Things appear to be going swimmingly with the equity markets over the last several days.  Both the US and Canadian exchanges have been rising, commodities have been creeping up, and stock pickers seem to be walking with an optimistic skip in their step.  All of this on the heels of (1) Ben Bernanke announcing no additional stimulus, at least for the time being; (2) paltry US employment data; (3) continued weakness in the US housing market; (4) dismal consumer confidence numbers; and (5) clear indications that short-term credit risk is rising. 

In the words of Mugatu, I feel like I'm taking crazy pills!

The bizarre rationalization I have been reading for this recent bout of investor optimism reinforces my feeling. It goes something like this:

"The worse the economy gets, the more likely Ben Bernanke will come to the rescue with a big stimulus package that will save the economy and the equity markets...oh and housing isn't that bad because prices are not actually falling off a cliff anymore, and employment is at least slightly positive, and really, who cares what happens in Europe. Plus, Warren Buffet believes in the American economy so why shouldn't I?"

I really don't know where to begin.  I have already summarized why additional monetary easing will not help the long-term prospects of the US economy. Counting on monetary easing is like an addict counting on his next hit.  It alleviates the pain for a while but it just makes a true recovery all that more difficult. 

Yes, it is true that employment and housing data are flat-lining, indeed rising slightly, which is an improvement over their precipitous declines of 2008-2010.  What some investors seems to forget is that these metrics should be extrapolated neither linearly nor parabolically.  This means basically that employment and housing data obviously cannot fall to zero, and as such their declines must at some point decelerate or flat-line.  The fact that they have now done so is hardly encouraging, and it doesn't mean they are on their way up.  This logical fallacy is like suggesting that a morbidly obese person whose health is in severe jeopardy has improved his condition by putting on no weight this year because he put on 100 lbs last year. Pass the crazy pills please.

For those who don't think Europe matters, I suggest they take a close look at the concept of contagion.  Here's a good introduction that focuses on contagion in the context of the Asian crisis.  Here is another.  Like it or not, Europe matters.  This will become evident when Greece, and perhaps Portugal and Ireland, officially default. 

As for Warren Buffet's investment in BoA, all I can say is what a sweet deal.  I wish I could have bought cumulative pref shares that yield 6%, pay a 5% recall premium, and come with essentially in-the-money warrants on a bank that is effectively backed by the US federal government.  I can't, however, and neither can you (unless you happen to be Warren Buffet...hey, you never know).