Today's market action was the most classic headline-induced frenzy we've seen since the Spanish banking bailout was first announced, but no one seems to be talking about why.
All sorts of headlines were out this morning as US stock futures soared (the Dow was up about 85 points at its high) in response to more nonsense out of the Eurogroup meeting.
All that was announced was that Spain is being given an extra year to meet its fiscal targets (which of course won't happen, and isn't relevant), and the leaders merely confirmed that the ESM is going to have the power to buy sovereign debts (what else would it do...)
In response, equities surged in the morning, though the commodity complex and euro were largely unamused. As markets were jubilantly digesting the news, sentiment started to weaken as the German Constitutional court announced that a decision on the constitutionality of German involvement in the ESM could take until 2013. Since then, markets have plunged through key support levels of 1340 on the S&P futures and appear to have further downside.
A simple ruling on an injunction could take anywhere from three weeks to three months; Germany is clearly stalling here and weighing their options. European leaders are biting their fingernails hoping the German finance minister can convince the court to speed the process up, considering Spain is expecting at least 30 billion euros within the next few weeks. Wolfgang Schaeuble (the German Finance Minister) seems to think a declaration of unconstitutionality 'would destroy the Euro project.'
If not, the cash will have to come from the EFSF, though given prior agreements, it remains to be seen how the actual capital risk will be placed, or if the EFSF even has the capacity to fund the bailout.
Even a hint that the ESM won't be ratified very soon is going to result in a repricing of risk assets, particularly stocks. The reasoning? Markets have recovered on the certainty that there will be direct intervention within the sovereign debt markets of distressed Eurozone countries (mainly Spain and Italy). Without actual purchases, the market will be left out to dry. Though equities have held up exceptionally well relative to oil, treasury yields, and the dollar's strength, they have the most to lose if ESM ratification worries start to gain ground.
As I've been saying for the last couple of weeks, the risk/reward profile is heavily skewed in favor of those who are short the market right now. US earnings are unlikely to be a catalyst for a new risk-on environment, and the ESM uncertainty is plenty enough for a few hundred points of downside in the Dow, and 50 points of downside in the S&P 500 (SPY). With actual debt purchases priced into the market now, the downside risk is very large. I am still short S&P futures as a way to take advantage of the favorable trading opportunity.
Disclosure: I am short SPY.
Additional disclosure: Short via S&P 500 Futures