my email. "Should I sell my shares of Freeport-McMoRan Copper & Gold (FCX, news)?" I was asked more than once when silver was on its way from $49 to $35. Understandable question. Shares of the copper and gold miner fell from $57.73 on June 4, 2008, to $12.18 by that Nov. 26. Who wants to go through that again?

When Renren (RENN, news), the Chinese Facebook, goes public at 75 times revenue or when the initial public offering of LinkedIn (LNKD, news) soars to more than $120 a share from its $45 offering price before closing at $94 on its first day of trading, it brings back memories of the dot-com bubble that saw Yahoo (YHOO, news) rocket 154% on its first day of trading. The dot-com bubble turned into the tech bubble and both eventually burst, wiping out not only newcomers like WorldCom, but also established names such as Lucent Technologies and Nortel.

When Greece totters on the edge of default with yields on its 10-year bonds breaking 16.5%, it revives fears of the mortgage-backed asset collapse that took down Bear Stearns and Lehman Brothers -- and almost claimed Citigroup (C, news), American International Group (AIG, news) and the global financial system too.

Fear isn't bad

This remembrance of bears past is a good thing. Fear is as essential to financial markets as hope. Without the latter nobody would buy anything, and without the former everybody would buy everything.

Image: Jim Jubak

Jim Jubak

But investors are supposed to move from blind panic to rational fear as a crisis moves further behind in the rearview mirror. (Although it's wise to remember that "objects in mirror are closer than they appear.") We're supposed to have learned something from a crisis that will make it less likely to occur in the future, but we're not supposed to jump at every noise or lock ourselves in a panic room whenever a car alarm goes off.

So what have we learned, and what do those lessons tell us about the current likelihood of a crisis turning into a market-shaking bear? (The kind of crisis I'm writing about here is quantitatively and qualitatively different from ordinary volatility or the 10% corrections that investors go through regularly -- and that we seem to be going through now.)

What we've learned (I think), No. 1: Extreme overvaluation precedes a crisis -- you might say it's a prerequisite.

Caveat to Lesson No. 1: Extreme valuations are sometimes hard to recognize. The overvaluations of the dot-com bubble were clear to all -- even if all thought they could make money as the extreme got more extreme. The extreme valuations in the mortgage-backed asset bubble weren't as clear -- you had to challenge the prevailing risk assessments for these AAA-rated assets in order to see how badly prices were inflated.

Where we are now on the scale of Lesson No. 1 depends on what market you're looking at. If you're worried about a conventional bubble, I'd say the danger is relatively low.

In emerging markets, for example, their relatively low price-to-earnings ratios -- the trailing 12-month P/E for the iShares MSCI Brazil Index (EWZ) was just 11 as of April 30, well below the 15.6 trailing 12-month P/E ratio for the Standard & Poor's 500 Index ($INX) -- argues that they aren't going to be the locus of the next blow-up.

If you're worried about a bubble in the U.S. domestic stock sectors that have done the best in 2010 and 2011, industrials and materials, their relatively modest relative P/E ratios should reduce your fears. The S&P materials sector trades at a below-index P/E ratio of 15.3, and the industrial sector is at just 17.2. I say "just" because, first, sectors such as telecom (at 18.9) and consumer discretionary (at 17.5) show higher trailing price-to-earnings ratios and, second, because the P/E ratio for the materials sector is down 13.5% since the end of 2009 and for the industrial sector it's up just 0.04%.

Worries about dangers in the eurozone seem more real. Greece is on the road to default -- unless the other countries of the European Union decide to throw more money at the problem. It's hard for me to see how Portugal avoids going the same route eventually.

And if default is the end of the road for these countries, then their bonds, even at the recent yield of 16.5% for Greek 10-year bonds, are overvalued (especially since many banks in Europe haven't yet marked all their holdings of these bonds to market prices). And, of course, right now Europe's financial leaders are hoping that they can hold the line without Spain falling into crisis. I think Spain will skirt the crisis, but I understand the depth of the worry. If Spain falls into crisis, then all current mechanisms for dealing with the crisis will turn out to be inadequate.

And then, as my caveat says, there are those instances of overvaluation that are hard to recognize in the same way that overvaluation in the mortgage-backed asset market was tough to see. For example, U.S. Treasurys would seem to be overvalued given the long-term problems in the U.S. budget and with the dollar. But are they really? The world currently is willing to pay up for the liquidity and security of this market. As long as that lasts, you can make a case that Treasury values are high but not completely out of line.

China's property market has the earmarks of a bubble, and some Chinese stocks are priced in bubble land, but is China as a whole overvalued by enough to constitute a bubble? Certainly bad loans at Chinese banks and massive off-balance sheet debt in the financial sector are legitimate worries. But given the Chinese government's track record of successfully burying bad debt (after the Asian currency crisis of 1997, for example), how much bad debt would be enough to rattle the entire economy?