Cognitive Dissonance Reigns As Risk Sentiment And Positioning Diverge

Tyler Durden's picture

It seems everywhere we look, talking heads are arguing that they expect a positive resolution to the EU debacle and yet market positioning does not suggest this is the case at all. Of course, we have seen snap-back rallies and sell-offs but the dissonance between the seeming consensus of unbridled optimism that European policy-makers 'get it' and the market's anxiety should be very worrisome - especially for the 'money-where-your-mouth-is' crowd. Morgan Stanley put it best recently as they noted their sense that most investors assume there will be some solution found (or put another way, very few assume that the alternative - a catastrophe of disorderly banking and sovereign defaults - is a base case) but few investors seem willing now to position for that benign outcome (most evidently seen in European Sovereign debt markets currently). Deutsche's Jim Reid is less optimistic but sees the same disconnect as he argues that at this point: "Who can honestly say they know exactly what rescue plans the EU governments are still discussing...".


Giving some broader context to the market's dissonance, Morgan Stanley (in their 2012 Cross-Asset Navigator) noted:

First, our sense is that most investors assume there will be some solution found – most likely with fiscal union and ECB support. Put another way, very few assume that the alternative – a catastrophe of disorderly banking and sovereign defaults – is a base case.


Second, despite the widely held view that catastrophe will be avoided, few investors seem willing now to position for that benign outcome. The most obvious example is European sovereign debt. Timing may be uncertain, but if the crisis is resolved, the outcome is not: yields on under-pressure sovereigns will be materially lower in a year. Conversely, bund yields would probably be higher. In short, a widely held consensus view is demonstrably not priced into asset markets because conviction levels are now so low.


Third, the consensus view that catastrophe will be avoided implicitly assumes that policy-makers – notably, Germany and the ECB – can and will do what it takes to preserve the union and avoid disorderly default. Anything that rattles those assumptions would be unequivocally bearish. That would include, for example, markets questioning Germany’s financial strength or the ECB ultimately refusing to provide the backstop to sovereign markets. More to the point, policy-makers have been reactive, not proactive, throughout the crisis. This has typically added to the cost of finding a solution. If events cascade – because of, say, downgrades to other important European countries – then markets may question whether policy-makers can retrieve control.


Fourth, as it stands now, we expect recession in Europe as a base case. Our macro colleagues believe that if there is not a fairly quick move to fiscal union, with ECB expanding its support for under-pressure sovereigns, then the recession will be deep – something not in the price. The tail risk to that bear scenario would be depression.


Finally, while Europe’s current situation reflects in part its peculiar institutional structure, it is not unique in terms of its leverage.

That has two follow-on implications. First, even if the European crisis is ‘resolved’, it’s only in the sense that Europe would look more like other highly leveraged regions: still facing a difficult end-game, but without the fragilities that frustrated policy-makers’ ability to kick the can down the road, as has happened elsewhere. Second, with markets now generally more alert to sovereign stress, and global growth slowing, it may be that the surprise of 2012 is that sovereign stress spreads beyond Europe to other developed economies.


And From Deutsche's Early Morning Reid:

Before we start today, who can honestly say they know exactly what rescue plans the European Governments are still discussing and which ones have fallen by the wayside never to be seen again. It’s extremely hard to keep up at the moment and extremely hard to analyse as even if ideas never see the light of day their mere discussion seems to have the ability to move markets. For example the four times levered EFSF package and insurance scheme of two months has been gradually fading from view and any remaining hopes probably subsided with S&P's negative credit rating watch listing on the EFSF yesterday following the previous night's negative rating watches on 15 EU sovereigns. This potential bailout plan was huge news at the time. Since then we've had speculation about Chinese/EM involvement, the IMF, ECB loans to the IMF, bilateral agreements, creating a central financial authority, joint Euro-area bonds, AAA-only ‘Elite Bonds’, making the EFSF a bank, making the EFSF co-invest in a SPV that could access ECB liquidity, using the EIB as a SPV, the Fed being involved, ongoing debates about the role of the ECB and now a slow march towards treaty changes. If we've left any out please let us know.


