The Politics of Delayed Disaster

The market expects Spain and Italy to apply for rescue, which causes their yields to drop, which eliminates the need for rescue, which causes their yields to rise, which forces them to apply for rescue . . . This is a classic paradox illustrating the damage of government mucking around financial market. It forces bifurcation of outcome into two disparate, extreme scenarios.

In theory, there may be a rational way to price the outcome, the probability weighted risk premium. But it's an unstable state; the smallest perturbation would cause the system to rapidly coalesce into one of the two scenarios, rendering the prior pricing wrong. Unable to settle into a stable state, the market can only go schizophrenic, which is what I think will come out of eurozone over the next few months.

But it does constitute a reduction in short-term risk, which is all the market can afford to worry about.

To me, this seems a much more rational explanation of the market's behavior than the supposed QE3 expectation. It's risk-on all the way until year-end, baby -- long stocks (SPY), gold (GLD), short USD (UUP), long commodities and commodity currencies, short volatility (VXX). Chinese stocks (FXI) seems a particularly compelling play since it's been beaten down relentlessly for months, and the risk would be perceived as much smaller provided the power transition does go smoothly.

That said, I will be watching FOMC meeting on Thursday very closely. The risk for disappointment is high. Going all the way in before then would be gambling. The market may be schizophrenic; I will try not to catch that bug.

At the time of publication, the author was long GLD and FXI.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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