Inflation or Deflation?

Some people are worried that debt and deficits and money printing are going to cause inflation to skyrocket. Other people are worried that AI and technology are going to cause us to go deep into deflation.

I acknowledge that there are both inflationary and deflationary forces, and I believe they will probably offset each other, leading to inflation of about 3%.

In the last 20 years, we have experienced both deflation and inflation. Deflation, during the financial crisis; inflation, during COVID. What were the causes of both? I would say they were both psychological, and I will go on to say that the primary determination is psychology, not the money supply or anything else. 

During the pandemic, we went a few trillion into debt and literally helicoptered cash all over people, and they started buying stuff on Amazon and stocks on Robinhood. Hard not to see the psychological impact of that inflation—everyone was stuck at home, and it was party time. Hard not to see the psychological impact of the financial crisis either. Prices started moving lower within hours of the Lehman bankruptcy. Again, that’s not economics; that’s psychology. People look at inflation ex-post and explain it away using economic arguments, but it has little to do with economics.

Can You Predict Inflation? 

Well, can you predict psychology?

If President Trump craps on the Fed and tries to remove governors, it’s not so much about the economic impact of those actions. It’s about the psychological impact of those actions—everyone knows that it will result in inflation in the future. I mean, gold is up a lot in the last few weeks, and who knows what it is pricing in—but the actions against the Fed are probably playing a role. If Congress passes the Big Beautiful Bill with its embedded deficits, it’s not so much about the actual deficits, which will take years to play out, and the economic impact of those deficits, but the psychological impact of that bill being passed. Again, gold is up a lot.

I am a trader, and I spend a lot of time thinking about psychology, and it is everywhere you look. See what happened to Oracle a few days ago—a few statements about future AI demand sent the stock up 40%. The economic impact of the next 10 years is discounted in a matter of seconds. The same is true of economics. The same is true of everything. Things get “priced in” instantaneously and contribute to our expectations about the future.

Everything is psychological.

What Are You Going to Do About It?

If everything is psychological, what are you going to do about it?

You might be thinking about buying Nvidia stock, and you might have done some fundamental research on how many chips they are going to sell in the next five years. You think your research is accurate and you are ready to trade on it. A few points:

• This is not a terribly original idea.
  

• Five years is a long time.
  

• All it takes is for the second derivative of sales to turn lower, and the stock will reprice.
  

• And all it really takes is a single comment out of management that business has slowed to turn your thesis into worm trash.

I literally just got this email from a Daily Dirtnap subscriber about some comments I made on Oracle, and The Economist’s latest magazine cover on AI:

But I can assure you that “demand not showing up fast enough” is a psychological phenomenon rather than an economic one, just as the AI bubble is also a psychological phenomenon. If you figure out when sentiment peaks, there is money to be made. Conversely, if you can figure out when sentiment troughs, there is money to be made. 

You generally want to short things when people are the happiest. You want to buy things when people are the saddest. You can get an indication of both from the popular press, as it tends to show up on the scene when people are really happy or really sad—because that’s what’s news. The press does not write about boring things. It writes about the extremes. That’s why magazine covers work.

One more piece of trading advice: Nothing goes up (or down) in a straight line. Nvidia itself has had multiple 50–75% drawdowns along the way. As has Netflix, as have a lot of other stocks.

I am going to say the dumbest thing in the world, but the technical analysis people say it all the time: You want to own the stocks that are going up, not the ones that are going down. I personally like to buy the stocks that are scudding along the lows, forming a long base, that people have forgotten about, which is the point of Heartland Investor, which I wholeheartedly endorse.