We admit to being fairly confused as to where we stand at the moment and the latest plan reported in the FT late in the US session yesterday is for there to be a package based around the EFSF, the ESM and maybe then the IMF. It is reported that allowing the ESM to run alongside the EFSF could strengthen Europe’s financial firewall when combined with new eurozone funds from the IMF. Under the plans being considered, the ESM is unlikely to have its headline €500bn from the start but the hope is that combining this with new IMF resources and a leveraged EFSF (to about €600bn) could create the “bazooka” effect leaders have been searching for.


We keep moving in circles trying out different permutations and combinations but in reality where is all this money going to come from? Is this all just a distraction to the fact that the ECB is the only agent with the financial flexibility to ensure that all nation states can refinance?


We don't think there is any chance of a quick fix to all of this. Although the market is getting more optimistic, even Merkel commented last Friday that the only real solution to Europe’s debt crisis was a fuller fiscal union, a process that will take years.


Investors are rightly confused and we agree with Reid that we don't think there is any chance of a quick fix to all of this. Furthermore, we fear that any belief in a reversion to pre-crisis levels of sovereign risk on the back of a solution is a pipe-dream as it is clear that risk premia are embedded now (like skews in options prices post 1987) and it is far more likely that Europe stabilizes at much wider levels - more like other leveraged regions.

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Forgiven's picture

Exactly.  For those that don't see it.  Wake up! That's not bird doo falling, that's the sprinkles of a pending SHITSTORM.

AngryGerman's picture

can't be anything else!

LawsofPhysics's picture

Oh yes, saving leveraged paper with even more leveraged paper and then taxing the trades on such paper.  Is there an ETF that allows us to bet on the half-life of this solution?

Tsar Pointless's picture


It's the "EFSF ESM Insufficient Funds We R Fd 3X Beta ETF".

Stax Edwards's picture

Try Gartmans new ETF's:

Risk On  - ONN

Risk Off - OFF

hbjork1's picture

It is not really Bernanke's fault.  It is in large part the faux Ivy League liberall arts financial education.  We the people have bowed down to it and pronounced it great. 

The problem is that 1, the people in these jobs need more time in the real workaday world. 

And 2. We must stop rewarding white color crime.  We all think we can get a cut.  Fact is, we aren't.  Instead we are going to pay. 

If I could have the buying power of my early IRAs and savings back, I wouldn' care about my SC medical or other payments. 


Spastica Rex's picture

I think you're using the term "liberal arts" a bit loosely.

Oh regional Indian's picture

The potential for outrageous profiteering off insider information boggles the mind.

Who is making money here....probably dark pools. Nuts if you can shake the global financial markets with the rumor of a supposed rumor's rumor. Even shrooming pennies in the seconds before an announcement breaks.

Fingerprints must be all over.



AngryGerman's picture

you don't get the emails? sorry for you...

DormRoom's picture

there are never quick fixes to structural problems.  EZ bonds have been mispriced for the last 15 years. 


Merkozy wants to make us forgot this glaring fact with quick fixes.  Someone should send Rompuy a christmas card with the parable about the boy & the dyk.e

slackrabbit's picture

There you go again!....always with the reason, the logic and common sence!!

CPL's picture

Agreed, how dare he makes sense like that.


Take the +1 and like it!

SokPOTUS's picture

C.D. - Where are you?  You should be all over this self-titled post...

Captain Kink's picture

That was my thought also, "Cog Dis Reigns..."?  Great, finally some leadership we can count on! 

Teapot_Dome's picture


I got a little falsely excited thinking this would be a new C.D. post.

Cognitive Dissonance's picture

Actually for a second there I was wondering who ripped off one of my unpublished pieces.

Time to change my password to something more complicated than "GoldSilverFoodGuns&Ammo". Next time it will be "CheckAllSightLinesInAdvance". :>)

Cognitive Dissonance's picture

Sorry. Slept late and ignored the world until it's screaming could be put off no longer. But it looks like Tyler covered all the talking points anyway.

