(MONEY Magazine) – Nostradamus, fix your vision! In January 1998, I watched a Wall Street investment strategist "guarantee" to a rapt audience that in five years, the Dow Jones industrial average would surpass 15,000. The argument couldn't be simpler. Demand from the young, growing Asian economies would stimulate the appetite for U.S. goods. Meanwhile, aging U.S. baby boomers would supply the investment funds to pump up the Dow. What could go wrong? Well, perhaps a couple of things.

Which raises the question: If the Dow Jones seemed so attractive five years ago, what should we think of it today, when it rests at a lower level? Let's take a look, applying the same four perspectives I used last year in (correctly) warning against the tech sector: price history, current valuations, business fundamentals and investor sentiment.

Price history, at first glance, would seem to offer excellent news. Over the past quarter-century, the Dow's 35%, 30-month decline is without precedent. Going back further, even the notorious 1973-74 bear market was neither longer nor a whole lot steeper than today's. So unless you think we're on the verge of Great Depression II, price history suggests that the downturn is about done.

Unfortunately, those performances are calculated before inflation--the standard but incorrect way of measuring market results. What really matters is purchasing power. And from that viewpoint, things aren't as bright. When adjusted for the higher inflation rate of the times, the Dow fell a whopping 51% from peak to trough in the early 1970s. To match that lowlight, today's Dow would need to descend to 5500. Now that hurts!

Current valuations are the opposite of price history: depressing on the surface but with a glimmer of hope. The bad news is obvious: Stocks are expensive no matter how you measure them: by price/earnings, price/book, price/sales or price/CEO popularity. Even after losing half or more of their value, many stocks still trade at higher than normal valuations. The bigger the bubble, the harder the fall--and bubbles don't get much bigger than the one we blew during the new era.

But just as price history must consider inflation, so too must valuations consider the investment competition--namely, the yields on bonds. Here the news is promising. The Dow's current dividend yield is 2% vs. about 3.5% for 10-year Treasuries. Since--to greatly simplify things--a stock's long-term return can be thought of as dividend yield plus earnings growth, the Dow companies need only boost their earnings over the long haul by 1.5% to match the Treasuries' gain.

Business fundamentals must start to improve, however, in order for the Dow to rise in the near fu-ture. Once again, the signs point both ways. On the negative side, the rest of the world continues to rely on the U.S. as the global growth engine. The burden has become heavy. The continuing implosion in technology and recent weakening in both consumer spending and consumer confidence suggest that the U.S. may be cracking under the strain.

On the flip side, the recession has delivered its customary, abrasive dose of corporate cleansing. The fluff has blown away, corporate debt is in the process of being restructured, and CEO excesses are in retreat. Unlike, say, Japan, the U.S. has never shied away from accepting its economic medicine, thereby keeping our recessions comfortably short.

Investor sentiment, the final indicator, is the most reliable. Although not particularly precise for forecasting short-term results, sentiment is highly useful for understanding long-range trends. When a book titled Dow 36,000 is respectfully reviewed, watch out. Conversely, when apocalyptic tomes about hunkering down in Treasury bonds and fallout shelters strike a popular chord, it's time to load the stock market shopping cart.

Today's sentiment is bad but could be worse. Sales of stock mutual funds are the weakest in more than a decade, and after holding firm for more than two years, the 401(k) investor is finally starting to flirt with cash. On the other hand, if I had offered an upbeat argument about why the Dow was about to turn around, would you have chucked this magazine in disgust? I fear not. People distrust stocks, but sadly, they don't yet loathe them.

Adding it up. See the pattern? The signals are mixed, but the message is very clear: This market is poised on the edge. During the next 12 months, it will either begin its next bull run or threaten the dismal records of the early 1970s. In that light, you should avoid holding an extreme portfolio--one that is either very low or very high in stocks. Instead, hedge your position by holding a balanced portfolio, consisting of about two parts stocks to one part bonds and cash.

If you're feeling somewhat brave, I have two specific strategies. One, place up to a third of your fixed-income portfolio into a high-yield bond fund such as veteran standouts Northeast Investors or T. Rowe Price High-Yield. I know, I've offered this advice before without apparent success, but a 10% yield in a world of 2% inflation is too pretty to ignore. Corporate America has a cough, but it's not that sick, folks. Also, if you really want to gamble, check out beleaguered telecom and brokerage companies like Level 3, Qwest or Ameritrade--$3 stocks that in two years' time could be 30[CENTS] or $30. The risk is great, but, to me, the math is even more compelling.