For a while it looked as if Australia was going to sail through the credit crunch unscathed, just as it did following the Asian financial crisis a decade ago. But latest figures show consumer confidence has slumped to its lowest level since the last recession of 1992, employment is growing more slowly and the pace of economic expansion is easing.

The subprime crisis in the US started in the middle of last year, when mortgage faults began to rise. Now the results have washed ashore in the lucky country.

"I think that luck has definitely run out. The deterioration in mood within the past two months is almost palpable," says Dominic McCormick, the chief investment officer at fund manager Select Asset Management.

Australian shares - led by the financial services sector - are down by more than 25 per cent since the beginning of the year. More than 50 per cent has been wiped off the value of the highly leveraged and financially engineered Australian listed property trust sector over the past six months.

Analysts expect the sharemarket to rally at some point but they are not anticipating a sustained recovery any time soon.

Adding to pressure on household balance sheets are mortgage interest rates at their highest level for 12 years, steeply rising petrol prices, more expensive food and higher rents. Banks are raising mortgage interest rates independently of the Reserve Bank and they are now almost at double-digit territory.

And the bad news continues. Superannuation returns for the year to June 30 are their worst for 20 years; the typical balanced fund has lost between 5 and 6 per cent. Evaporating wealth, higher mortgage repayments and higher food and petrol prices have contributed to debt-laden consumers feeling less financially secure.

Yet many economic fundamentals remain intact and Australia is likely to keep growing at a faster rate than most developed countries.

"China and the benefits of the resources boom are still underpinning the Australian economy but on the financial side and on the asset price side we have seen some enormous wealth destruction," McCormick says.

The worst housing downtown in the US in 25 years, falling house prices in Britain, the continuing credit crisis and soaring energy costs have rocked investor confidence around the globe.

Economists at Commonwealth Securities now put the chances of a global recession at 40 per cent. "The US economy is at risk of taking another [turn] downwards and we are seeing the second phase of the credit crunch coming through now," says Savanth Sebastian, an equities economist at CommSec.

"We are starting to see borrowing costs rising again and that is a big concern when you have got inflation hounding on your doorstep as well."

Of course, no one knows for sure how long the downturn will last and markets could make a sustained recovery. But by the same token, any sustained recovery could be a long time off.

History shows that sharemarkets can spend very long times in the doldrums.

The Australian All Ordinaries Index, for example, did not regain its 1987 peak until 1996. Japanese shares are still worth just a little more than 30 per cent of what they were trading for at the time of their peak in 1989. And US shares did not surpass the 1929 peak for 25 years. US shares are now worth about as much as they were 10 years ago.

But it would be wrong for Australian investors to be overly pessimistic. McCormick says that after some panic selling, particularly by those who have borrowed heavily to invest in the sharemarket, value is reappearing in some sectors of the market.

He thinks the selling of listed property trusts has gone too far. "We think that the LPT sector is getting close to pricing in an Armageddon-type scenario," McCormick says. "Even assuming asset devaluations, you are still talking quite massive discounts to net asset valuations." (See also story on p10.)

Australian shares have been driven down so far it is probable there will be a rally. However, McCormick doubts whether that will signal the end of the bear market.

Shane Oliver, the chief economist at AMP Global Investors, says Australian shares are now trading on a forward price-to-earnings ratio of 11 times, which is well below the average of the past decade of 15.2 times. "While industrial companies are likely to see further profit downgrades, current share prices are implying a nearly 30 per cent fall in overall profits. This seems very unlikely with resources likely to deliver very strong profit growth," he says.

Fund managers like to point out that the big emerging economies, such as China and Brazil, are decoupling economically from the US. That is partially true but the world's biggest economy is either in recession or skirting close to it. When the US economy slows sharply, the rest of the world also slows.

China's economy is slowing, even though it is still expanding strongly. Its sharemarket is down 50 per cent from its peak in October last year.

No one can time their entry and exit into the market perfectly but investors should be able gauge whether a market is too overheated or has been sold off too heavily on the pessimism.

The turmoil on financial markets is again testing the veracity of the old truisms of the investing, such as it is "time in the market, not timing" that makes the most money.

But those cliches tend to ignore the realities - investors need to remain alert to risks and act on them.

So what should investors do? McCormick says people should not blindly put more money in the sharemarket. He thinks it is likely that Australia will avoid a recession as the benefits of the resources boom continue to flow through the economy and offset negative influences.

CommSec's Sebastian says about $45 billion worth of excess cash will flow through the Australian economy over the next year because of the big increases in the contract prices for iron ore and coal.

"That should see national income increase by about 4 per cent and we have not seen that size increase for a very long time, if ever," Sebastian says.

He says although Australian shares are cheap on a price-to-earnings basis, investor sentiment is being driven by fear and there is no obvious catalyst for a sustained turnaround.

"It is a global sentiment rather than fundamentals locally and that is what is driving the market mostly at the moment - the fear-driven factor," he says.

"But domestic demand is slowing significantly. We have a two-themed economy where we have the resources sector driving economic growth and the rest of the economy falling by the wayside at the moment."

McCormick is clear on one thing - he says investors should reduce their gearing into markets to manageable levels and that cash should be kept on hand for opportunities as they arise.