A Rip Van Winkle hypothetical

An editorial in The Economist magazine (May 1) puts forward a Rip Van Winkle hypothetical as sentiment in the financial markets seems more positive at this stage.

"Imagine that you had fallen asleep last July," suggests the editorial's writer (who is unnamed in the style of editorials). "On waking today, you would be astonished at the state of housing markets, the prospects for consumer spending and the trends in forecasts of economic growth."

Under this hypothetical, you would have slept through the mounting concern in recent months about the credit crunch and the dramatic rescue of Bear Stearns.

And the British magazine makes its point, such a Rip Van Winkle character emerging from a long sleep would certainly not assume that the worst is necessarily over. "Nor should investors, just because they have lived through it all," it states.

This is sound reasoning in my view. Investors can easily fall into a trap after experiencing a period of economic uncertainty and highly volatile bear markets of mistakenly believing that any good news is a signal that good times have arrived again. It isn't necessarily so.

The Economist warns that it is too early for investors to relax in the belief that their troubles are all over.

"[Just six weeks ago] analysts competed to produce the highest possible forecasts for losses from the credit crunch. Everything [now] seems a lot calmer.

"Stock markets have stabilised and corporate credit spreads -the excess interest rates paid by risky borrowers - have come down sharply. Gold is cheaper.

"Bankers talk about having put the worst behind them. The Bank of England's twice-yearly Financial Stability Report [released last week] was cautiously optimistic and America's Federal Reserve was relaxed enough to cut the pace of its monetary easing.

"But the fight ahead still looks bloody," warns The Economist. See: http://www.economist.com

Footnote: Many younger investors may have grown up without being read the tale of Rip Van Winkle. He was the character in a short story by American author Washington Irving. Rip was a lazy farmer who went to sleep for 20 years in the Catskill Mountains of New York, waking up an old man in a very different world.