The financial markets have had plenty of wake-up calls in the past year or so. Yet markets adapt rapidly. We’re growing to accept things as normal which once would have seemed unthinkable.

“When things get back to normal…” How many times do you hear people saying that?

We all crave normality, particularly after a bit of a shock. “Business is back to normal and residents are breathing a sigh of relief,” the San Bernadino Sun reported earlier this week, after Tuesday’s mini-earthquake in Southern California which thankfully resulted in no casualties. But the paper also warns: “City leaders say the quake is a good wake-up call for all to start planning for the Big One”.

The financial markets have had plenty of wake-up calls in the past year or so. Yet markets adapt rapidly. We’re growing to accept things as normal which once would have seemed unthinkable. Massive bank bail-outs, property prices crashing at their fastest rate in decades – and after each new shock, the optimists raise their heads again, and say that we must surely be near the end of the bad news. Things might be bad, but they can’t get any worse. All the bad news is priced in.

This attitude is dangerous. Because rather than kidding on that things can’t get any worse, smart investors should be getting themselves ready for the Big One…

More dreadful results coming from every corner of the economy

Any hope that this financial crisis will all be over by Christmas should by now be dead in the water.

For starters, UK house prices declined the most in almost two decades in July, reported Nationwide yesterday. Prices fell 1.7% from June and are now 8.1% down on a year ago.

It looks like the pace of decline is accelerating. And it’s having a big impact on our attitudes. British consumer confidence has now hit its lowest point since records began in 1974, according to GfK/NOP, having plunged again last month. It’s now well below even the worst level reached in the early 1990s recession. “With the growing spectre of the UK going into recession”, says GfK researcher Donna Culverwell, “people are pessimistic and concerned about their future”.

The survey’s measures of people’s feelings about the general economic situation and the climate for major purchases like houses also slipped to their worst levels on record. Perhaps in the wake of this week’s revelations that the CBI’s retail sales index for July plummeted to its lowest point in 25 years, and the 72% collapse from the peak in UK mortgage approvals, that’s no shock. But again, all this doom and gloom, which just a year ago would have been unthinkable, is fast going mainstream.

Then there are the bank results. Earlier in the week, Lloyds TSB (LON:LLOY) kicked off the reporting season with a 70% first-half profit slump, after a £585m asset write-down and a warning about rising mortgage bad debts. And yesterday it was HBoS’s turn, serving up numbers a mere 56% lower.

No doubt there’ll be more of the same as the rest of the results roll in. Loads more write-offs due to stupid lending decisions from the people who used to think they could lecture you about financial rectitude. Yet, despite the dreadful results, the market thinks that it’s got the bad news priced in.

Hargreaves Lansdown analyst Richard Hunter said the HBoS results contained no negative surprises. Indeed “the actual profit figures were slightly ahead of expectations, suggesting that another contribution to the beginning of the end of the credit crunch may have been made”.

This blithe acceptance of once-unthinkable financial carnage is not restricted to us Brits. Across the channel, the eurozone’s in the same boat.

Spanish banks are in big trouble as the country’s house prices crash even faster than the UK’s – they’re down 34% from the peak, according to this week’s official data. So Spain’s banks needed almost to triple their borrowings in the last year from the European Central Bank to $74bn, said Bloomberg this week.

That’s the fastest increase in Europe. And what’s the ECB done? Answer: happily coughed up the cash to the Spaniards.

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Source: Don’t Be Fooled, the Bad News Isn’t Priced in Yet