(FORTUNE Magazine) – The worst is over, right? That's what a lot of people on Wall Street are currently saying. And with the Dow holding steady and the Nasdaq up some 20% from its low, it's easy--almost too easy--to believe that we're headed for a relief rally like the surge that followed 1998's market swoon.

Indeed, even with a lot of ominous economic data out there, Wall Street's faith in equities remains pretty much intact. "Buy the dips," says a January report by Merrill Lynch strategist Christine Callies, and she's far from alone. First Call reports that Street strategists recommend that on average 70% of your portfolio be in equities. The consensus is that the current slowdown will be nothing but a bad memory by the second half of this year, and expectations for both the overall market and major tech stocks are still sky-high. Goldman Sachs as well as CSFB say the S&P 500 will be at or above 1,600 in 12 months, a gain of almost 20%. And even though CSFB recently reduced its 12-month target for Cisco from $87 to $65, that still represents a 55% jump from Cisco's current price.

It sure sounds nice, but there are strong reasons to be cautious right now. Wall Street firms make money by selling stocks, and it's probably naive to expect them to say that stocks are a bad business. Analysts' "buys" are notoriously untrustworthy. And as for the strategists, these are the same people who have been saying "buy" since the Nasdaq crossed 5,000 (see "The Price of Being Right," on analyst Mike Mayo, earlier in this issue). This is also the same crowd who argued that tech stocks were growing so quickly and had so little debt that they would be immune to rising interest rates, and who predicted when the Fed first began raising rates in 1998 that there would be one increase, then two, then three...you get the idea.

"A highly paid Wall Street professional isn't going to say, 'I'm sorry, I missed it, I cost you millions, and now I don't know what's going to happen,' " says J. Thomas Madden, chief investment officer at Federated Investors. But the truth is, no one does know. And some market observers like Madden are concerned--in part precisely because the Street seems a little blithe about the current downturn. Sentiment watchers wait for faith to turn to utter despair before a market slide reverses course. "It's complacency, concern, then capitulation," says preeminent skeptic Byron Wien of Morgan Stanley, who notes that we haven't seen real capitulation yet. Some grizzlies are even reworking the old phrase--the only thing to fear isn't fear itself but rather the lack of it.

"Investor psychology is intact to a greater degree than the severity of the Nasdaq collapse would have led me to predict," says Madden. "It has to make you somewhat nervous, since the typical bear market isn't over until there's panic and abandonment of an asset class." And Bernie Schaeffer, of Schaeffer's Investment Management, notes that "most of the current optimism for the months ahead is centered on a major recovery in tech stocks." The recent rally, he says, has "postponed, but in my opinion not necessarily avoided," another test of the lows we saw in early January.

Much of the optimism is based on the belief that the Fed will fix everything, including our portfolios, by aggressively cutting rates--the mantra being "In Greenspan we trust." Karl Mills, vice chairman of Jurika & Voyles, prefers to call it "knee-jerk optimism." Given the magnitude of the Nasdaq's crash and the negativity that he's hearing from consumers and companies, Mills isn't sure that such a quick fix is forthcoming. "How can you have a bubble of this magnitude and have it fixed in 15 minutes?" he asks. At the very least, it's ironic that the same people who believed that tech stocks were impervious to interest rates are now looking to interest rates to spark a recovery.

It's also seductive to think that since the market is cheap relative to where it was recently, well, it must be just plain cheap. But many stocks that dominate the headlines aren't, at least not by historical standards. The Nasdaq 100 still trades at about 55 times 2000 estimated earnings, according to IBES, while the S&P 500 sells for some 24 times, vs. its average of 15.1 since 1926, according to Ned Davis Research.

What's more, the tremendous disparity between growth and value stocks persists. Andrew Bischel, the president of money management firm Spare Kaplan Bischel, says that according to Barra, a quantitative research firm, growth stocks historically sell for about five P/E points more than value stocks do. At the market's peak last spring there was a 35-point spread between them; today it's a still-hefty 20 points. Mills also notes that since 1974, value stocks have returned roughly 16% annually, while growth stocks have returned 14%. The cycle of value stock outperformance has, on average, lasted about five years, while growth stocks have outperformed for an average of 3.5 years. If the second half of 2000 marks the beginning of a value stock cycle, then history suggests it could last awhile.

The wild card that will likely decide whether the worst is over is earnings. Traditional valuations say that stock prices are determined by two factors--interest rates and earnings. Right now there's a tug of war between falling rates (good) and falling earnings (bad). According to IBES, analysts have cut their 2001 earnings forecast for the overall market from 14.8% three months ago to 8.1% today; 2001 earnings forecasts for technology have slid from 24% three months ago to 10% today.

The question is whether that profit slide is already factored into stock prices. Recent market rallies have been sparked by the belief that the earnings news will in fact be less dire than we now expect. Microsoft recently reported results that were in line with estimates, and companies such as IBM are sticking by their forecasts. Still, some economists are predicting that S&P 500 earnings won't grow at all this year. As for the long term, Richard Bernstein, Merrill's quantitative chief, points out that analysts' five-year earnings-growth forecasts for the S&P 500 haven't been scaled back--which means that there's more room for disappointment should the slowdown in earnings last longer than the first half of 2001.

None of this means that investors should put all their money under the mattress. It just means that caution is warranted, because some things have definitely changed since the go-go days of last spring. We've learned that not every IPO is destined to be the next Microsoft, and that some surprising parts of the technology industry--like PCs--may be cyclical. We've also learned that the new economy follows some of the same rules as the old economy. Those lessons make it hard to believe the argument that stocks aren't risky or that P/Es can expand to infinity. In other words, be as careful of stocks with big expectations and big P/Es at Nasdaq circa 3,000 as you may wish you had been at Nasdaq 5,000.