This week, American investors have taken denial and myopia to a whole new level. Despite myriad signs that the European debt crisis poses a clear and present danger to the worldwide financial system, the Dow rallied strongly on Monday, closed mostly flat on Tuesday, and recouped all of its intraday losses to close mostly flat on Wednesday, as though Wall Street operates completely independently of the events unfolding in Europe.
Investors in the U.S. seem to be consumed with a sense of 'American Exceptionalism' that could prove quite dangerous should it cause them to dismiss the very real possibility that Greece could soon exit the euro, triggering a series of decidedly undesirable events that could end with Spain seeking an international bailout.
On Tuesday, former Greek prime minister Lucas Papademos noted that although a Greek exit from the euro was still unlikely, it was now indeed a real possibility and estimated the cost of such an exit could exceed $1 trillion...
Papademos cited estimates that the overall cost of a Greek exit could range from 500 billion to one trillion euros ($640 billion to $1.3 trillion) including the impact on market valuations, cross-border contagion effects and damage to the real economy.
Papademos's comments caused barely a wave in the U.S., as the Dow briefly fell 50 points before recovering before the close of trading. The idea that Greece will soon make its exit was reinforced by a report which claimed that during a teleconference of the Eurogroup Working Group, officials agreed that each country in the eurozone will now prepare a contingency plan to deal with the consequences of a 'Grexit'. Citigroup now puts the chances of a Greek exit at between 50% and 75%.
The main concern is that if Greece leaves the currency, depositors will pull money from Spanish and Italian banks en masse--Societe Generale sees a 20-30% deposit outflow in Spain and Italy in the event Greece leaves the union. Additionally, it has been suggested that eurozone GDP could take as much as a 4% hit as confidence deteriorates rapidly. This of course, is on top of the chaos that would ensue in Greece when the country returns to the drachma which would most likely depreciate by as much as 80% against the euro as soon as it's issued.
Against this backdrop, individual investors in America learned (via the debacle that was the Facebook (FB) IPO) that Wall Street cares very little for their well-being. While home players placed what they thought were conservative limit orders at around $42 dollars, institutional investors knew better than to pay-up for the shares thanks to the inside information they received from Morgan Stanley regarding cuts to Facebook's full year and quarterly revenue targets and full year EPS. As if the fact that the underwriters were cutting estimates even as they pumped the stock wasn't enough to stack the deck against the retail investor, glitches in the Nasdaq caused irregular trading not only in Facebook, but in multiple other stocks, causing investors to get bad fills on Apple (AAPL), Netflix (NFLX), SPY, and other names according to Nanex.
All of this should have led to an outright destruction of confidence this week. Instead, investors have yet again switched on the blinders. They do so at their own peril. The only bright side here is that, thanks to the fact that stocks have not dropped precipitously this week, there is still time to buy put protection on the S&P 500 (SPY) or get long the VXX. The market will not be able to pretend everything is fine forever.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in SPY over the next 72 hours.