Now can I go back to bed? It's a cold rainy late Fall day here. :)

RobotTrader's picture

Today is the last chance for the bears.

More than likely, the Eurozone problems will be fixed by Friday

And stocks will start moving tomorrow frontrunning the news

AngryGerman's picture

robo! you little overoptimistic sneaky bastard. don't spoil the surprise...

narapoiddyslexia's picture

So Greece and the others aren't going to default after all? Whew, I was worried there for a second. Thanks, Robo. Its good to know its all over. Friday fixes everything. I'm going to write that down, by the way. With your name on it.

Tsar Pointless's picture

Hahaha! Funny stuff.

And all of the problems here in the United States of Amerikkka were "fixed" with TARP. And with the QE family. And with TALF. And so on.

I guess you're on your way over there to help man the printing presses. Be sure to French-kiss your mom good-bye.

Not that you don't already do that everytime you go out for another supply of Cheez Doodles.

lizzy36's picture

Couldn't agree more.

Everything and everyone will be backstopped. It will be awesome. Gravity has been suspended. 

Time for Money Mangers to make their benchmarks and their bonuses.

Don't be sore buy some more! Don't just double down use a bunch of leverage and triple down. Afterall failure has been made illegal!

Spastica Rex's picture

We're approaching the singularity. On the other side, pure positive thought will manifest itself as reality. Negative thought will be washed away and destroyed. We will all merge as one collective consciousness, eternally contemplating the latest generation holy iPad.

NotApplicable's picture

Singularity was what I thought when I saw your perpetual motion +1 post, above.

Change will happen so fast, even the HFTbots will be unable to keep up.

Should be a real hoot.

Sunshine n Lollipops's picture

Multiple singularities of positive negativity!

AKA, massive debt = massive bonuses! 


slewie the pi-rat's picture

timmah is traversing the EU

er, make that greasing the EU

historically-speaking, of course

WonderDawg's picture

I'm so fucking tempted to buy some LNKD and CRM puts today, not sure I can stop myself. What to do?

NotApplicable's picture

Invest in your favorite spirits and get drunk instead. Far more productive, as well as less stressful.

Stax Edwards's picture

FWIW I closed out my LNKD short.  Still have a strategy but not just yet.

WonderDawg's picture

I almost pulled the trigger on LNKD last Thursday. Glad I waited, but it is awfully tempting right now.

SheepDog-One's picture

MomoFaded youll never get back to DOW 12,700 where you went all in are fucked.

homersimpson's picture

12.7K? You're being too nice. The dude was long at 14k..

homersimpson's picture

The only thing fixed is this stock market.

You're the poker player everyone wants to play with - you're always willing to go all in with the worst hands.

slackrabbit's picture

I have spoken to my Yoda doll, and I can tell you this problem will be fixed by Friday!

Schmuck Raker's picture

My Magic 8 Ball confirms that:"It is certain".

Dr. Engali's picture

This doesn't read like a CD post. I smell an imposter.

Cognitive Dissonance's picture

Tyler is the original CD as far as I'm concerned. He certainly creates Cognitive Dissonance on a daily basis.

hedgeless_horseman's picture



Cognitive Dissonance Reigns

Congratulations, CD!  You deserve it.

Cognitive Dissonance's picture

Does the position come with an obscene salary and benefits? And am I paid in fiat or Precious Metals?

CPL's picture

Hand shakes and "job well done" is all the powers that be are offering after stealing anything not nailed down.

LawsofPhysics's picture

Two big stick saves already today as the half life for saving leveraged paper with even more leveraged paper gets exponentially shorter.  Well it's been fun profiting from all this market volitility, time to get some more physical and small denominations of cash.

A Lunatic's picture

I'm buying the dips like a madman. So far I'm stocked up on bean, cheddar, clam, onion, fry sauce and guacamole.

Everybodys All American's picture

Sell the news either way ...

CPL's picture

Everybody DEAD!!!  DJIA up to 16000

Everyone rich!!  DJIA up to 16000

vegas's picture

Who cares?

CFTC fines Merrill 350K for cotton futures violations. I feel better now. [They must need new copiers or something]