The Mystery of the Costanza Market

06/19/2012 2:13 pm EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

The recent outbreak of optimism has several probable causes, but perhaps it’s best not to dig too deeply, writes senior editor Igor Greenwald.

Things are so terrible all over, no one can figure out why the stock market is going up. This is a very recent phenomenon, and here I’m referring to stocks going up, not to things being terrible all over.

It was only two weeks ago that the S&P 500 broke below its 200-day moving average after a 9% skid over the prior month, written off by everyone and their Facebook (FB) broker as a perpetual loser headed for another beatdown.

Bond yields were at record lows, the commodity markets on their knees, and recent converts to the school of gloom and doom were a dime a dozen. Some of them prattled on about the global leadership deficit, when in retrospect the thing to do was to buy triple-long ETFs and out-of-the-money calls.

And since that day of dread, bulls have been partying it up on parole, not intimidated one bit by the death rattle of the Eurozone, Chinese and Indian woes, and generally disappointing US data.

Spanish yields above 7%? No problem. Weaker US retail sales and rising jobless claims? All the more reason for the Federal Reserve to act. Crude slumping in recessionary fashion? That much more gas in the consumer tank.

How to explain this outburst of risk-taking against a backdrop of financial crisis in Europe and slowing growth all over? It’s a fine market mystery that might hold valuable clues to the future. So let’s round up the usual suspects, torture them some, and see if anyone confesses.

So, is this about the Greeks voting not to make trouble? An abrupt default and ditching of the euro was certainly a threat to roil Europe, and with the Greeks on board for more pain, the markets have dodged that bullet for the moment.

The trouble with that theory is that the bullet was well known to be a bank, since the opposition to the current arrangement was not planning anything of the sort. And the election’s winners have already petitioned Europe for better terms, albeit much less leverage than their opponents would have wielded.

Perhaps stocks are simply a compelling value? Different yardsticks offer widely divergent opinions on this score, depending mostly on whether they’re measuring returns against present-day alternatives (dirt cheap!) or historical precedents (anywhere from reasonably priced to seriously overvalued.) Skeptics don’t see how record profit margins can stick in the midst of a global macro slowdown.

And indeed, earnings estimates have been in broad retreat, to the point where they would call for a year-over-year loss were it not for lower loan-loss reserves by banks and Apple’s (AAPL) quarterly golden egg. But Oracle (ORCL) has already crowed it's “better than expected,” and there’s no reason to think others won’t follow suit, since neither corporate nor consumer spending has yet fallen off a cliff anywhere other than southern Europe.

This seems like a better excuse for optimism than anything that’s happened recently in Greece. The trouble is that all of this was just as true (a bit more so, in fact) when stocks where flaming out in May, so that it’s not obvious why this should have started to matter again in June.

And then there is, of course, tomorrow’s Fed meeting, with speculation rife that it will usher in more asset purchases to guard against the threat of another economic slump the country and the world can ill afford. This is perhaps the easiest explanation of them all, and certainly the most widely cited one.

On the other hand, no one at the Fed has given anyone cause to think that they’re ready to launch QE3 tomorrow. Chairman Ben Bernanke and his key allies on the board have been careful to note of late that additional easing has its costs and risks (notably the likely increases in commodity prices.)

The Wall Street Journal’s Jon Hilsenrath has a story today about how easing by the Fed has helped the affluent and the secure so much more than those with impaired credit access. And even if you’re not inclined to read that as an insider hint not to expect miracles tomorrow, the Fed is obviously wondering how much more it can do, and to what end.

So maybe it’s not about the Fed after all. As hedge-fund portfolio manager Mark Dow tweeted this morning, “Buzz is 'what happens if Fed accommodates and market falls anyway?'. Real pain trade is Fed does nothing and market rallies.”

He followed up with this: “What if the Fed doesn't throw a party and everyone comes?”

That would be entirely counter-intuitive of course, and therefore entirely consistent with recent market tendencies. There’s now a meme on Twitter attributing the market’s levitation on bad news to Costanza Rules, after the Seinfeld episode in which Jerry convinces George that “if every instinct you have is wrong, then the opposite would have to be right.”

Which is another way of saying that the burden remains on the bulls to show that the current thrust can last in a decidedly chilly economic climate. And maybe the mystery of why the market’s been going up is best left unsolved. Because once we realize why it’s been going up, it will surely start going down.
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