Top 5 Reasons to Stop Freaking Out About Financial Armageddon

OK, everybody calm down. The American empire isn’t collapsing. You don’t have to buy guns and move to the mountains. We’re not facing another Great Depression. And if you’re an investor, you can be assured that there will be plenty of profitable opportunities again…

Warren Buffett famously said that you have to be greedy when others are fearful, and fearful when others are greedy. Wise words, especially when investors get swept up in the short-termism of sensationalist financial media.

I believe we’re still far away from a point of capitulation, and the stock market correction might continue for a few weeks. In the meantime, it might be useful to take a long-term perspective on some of the doomsday predictions that have been circulating.

Reason #1: This is Not the End of the U.S. Empire

Being a foreigner living in New York City, I’ve always been intrigued by how many Americans feel insecure about their country’s domination of the global economy.

This isn’t a recent phenomena, and some might go as far as to say that this insecurity is deeply rooted in the American psyche. During the Cold War, the Soviet threat turned out to be an illusion. Everyone thought Japan was taking over the world in the ’80s, but it didn’t work out that way. And we might end up saying the same about China.

According to a Gallup poll in February, 52 per cent of Americans think China is the world’s leading economic power. Nothing could be further from the truth: China’s Gross Domestic Product is less than two thirds that of the United States. GDP per capita is roughly one to six ($47,123 to $7,518), according to 2010 figures from the International Monetary Fund. As far as productivity is concerned, one American produces, by some estimates, as much as six Chinese.

Is America going through a tough time? Yes. Is America’s empire collapsing? Absolutely not — it’s all in your head.

Reason #2: It’s Good For The (Overvalued) Stock Market To Correct Itself

The stock market has dropped almost 10 per cent from its April high, but no one wants to buy on the dip. The reason? It’s quite simple, actually. The recent market manipulation of the Fed’s quantitative easing program (i.e. QE2) has distorted market mechanisms to the extent that most fundamental investors scared away.

The Fed has done some serious damage to investor confidence, and it’s going to take some time for the damage to be undone. But Bernanke & Co. are running out of bullets, and they can’t keep propping up the market forever. The market now needs to discount a new reality — a deleveraging financial system, austerity and structural unemployment (just to name a few factors).

This is, of course, a healthy and necessary step. It’s the way stock markets are supposed to work. And when the deleveraging ends, stock market valuations will come down to more reasonable levels, offering attractive risk/return opportunities for investors.
 
Reason #3: The U.S. Dollar is Not Going to Collapse

The widely-held belief of a greenback collapse is probably an extension of American insecurity described in reason #1. It’s interesting that so many investors take the currency’s demise as a given, and this excessive pessimism definitely raises a flag.

The long-term outlook of the dollar is a complex topic, and I’m not going to go into details. The most likely scenario, in my mind, is a gradual decline, as opposed to a sudden collapse. And a gradual decline could lead to a new renaissance of American exports.

Who knows, maybe the U.S. can become a net exporter again? That might sound ludicrous, but the inherent flexibility of the U.S. economy makes this a real possibility. (By the way, U.S. exports to China have already begun showing strong growth)

Reason #4: The U.S. is Already Solving its Debt Crisis

People often freak out about countries’ sovereign deb to GDP, but there’s really nothing special about government debt. “What matters is total leverage, and it turns out, the U.S. is already making progress on this front,” wites Joe Weisenthal at Business Insider.

Judging by this chart, compiled by Morgan Stanley, it’s clear that on net, the U.S. has been deleveraging for a while now, even if nominal government debt continues to rise.

Between the economic growth, and debt reductions at the household, things are already getting more “sustainable”, according to Weisenthal.

Reason #5: Crisis Presents Opportunities

Every crisis presents opportunities, and America has become great because it could make the most of past crises. There is no reason to believe that it’s different this time around…

(By Eben Esterhuizen, CFA)

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