There’s a new and different kind of inflationary shock coming to the market…

And right now, I don’t think investors are properly prepared for it.

Right now, everyone from Wall Street investors to regular people are talking about out of control inflation.

The very same high inflation that I first predicted in early 2021.

But right now? I’m less and less worried about inflation.

I’m increasingly worried about what happens after the inflation we’re currently seeing.

I’m not alone, either.

The fear, among many experts and industry leaders, is not inflation.

Rather, many of these figures fear the possibility of impending deflation.

• Cathie Wood, Wall Street’s most prominent growth fund manager, has expressed worries that the Federal Reserve might go too far and trigger economic deflation.

• Elon Musk, CEO of Tesla and SpaceX, recently expressed the same concerns, saying that falling commodity prices were “neither subtle nor secret.”[i]

• And Jeffrey Gundlach, one of the most successful bond investors of all time, has pointed out that while everyone is worried about inflation right now, the risk of deflation is growing higher and higher.

“In spite of the fact that the narrative today is exactly the opposite, the deflation risk is much higher today than it’s been for the past two years,” said Gundlach. “I’m not talking about next month. I’m talking about sometime later next year, certainly in 2023.”[ii]

I published a similar warning about this in December 2021 when I wrote:[iii]

The U.S. doesn’t need to have bare shelves and starving citizens for supply chain disruptions to be a significant problem.

Like a double pendulum, very small perturbations [in the economy] result in chaotic and unpredictable effects.

Right now, everyone is talking about inflation inflation inflation as prices are going up.

But what happens next year, when suppliers and vendors are going to be getting fewer orders and purchases?

They might constrict supply. Again.

Everyone lowers prices to try to clear their stock.

And because the Fed is about to taper support of the markets and raise interest rates, stock values will be under a lot of pressure.

If all that comes to pass, by this time next year everyone will be worried about deflation deflation deflation.

So far?

Much of what I predicted then — even before everyone was seriously talking about inflation! — has already come to pass.

By August 2022, huge retailers like Walmart and Target had a massive oversupply of inventory and had to massively slash prices to sell goods.[iv]

While most of the world is going through a calamitous food crisis that are driving up prices, certain commodity crops, like soybeans, are in astonishing oversupply.[v]

And now the cost of freight shipping is starting to fall sharply.[vi]

This is going to alleviate a lot of the inflationary pressure that have pushed prices upward. At the same time, it also means that these companies will be earning less money — which means they won’t be able to invest in goods, supplies, or employees.

All of this is happening right as the Federal Reserve Bank and other central banks around the world are raising interest rates to try to fight inflation…

Inflation which looks like it is already resolving on its own without further intervention.

Soon, I expect the inflation music to stop. And when it does, history tells us a lot about what could happen next…

Particularly, something economists call a “disinflationary shock.”

What is a “Disinflationary Shock”?

The impact of inflation on stocks is pretty well known and fairly often studied by economists.

 One paper from the National Bureau of Economic Research showed that “disinflation shocks promoted market booms and inflation shocks contributed to busts.”

A “disinflation shock” is any surprising decrease in inflation. One that’s not expected.

The study expanded on this:

“The evidence reported here provides support for the view that unanticipated changes in inflation and interest rates have played important roles in major movements in the U.S. stock market since World War II. We find that inflation and interest rate shocks have large, negative impacts on stock market conditions, apart from their effects on real stock prices. Disinflationary shocks, for example, can help explain the U.S. stock market boom of 1994-2000, whereas inflationary shocks can help explain the bust of 1973-74.”[vii]

This should resonate with anyone who invested in stocks in 2021 and 2022. Inflation and interest rates both increased at a shocking pace, which scared many investors into selling. 

The reason why high inflation causes stock market volatility and crashes is fairly intuitive.  

Higher inflation creates more economic uncertainty. This harms the ability of companies to plan, invest, grow, and engage in longer-term contracts.  

Plus, big companies with lots of control in their market can increase their prices to lessen the impact of inflation. But many companies can only partially pass on the increased cost of raw materials. This causes profit margins to shrink. 

But there’s another important thing to keep in mind about these findings…

Economists and consumers are expecting inflation to range from 4.8% to 6.22% in mid-2023.[viii]

But my models, the bond market, and simple algebra seem to suggest that the rate of inflation will likely be lower than that. Possibly much lower.

That means, in 2023, we might see a disinflationary shock, which apparently promote “market booms,” according to the research.

So we might end up seeing a situation like in the high-inflation period of 1974 and 1975… When the market went down by -29.7% one year, but then went up by 31.5% the next year.

But this exciting prospect — a stock market boom — comes with a very real and very scary caveat.

See, these market booms triggered by disinflation?

They usually come after a market crash or recession.

So while I am expecting a brief stock market rally in October and November of 2022…

My main concerns are twofold…

First, another big market drop in January or February of 2023 — especially if holiday retail sales are dismal due to an economic recession.

Second, that the Federal Reserve raises interest rates so high that we experience deflation rather than disinflation by mid-2023.

The difference? Disinflation means high inflation reverts back to normal.

Deflation means that inflation goes in reverse, and the value of money goes back up.

This would be extremely bad for the global economy and would potentially be worse than inflation.

Why?

Because if you know that your money will be able to buy you more stuff next month, due to deflation and prices decreasing, then you won’t spend any money this month.

And if everyone avoids spending like this, we’ll suddenly have another situation like we did in March and April 2020, when lockdowns effectively forced deflation to occur and subsequently triggered all the crazy, insane market turmoil we’ve seen since.

[i] https://www.cnbc.com/2022/09/14/cathie-woods-contrarian-deflation-call-gets-endorsements-from-elon-musk-jeffrey-gundlach.html#:~:text=Meanwhile%2C%20the%20Tesla%20CEO%20called%20falling%20commodity%20prices%20%E2%80%9Cneither%20subtle%20nor%20secret%E2%80%9D%20and

[ii] https://www.cnbc.com/2022/09/14/cathie-woods-contrarian-deflation-call-gets-endorsements-from-elon-musk-jeffrey-gundlach.html#:~:text=In%20spite%20of,certainly%20in%202023.%E2%80%9D

[iii] https://www.diywealth.com/blog/your-3-step-guide-for-destroying-the-global-supply-chain#:~:text=The%20U.S.%20doesn%E2%80%99t,about%20deflation%20deflation%20deflation.

[iv] https://www.cnbc.com/2022/08/06/the-walmart-target-inventory-misses-include-a-message-for-main-street.html

[v] https://www.spglobal.com/commodityinsights/en/market-insights/latest-news/agriculture/091322-oversupply-likely-as-us-my-2022-23-soybeans-harvest-heading-towards-record-high

[vi] https://www.rnz.co.nz/news/business/474824/shipping-costs-decline-but-not-expected-to-return-to-pre-covid-levels

[vii] https://drive.google.com/file/d/1cukAwt1HK6h9SkWK2wjTqeEnFTQmI97-/view?usp=sharing

[viii]  https://ycharts.com/indicators/us_expected_changes_in_inflation_rates_next_year and https://ycharts.com/indicators/us_oneyear_ahead_inflation_expectations