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Extreme Front Running: Why Super Mario Draghi Will Disappoint


The crowd in front of the ECB are a little too sure of themselves in light of economic and political trends.

Back in early September, this tweet caught my eye.

People were lined up in front of a New York City Apple (AAPL) store a week before one of the company's major media events without knowing nothing what Apple would launch or when.

As a socionomist and a researcher in confidence-driven decision making, the action in front of the Apple store spoke volumes about consumers' confidence in the company.  Even before the iPhone 6 was announced, these people knew they had to have it.

With my clients, I used the CNBC tweet along with a chart of Apple stock to suggest near-term caution. Often, what is happening outside of the market can be helpful in measuring investor sentiment in the market. Going into September, Apple stock was trading at an all-time high. That consumers were in line for Apple's next product without knowing what it was fit well with a stock at a major mear-term peak in price. Apple's stock price and the behavior in front of its store both reflected peak confidence.

As things played out, Apple stock fell from just about $103 at the beginning of September to $94 at its mid-October low. The expression of extreme confidence that I saw in the image above matched the extreme confidence of investors.

While I am sure the people in the image above didn't think of their actions this way, they were in essence front-running Apple. They were positioning themselves ahead of news that they believed would work out in their factor -- that their time spent in line would be well-rewarded.

Absent inside information, the act of front running requires extraordinary confidence. Not only must investors accurately anticipate when an announcement will be made and what it will contain, but they must also anticipate how other market participants will react to the news. Market prices are determined not by what you believe, but what others around you think.

To me, Europe looks at lot like the New York Apple store three months ago. Investors are all lined up waiting for Mario Draghi's QE announcement.

As best I can tell, the first people started to get in line back in early May. With the euro trading at 1.40 to the dollar and European inflation dangerously low, Mr. Draghi first suggested the central bank was ready to act in June.

Over the past six months, Mr. Draghi has succeeded in stretching out the implementation date further and further into the future.  Over this time, European inflation has become deflation and Greece has fallen into chaos.

While Mr. Draghi has yet to act, his promises for what is to come, coupled with economic and political news out of the region, has created a huge crowd standing in line outside of the ECB's Frankfurt headquarters.

Since he first opened his jaw last May, the euro has lost 16% of its value against the dollar (trading at 117) and the yield on European sovereign debt (excluding Greece) has collapsed. German, Spanish and Italian debt are all trading at or near record low yields -- with some, like in Germany, negative.

With two weeks to go until the central bank's next meeting, there is a now a huge crowd front running the ECB. But like the Apple store group three months ago, they still have no specifics on what the ECB will really do, and when it will be done.

What worries me is that the crowd believes that they will be positioned correctly. They think that no matter what Mr. Draghi does, the euro will continue to fall and European sovereign debt yields will tighten further, so those standing in line will be handsomely rewarded for front running the ECB.

If the crowd were small, they might have a chance, but the lop-sided positioning that I see suggests caution ahead. Much like the way US government bond yields bottomed ahead of QE3 in July 2012, I wouldn't be at all surprised to see the euro and European sovereign debt yields bottom ahead of the next ECB meeting. Where US investors front ran QE3 in a stampede, global investors have done the same thing with respect to the euro and European sovereign debt over the past six months.

No matter what Mr. Draghi does at this point (and given how social mood is falling across Europe, I have my doubts that he can do much if anything) I am afraid that he will disappoint the market.

As I noted above, based on the expressions of extreme sentiment that I see, I expect that the euro and European sovereign yields will rise, not fall further, this year. And needless to say, the dollar reversal could also put some life into both oil, gold and other commodities, too.

The act of front running requires confidence. That so many investors are now front running the ECB in such enormous size suggests that a major turn is near.

Peter Atwater's groundbreaking book "Moods and Markets" is now available on Amazon and Barnes & Noble.
"Peter Atwater brilliantly provides a framework for understanding both the socioeconomic hubris that led to the great credit bubble of the past decade and the dark social-psychological hangover that has resulted from its collapse. In so doing, he offers an invaluable guide to what promises to be a very difficult and turbulent period ahead as we experience what he calls the 'me, here, and now' behavioral tendencies of the post-crash world."  -Sherle R. Schwenninger, Director, Economic Growth Program, New America Foundation

Twitter: @Peter_Atwater
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