The Exchange

Connelly: The Market Is Still All About Greece

The Exchange

By Terry Connelly, dean emeritus of the Ageno School of Business at Golden Gate University

The U.S. hedge funds that have badly underperformed the market this year basically have two choices as the drama of 2012 approaches its third act: either chase the stocks they have missed (driving the market up still further), or use their muscle to drive the market down so they don't look so bad.

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Thus far, it seems they have opted for the latter — no better evidence than in the five-day fall in the markets this past week, and especially the fall of Apple down to a P/E ratio that might make one think the company sold mining equipment, or electric power.

Moving Markets

In this campaign of market manipulation, the hedgies have relied on two "tried and false" scare tactics. The first is the idea that the just-concluded corporate earnings reports will show an aggregate decline for the first time since 2009. They used that prediction about Q1 and Q2 this year to drive down the markets just before earnings were announced, and they were proven wrong, but not before they wiped out a lot of other people's gains and were able to buy back in more cheaply as earnings surprised to the upside. But many of them were smoking their own dope and missed the rallies. Moreover, while about 20 percent of the S&P 500 have given advanced warnings of earnings shortfalls, the major firms that have actually announced Q3 earnings thus far, including JPMorgan, Wells Fargo, Yum Brands, Alcoa, Fastenal and Costco, have in fact reported profits that beat street estimates and some have even raised guidance for the next quarter or the coming year.

The second scare tactic is the political gridlock, "fiscal cliff" scare concerning the truly predictable catastrophic effects on the U.S. economy in 2013 (and in Q4 of 2012 by way of anticipation) if the Budget Control Act is allowed to take full effect. But if the lame duck session of Congress simply kicks the can down the road for six to nine months in order to pass resolution of the great political divide on to their successors and President Whichever, this sky-falling scenario will also not come to pass.

Trading on the 'Greece Effect'

But now a third specter of doom has magically reappeared on the horizon just in time to push the U.S. market down even further in the coming week or so — our old friends the Greeks and the euro. Again the Germans are casting their usual aspersions on anyone in authority (like the head of the IMF) who suggests that Europe should let up a little on the waterboarding of the Greek economy — i.e., holding the Greek fiscal situation under the water of austerity and then expressing exasperation that the Greek economy isn't breathing!

For the moment, the fight is indeed over whether the Greeks should be given a couple extra years worth of "breathing room" to meet the stated deficit reduction targets tied to continued European and IMF financial aid packages. German resistance to this notion, advanced by the head of the usually "strictly business" IMF has set German financial officials' teeth on edge very publicly, so now the hedge funds have the "euro-geddon" scenario back in play. And right on cue, we can expect Greek politicians to "round up the usual protestors" to hit the streets and carry on their "negotiations" with the Germans in the only way left to them.

The Greek situation is indeed serious: While the IMF estimated at the time of the latest bailout agreement earlier this year that its economy would shrink by 4.8 percent this year and then stabilize flat in 2013, that agency now projects a 6 percent fall for 2012 and 4 percent next year. On paper, any extension of Greek obligations sounds like a classic case of good money after bad. Once the argument leaves the streets in coming days, the discussion will center on whether the two years the Greeks want will be funded by extending their debt maturities or lowering their interest rates or both — either way, the "bailer-outers" will lose money.

Chancellor Merkel of Germany will have the last call on this debate, and she has been reasonably adept at protecting the euro from collapse. There is no real reason to expect she won't prove the same this time — her elections are later this year. And the whole mess will probably bubble along unresolved until, after the U.S. elections on November 6, as Europe will not want to be "blamed" for the U.S. result, whatever it is.

Meanwhile, the hedgies have three weeks to work the market down tactically with fears of a euro collapse, and then be ready to pounce on the "buy" side when the sky again doesn't fall.

Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.

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