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Samuel Lee is an ETF analyst with Morningstar US.

We're in strange seas, where a downgrade of US debt causes treasuries to soar and economists prescribe more debt to cure a debt hangover. Tossed by the violent eddies and streams of sentiment is Europe. Dare we ride it into the unknown?

The rewards are tempting. By a slew of valuation measures, European stocks look cheap compared to historical levels. European equity cash flows look juicy and if the authorities contain the crisis investors can expect a massive rally as cash flow-to-price multiples expand from their depressed levels.

However, European equities may be a value trap.

Risk

Let's walk through the nightmare scenario spooking the markets. The European project is doomed. As investors move to flee Italian sovereign debt, a self-fulfilling panic takes hold. Spiking interest rates drive up Italy's debt service to unbearable levels, and pitch the country into a state of near-certain default.

The run soon engulfs Spain, Portugal, Ireland and perhaps even France. Losses on trillions of dollars of sovereign debt blow through the buffer afforded by the bailout fund, itself largely paid for by the nations it's supposed to backstop.

The blow to banks' balance sheets ignites a eurozone financial crisis, transmitted by an elaborate and opaque web of cross-holdings, derivatives and debt exposure. Runs on banks begin.

The negative shock to sentiment and incomes spurs massive deleveraging, whereby everyone rushes to pay down debts, sending the economy into a self-reinforcing decline. Lacking independent currencies, the insolvent nations face the prospect of a decade or more of painful re-adjustment as wages and debt burdens fall to restore economies to equilibrium.

Massive social unrest forces governments to pursue the nuclear option: leave the euro and default on their debts by running the printing presses and outright abrogation. So the euro currency union disintegrates.

Note how the doom loop starts with a shift in expectations - that fickle thing that can stay quiescent for years only to erupt with little rhyme or reason. Recall how in the summer of 2010 sovereign debt fears erupted for a few months and were pacified by some grudging bailouts, only to reemerge a year later.

The best way to kill the current panic and the future possibility of them is for the European Central Bank (ECB) to pledge unlimited purchases of sovereign debt to keep yields low.

However, public opinion, the German technocratic elite's hard-money beliefs, and the European Union's political structure seem to bind policy responses to a menu of shoddy choices that end in different kinds of disaster, the slow or the fast kind.

Expectations, mirrors

The nature of self-fulfilling panics means investor sentiment will largely set outcomes. If the market is fooled by palliatives (doubtful), stock prices can rise and stay there for years until the next cycle of panic sets in.

The irony is that as the market becomes more complacent, the political will to engage in painful reform ebbs, sowing the seeds for the next cycle of panic.

We suggest two competing approaches to profit from Europe's debt woes. One is to aggressively ride momentum, buying when European stocks do well, and selling when they do poorly. Investors could time their exits and entries with momentum indicators such as the 200-day simple moving average.

The market's optimism and pessimism will be self-reinforcing owing to the expectation mechanism we described. A simple 200-day moving average strategy applied to the STOXX Europe 50 would have sold out before the worst of the recent draw-downs.

Historically, market states characterised by high volatility and recent declines tend to be followed by major declines and even more volatility.