If you are planning to downsize, I recommend that only when the lifestyle you want dictates that. If solely for financial reasons, I recommend not downsizing now. The reverse from paragraph 1 would apply and that is not in your favor.
If you are bouncing around the idea of selling, just speak to a Realtor and have them evaluate your home, condition and they can let you know about how much homes are selling around your area and how long are they on the market and what you might possibly expect to see how of a home sale financially.
Now, is it a good time for you? Depends on the availability of homes for sale in your market. What activity has been like, and whether you have a shortage to begin with. I'm not familiar with the part of the country your particular town is in - but I have lived in DC at a time when the interest rates hovered around 14% and still homes were in high demand.
Supply and demand is what drives a market whether it's Christmas toys or homes. If you have a good product in a location that is desireable, by all means get your home on the market; because you can also capitalize on an upgrade for yourself.
What better time will there be? Once all the dust settles, if you sit out on the sidelines, you may miss a great deal!
You may give up a little on the percentage when selling - but what you gain will come back at you once the market recovers... (I don't have a crystal ball for when that will happen - but it's not too far in the future).
To answer your direct question "will it ever"? Yes. It always does. We have cycles just like any other industry. There was a time when the wireless companies went from $40 per share to under $4: they have rebounded and are stronger than ever.
The housing market must right itself - and pay for the sins of the past. Once we get back to reality and the market catches up with itself we will all benefit. I wouldn't look for the 10% annual appreciation - I do believe those days are done (hopefully).
Remember the tortoise and the hare? Slow and steady gets you there....
For instance: Say someone purchased a $300K home in 2005 with and ARM. It re-sets in 2007 and the borrowers now can not afford the new rate. The price of the home never changed ($300K). The home was not affordable in 2005, and it is certainly not affordable in 2007. Furthermore, the talk of government bail outs are not for new buyers, they are for people that bought years ago.
As for the question at hand, Yes. It is a good time to sell a home. You just have to price it competitively, that is, DROP THE PRICE.
Generally speaking, the housing market is soft and seller's expectations remain lofty. I would advise that you contact a realtor in your area who is reputable and have them prepare a CMA (market analysis) on your home. That will at least give you an idea of the price range that you can expect with a sale. Then, depending upon the timeline you require to actually complete the sale, you can decide whether to focus on the lower or upper end of the range.
As far as where the market may be a year from now... well let's just say if I really knew that answer, I'd be a rich man. The market slump we're experiencing today came upon all of us rather suddenly about a year ago and none of us saw it coming. It is just impossible to tell where things will go.