Years ago when I was just starting out as a journalist I remember going to a media studies workshop. Only one lesson has managed to penetrate the fog of time: It was about how TV newscasts can manipulate images for dramatic effect, and it was as simple as it was effective. It just consisted of two short video clips.

The first clip was an extreme close-up of a deadly row of police officers in black riot gear standing steadfast as protesters spat in their faces. It was intense and dramatic and it got your attention. It looked like all hell was about to break loose. The second clip was a wider shot of the same scene, from farther away. In this clip you could see that much of the drama in the first shot was an illusion. This was obviously a minor protest, and everything was well in hand. There were about eight cops, and there were maybe five active protesters getting in their faces. Behind them was a small crowd of onlookers who looked, well, bored. They were chatting with each other about their plans for the weekend, drinking coffee. Most were shoppers out for the day who stopped to see what the fuss was about.

The lesson here is that if you get too close to the action, you can get a distorted impression of its significance. It often pays to pull back a little and get some perspective. This is a lesson that investors should heed when considering the state of today’s markets.

When you watch the evening news, it looks like the whole market system is breaking down, but take a few steps back to get some perspective. To help you do that, let’s go back to basics for a moment and consider how stocks are actually valued. One of the more accepted ways to do it is the discounted cash flow method. The idea is to estimate all of the future profits the stock will bring the shareholder, discount them to take into account the time value of money, then add in what the shareholder will get when he sells.

It’s a flawed model when it comes to predicting what level a stock will actually trade at, but it’s a great reminder that stock prices, at some level, must be tied to earnings. Yes, over the short term, a company’s stock price and its earnings per share can get seriously out of whack. But when prices gallop ahead of earnings by too much, sooner or later there is a “correction” that brings them back down to earth.

If you turn to page 9 of this issue you’ll find a graph that you can think of as a bit of an antidote to the frenetic analysis on TV. It shows how the ratio of prices to earnings (called the P/E ratio) for the stocks in the S&P 500 index has changed since the late 1800s. As the earnings go up, so should the price, and vice versa, so in theory, the P/E ratio should stay within the confines of a horizontal band. Of course what you actually find is the P/E ratio jumps all over the place. Still, over very long periods of time, it eventually has been yanked back to an average value of about 16.

Now take a look at what’s been happening lately. The graph clearly shows that starting in the 1990s, prices began getting way ahead of earnings. By 2000, that P/E ratio was higher than it’s been in recorded history. Since then, of course, prices have come crashing down to earth in a spectacular fashion.

In other words, the current slump in the market isn’t a sign that the market is broken—it’s a sign that the market works. It was the run up in prices in the 1990s that was worrying. The correction that we’re seeing now—albeit in a very painful way—is actually reassuring. As Norm Rothery, our investing expert, notes in the accompanying story, even after the crash of 2008 and the recent decline, that P/E ratio is still a little on the high side. So stock prices could still drop from where they are now. But don’t lose faith in investing if they do. After all, the market is behaving exactly as it should.