It seems like the distant past, but in reality it was only just over two weeks ago when the Group of Seven club of rich countries announced its five-point plan for ending the financial crisis. The initial response from stock market players bordered on the euphoric. 'Equities have bottomed,' pronounced an e-mail message from one respected analyst, who concluded that the G7's concerted policy action had ended market uncertainty and put a floor under share prices. 'The buying opportunity of a generation,' proclaimed another message from an equally reputable strategist, who argued that shares looked exceptionally cheap on a historical basis and were primed to snap back, earning handsome returns for anyone smart enough to buy amid the turmoil. Unfortunately, neither determined policy action nor attractive valuations have carried much weight with investors over the past two weeks. Instead, the brutal deleveraging process has continued, as hedge funds unwound their positions, selling whatever they could to raise cash. Meanwhile, conventional investors have been reassessing their expectations for company earnings given the deteriorating economic environment. The fear now is that the trickle of corporate defaults and failures of recent weeks could turn into a flood as business conditions worsen, further damaging sentiment and forcing share prices even lower. As a result, following yesterday's 12.7 per cent fall in the Hang Seng Index, the Hong Kong market is down 65 per cent from its peak 12 months ago and 25 per cent below where it was immediately before the G7's announcement. So, while the market may have looked cheap two weeks ago, it looks a great deal cheaper now. Two weeks ago, the Hang Seng was valued at about 10 times trailing earnings, its lowest level since the Asian financial crisis. After yesterday's fall it was at about 6.7 times trailing earnings, its lowest valuation since the slump of 1982 (see first chart). And still there are precious few buyers. Part of the reason is that although the index might look cheap on a price to estimated earnings basis, investors are highly suspicious of brokers' earnings forecasts, thinking they look wildly optimistic given the deteriorating environment. During the Asian crisis, the Hang Seng's earnings per share fell by half. Even if the market were to be valued at 10 times earnings, a similar drop in earnings now would push the index down a further 20 to 25 per cent to about 8,500 points, or much the same level it fell to during the Sars scare of 2003. However, price-earnings ratios are of limited value in this environment. Given the opacity of the earnings outlook now, many analysts prefer to value shares using a price to book ratio. Hong Kong stocks look cheap on this basis, too. After yesterday's fall, the Hang Seng was priced at just a whisker over 1 times book value (see second chart). Consider what that means for a moment. Book value is the value of a company's net assets: the amount you would theoretically expect to realise if it was wound up and all its assets sold off. So at a price-book ratio of 1, in effect the Hang Seng is priced for the immediate bankruptcy and liquidation of every company in the index. That's certainly cheap, but in August 1998, in the depths of the Asian crisis, the Hang Seng dropped to a low of just over 0.9 times book value. A similar fall this time would see the index trading below 10,000. So although Hong Kong stocks do appear cheap on a historical basis, there is nothing much to say they cannot get cheaper still. And although value-driven investors who buy now are likely to make impressive returns on a five-year time horizon, few are prepared to put up with the losses they could easily suffer over the coming weeks or months. As New York University professor Nouriel Roubini - one of the leading prophets of this crisis - warned on Friday, 'Fundamentals and long-term valuation considerations do not matter any more What matters now is only flows.' Well, for the time being, markets are flowing in one direction only: downwards. It would be a brave investor who dared swim against this tide.