Meanwhile, we are also hearing all sorts of scary stories about housing prices falling more than at any time since the Great Depression, the value of the dollar plummeting as well, oil prices soaring to record levels, other measures of inflation rising, employment declining, huge levels of corporate, government, and individual indebtedness, extremely low savings rates, uncertain values for trillions in derivatives (whatever they are), potential runs on investment banks if not for unprecedented bailouts arranged and partly insured by the Feds, talk of crises and meltdowns, etc.

Now it would seem we are in a bit of an irrationally negative market tailspin and maybe should just "get over it" and return to the quite profitable market surges we have again gotten used to more recently. In the last half of 2007, for instance, stocks were largely momentum driven just as they had been in the late 1990s. Real values for companies and their common stocks were not seen as particularly relevant. Why cannot we just resume that kind of powerful, greed and emotion led advance?

Even today, after the declines of much of 2007, our real estate is too highly priced if one looks at historical ratios of mortgage costs vs. household income. By some estimates, it still has to fall, on average another 20-30% just to match those prior norms. But financial cycles seldom just stop at the mean either on the upside or when headed back down. So, before this depressing spiral is over, incomes likely need to rise significantly, house prices fall substantially more, or some combination of the two. The last time things were as out of balance in the US was just before the Depression. From 1929, prior to the year's fall crash, till the boom following World War II restored more reasonable prices and incomes was about 17-18 years. This is consistent with the long complete real estate cycle which, including up to down and then back to the mean, tends to run for about 35 years.

Are our stock markets in better shape? Let's see. The average historical price to earnings ratio of the S&P 500 Index (roughly 75% of the US stock market by capitalization) has been about 15. At the height of the "irrational exuberance" phase of the late 1990s, it got up to about 37. At that level, investors were willing to get just a 2.7% "earnings yield" return on their investments. Today, even after the drops in stock market prices since the beginning of the year, it is about 18, as yet roughly 20% above average. And markets tend over time to return to the mean, so that 20% is probably itself unsustainable for the long-term.

But we are also in a downward earnings cycle. As people see the value of their homes' equity (most folks' biggest investment) declining, they are likely to reign in spending, particularly as there are stresses too on the economy from high energy and health care costs, food price inflation, and layoffs or company closures as the housing recession settles in. With lower earnings, the P/E ratio will be higher, everything else being equal, unless or until there is a more major drop in stock prices.

Or we can review the price to book value ratio. Historically, it has been around 2.0. But today it is around 2.6 for the S&P 500 Index, roughly 30% above the norm.

If we take into account the substantial amount of debt and credit risk currently floating around corporations, hedge funds, and other financial entities, the values prevalent in the markets are even more suspect. Who could have believed that a major financial player like Bear Stearns, a $167 stock only a few months ago, would be worth but $2 a share early this week?

In short, both for common stocks and real estate, prices still appear to be at least 20-30% high, based on historical levels. Since the greed vs. fear fluctuations tend to go too far both on the upside and downside, and to date neither the excesses in stocks nor those in real estate have been fully wrung out, arguably it is not currently irrational to be negative on these two basic types of financial markets.

For instance, one might keep debts to a minimum, live on less than the available income, and increase the savings rate. Now is the time to risk in new investments only what one can afford to see fall substantially in price and perhaps stay lower for an unlimited period. While I do not advocate selling at a net loss, it may be helpful to use market surges (such as we saw on 3/18), as opportunities to unload, by the amount of the portfolio's increase, stocks of companies with too much debt or with higher P/Es and price to book values, or to exchange mutual funds into short-term bond funds, money market funds, or certificates of deposit. One may wish to adjust the portfolio allocation, lowering the percentages of assets held in equities or to primarily invest through a dollar-cost-average approach. Yet I would not go overboard in such a reordering of risk. Ironically, once it is generally apparent that the markets are heading down and we are in recession, the values become compelling enough that market turnarounds may be only several months or a year or two away.

And I am certainly not absolutely convinced we should "look out below!" My analysis is as subject to error as anyone's. In any case, there may be many short-term fluctuations before a long-term trend becomes fully apparent. I am, however, sure that we have a greater than normal amount of risk today in real estate, stocks, and the economy as a whole.

Because, whether in favorable or unfavorable conditions, stock prices have a tendency to move unpredictably, pioneer value investor Ben Graham advised never being fully out of the markets but instead keeping at least 25% of one's liquid holdings in stocks or stock mutual funds, though never more than 50% so invested if one perceived that equities in general were overvalued, as seems now the case. The balance of liquid investments he would just put in short-term government bond holdings, as a way to keep one's investment powder dry. Once a desired allocation has been achieved, it is often advantageous to rebalance after the markets' upward or downward flows have caused some categories of assets to get significantly above intended levels or others significantly below. In this way, one may assure selling assets when high and buying when low.

If one adheres to such stock, reserves, and real estate guidelines as above, it should help with weathering most eventualities.

After a real watershed has occurred, when in the financial sphere most people have thrown in the proverbial towel and have sworn off investments forever, wondering how much farther down the markets and this awful time have to go (as occurred in late 1974 and 2002, following terrific two- or three-year debacles, respectively), then will likely be a good point to increase one's riskier asset allocations and load up on a new array of bargains such as may only appear once each generation or two.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)