Is it all over for stocks?

None of what you've just read amounts to a reason to sell stocks. The returns of the past 12 months tell you little about the next 12. To the contrary, if you've already built a financial plan that can withstand long bears and if you've found you really do have the stomach for volatility, this market could prove to be an opportunity.

Investors who stick to their target allocation and rebalance by selling bonds and cash to make up for the shrinkage in their stock portfolios will just be getting a lot more shares for their buck. And by several measures of valuation the potential for gains has significantly improved.

For starters, the market's price-to-earnings ratio - which tells you what it costs to get a slice of earnings - is as low as it's been since the mid-1980s. The Leuthold Group calculates the S&P 500's P/E based on the index's previous five years' earnings average. By this respected gauge, the market's P/E has fallen all the way from 40 in 2000 to just 12 today. Low P/Es have often set the stage for higher gains over the next decade.

Also, check out dividend yields. Right now dividends on S&P 500 stocks are paying you 3.4%, up from 1.1% earlier this decade. One conservative way to estimate future stock returns, used by longtime bear Arnott, is to add the current yield to the long-run growth of earnings, which generally runs one to two percentage points above inflation. That gets you to an expected real return of around 5% after inflation, enough to pay for some risk taking. Some erstwhile stock skeptics are even more bullish. GMO's Grantham projects annual after-inflation gains of 8% over the next seven years.

We're still talking cautious optimism. Arnott sees even better deals in those depression-priced corporate bonds, as well as REITs and munis, so diversification still makes a lot of sense. And Grantham warns that the S&P 500 could easily lose another 25% before it recovers.

So why not just shift to those cheap bonds (or cash) and wait for the bottom? "The answer is that nothing is certain in life," says Grantham. Losses of 25% are always a real possibility with stocks, and you shouldn't go there if you can't accept that.

The problem with trying to time the market, especially for individuals, is that no one waves a green flag on the floor of the New York Stock Exchange to announce the start of a rally. The Great Stock Comeback of 20?? may be well under way by the time you notice. And you'll have missed the chance

Some problems in life have a yes/no solution - either you fixed the leaky faucet or you didn't. A lot of financial advice tries to reduce the question of how much stock to own to a matter of plumbing, but it is more similar to a health-care problem. Every choice you make involves a trade-off of benefits with side effects and risks. (Bodie often draws an analogy to back surgery he underwent, which carried a small risk of paralysis.) Stock investing should raise your wealth, but the danger of losing money can never be argued or strategized away.

There's one thing that you can always do to make the problem smaller: save more. The more you salt away, the less you need to count on your money to grow at a high rate. Alternatively, the more you can build your assets, the more you can afford to risk if you have the fortitude for it.

For a generation of investors shaped by the explosive markets of the 1980s and 1990s, that may sound like awfully tough advice. But toughness is what you'll need to survive this market.

Carolyn Bigda contributed to this article. 

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