| Dear Reader, There's no way around it. The market is a dangerous place.  Sure, there are times everything “seems” easy. Everyone is riding the highs, and for a moment we collectively forget the tough times. “Bull market, dude.”
But those times don't last, and for the inexperienced investor, the end of those good times is always a surprise. Good thing I'm not an inexperienced investor. I've made my living in the markets by paying attention to sentiment and psychology. It's served (and my readers) me well. - So, when I repeatedly start seeing empty shelves and bins at the grocery store my radar goes off.
Last week, I sent out an issue of my private newsletter The Daily Dirtnap that was simply titled “WARNING.” In it, I implored my readers to liquidate stocks prior to what I saw as imminent market correction. A few days later, one of my readers sent me this email: - “I don’t know the internal reasons why you changed your views (...) But I went with your call and you saved me a boatload of money. Just keep on letting Jared be Jared.” –G.L.
This WARNING marked an important change in sentiment for my letter The Daily Dirtnap and caused us to liquidate more than a few positions. In fact, anything that was not related to inflation, or part of a firm, long-term thesis, was cut. - Why? Because inflation is no longer benefiting the capital markets (equities). We are past the fun part. It’s time to take a new direction.
I feel strongly that you could benefit from reading the issue itself, so I am including it below (be sure to catch what I have to say at the end of this email). The Daily Dirtnap | 13SEP21 WARNING I have some bad news. Let’s keep this simple. Demand keeps going up. Supply keeps going down (from these mysterious “supply chain issues” and other unknown factors). We’re experiencing shortages of a bunch of different stuff, especially food. What if the shortages don’t get better—what if they get worse? What if, a few months from now, you walk into a grocery store and it is completely empty, except for the Beyond Meat? - What if the buying turns into panic buying?
What if...people think we are going to run out of food? That is the nightmare scenario I am proposing. Shortages become so pervasive that people can’t get food or essentials. Inflation spikes to 20 or 30%—or higher. It's within the range of possibilities. My first piece of advice to you is to go to the grocery store and buy as much food as you can carry. - The first rule of panicking is to panic before everyone else does.
Go and spend $1,000 on essentials and store them in your freezer or pantry. I don’t ordinarily do this. In spite of having a pretty big house, there is not a lot of space to store stuff. We will make it fit. We made a big grocery trip over the weekend, and we will make another one next weekend. We will keep doing this until the house is completely full. I mean, worst case scenario is that this never comes to pass, and you have a house full of food, and you eat it down over time. - My second piece of advice to you is to...sell stocks.
I’m getting the sense that the stock market is starting to get concerned about inflation, especially Friday’s gaudy “Producer Price Index” (PPI) number—which is up 8.3% over the last 12 months. 
(When producers pay more to produce, we pay more to consume.) - If we get double-digit inflation, the stock market is going to go down. For sure. We are past the “fun” part of inflation and on to the “bad” part.
And the amazing thing is that it didn’t take long. And you can guess, the government’s response to massive shortages is going to be monumentally stupid, and make it monumentally worse. The sentiment implications of civil unrest at grocery stores are not nil. For now, we have shortages in specific goods, and abnormally high prices in other goods (like meat), but soon, we will reach the tipping point, and hoarding will ensue. Hoarding is a natural reaction to scarcity. - Stocks are going to come under serious pressure.
So over the course of the next week or two, we are going to substantially liquidate much of the portfolio, unless it specifically pertains to inflation, or is part of a firm, long-term thesis. I’ve been bullish for a very long time, but no more. Time to turn the ship around. There’s plenty of liquidity (for now). - Here’s the thesis: If inflation spikes well past 10%, the Fed is going to be forced into doing something about it, because they will be embarrassed.
I have always said that the Fed will not hike rates until they are embarrassed. If we have inflation well into the double digits, it will be clear by then that it’s not transitory (which you and I have known for over a year now). The timeline of rate hikes will be pushed up substantially—maybe even immediately—and we’ll be looking at a huge liquidity shock to the capital markets. I hesitate to use the word “crash,” but you get the picture. This will play out over the next couple of months. I have a feeling that things are going to get very ugly. Let’s put it this way. Inflation has entered the public consciousness. Everyone is aware of it. First, it was merely a nuisance, and now, it is getting to be a problem. Wait for the first grocery store to run out of meat. Or bread. Or produce. And it makes the news. Kind of like a run on the bank. I always say you have to have a big imagination in this business. The economy is poorly functioning, with labor shortages and shortages of raw materials. - A healthy economy is not plagued with shortages and dysfunction. And the trend is toward more dysfunction.
I tangentially asked for some inflation anecdotes from all y’all (hey, we are in the South) and boy did you guys deliver. Some incredible stories. I can’t share them here, but let me just say that if you could see my inbox, you would have a lot more conviction on inflation. It is not stopping, it is not going away, and it is only going to get worse, and it has the potential to explode higher. I’ve spent some time talking about stocks, but we have not yet discussed the implications for the bond market. Well, it’s hard to imagine that Treasuries will stand still with inflation approaching 20%. Stranger things have definitely happened, but the bond market seems vulnerable here to me. And credit: Remember that financial market risk is determined by the volatility of inflation. I can see an environment in which spreads widen dramatically. If you’re making markets in corporate bonds, this would be a good time to keep things close to home, and not carry a lot of inventory. Volatility will spike, to VIX 40 at least. We’ll be having 2% daily moves in the index, or more. I am generally not a fan of long volatility trades, like VXX or VIX futures or options, but now is as good a time as any. We are in a higher volatility regime than we were in 2017, and we will go to yet an even higher volatility regime. I am an inflation bull, but I no longer believe that it will benefit the capital markets. We are past the fun part. The next part could end with rationing. And Americans really, really do not like rationing. We haven’t even discussed the new vaccine order, which will result in millions of people leaving their jobs on principle. You think labor shortages are bad now. In case I wasn’t clear earlier—go to the grocery store and load up. Unlike the stock market, there are no consequences to being wrong. -ISSUE END- Outside the Box I hope you found the above helpful. The time has come to change our investing strategy (and perhaps stock up on a little extra chicken and beef, or in my case… cat litter). - This is how it works. A good investor pays attention to sentiment. A good investor pays attention to trend. A good investor knows enough to be contrarian and not do the same thing that everyone else is doing.
That’s what we are doing over at The Daily Dirtnap. If you’d like to join us, you’re more than welcome. You can read more about what function the The Daily Dirtnap can serve in your life here. Otherwise, good evening. I’ll email you on Sunday with HOW TO MASTER SENTIMENT, EP. 2. Until then... be careful out there. 
Jared Dillian
Editor, The 10th Man and The Daily Dirtnap
Mauldin Economics | 