Jay:  Today’s show guest is Jared Dillian, editor of the Daily Dirtnap, a daily market newsletter for investment professionals which he’s been publishing since 2008. Jared is an ex-colleague of mine during my time back at Lehman Brothers in the early 2000’s. Back when he was a trader, he used to write a daily Bloomberg market recap, The Distribution of Clients. And after the financial crisis of 2008, he built up such a following that he decided to keep writing full-time.

Jared is the author of several books and also a regular contributor at Forbes, Mauldin Economics, and a columnist at Bloomberg View. His newsletter, the Daily Dirtnap is one of the only financial publishing newsletters I actually subscribe to as he is a contrarian by nature and always gives me a unique perspective on how to look at the market. I hope you enjoy my discussion with Jared today.

Hey, Jared, thanks so much for joining us. We’re excited to have you on.

Jared:  Thanks for having me.

Jay:  You have quite a unique background, and so I’m curious. I like to ask guests how they got started in investing. So maybe you could give our audience a little bit of color on your background and how you got started.

Jared:  So I started my career in the US Coast Guard, actually. I went to the Coast Guard Academy, and I was a commissioned officer. I served five years after I graduated, and it was while I was in the Coast Guard that I became interested in investing. Read a lot of books on my own, but also went to business school part time at the University of San Francisco.

And while I was doing that, I got a job on the P Coast Options Exchange as a clerk, just running tickets around. I mean, this is– number one, this is back when there were exchanges, and number two, this is back when they were paper tickets. So, this is really a long time ago. And I learned about options. I learned about volatility. That was really my first introduction to trading and finance.

I applied to a bunch of banks after graduation, and Lehman Brothers was the most interested in me, and I was able to use my background in options in the interviews, and it worked out really well. So, I traded at Lehman Brothers for seven years. I did index arbitrage, and then I ran the ETF desk. And after that, I started The Daily Dirtnap in 2008, and I’ve been doing that ever since.

Jay:  So that’s quite a unique background. How did you get started in writing because it’s not that common that people go from institutional to financial publishing? Was it something that you were doing concurrently on the side during your time at Lehman?

Jared:  Well, I started writing financial commentary in about 2003, 2004 for my institutional customers and ETFs. Basically, I was goofing around. I was trying to be funny. I was trying to be witty. And my stuff was good, and it spread like wildfire. I had thousands of people sign up for my distribution. And I mean, to be honest, there wasn’t really a lot of substantive stuff. It was mostly entertainment, but it had this viral quality to it. And I said maybe I can make a business out of this.

So keep in mind, I had always been a writer. I won writing awards in high school and in college, so I’d always had this in the background. And then when I left to start The Daily Dirtnap, I had the writing part down, but I was not much of a financial analyst. Keep in mind, I was just a trader. I was just making markets. I was kind of a flow monkey.

So I wasn’t really a thoughtful guy when it came to macro and high-level thinking, so that was what I had to learn. But it’s worked out great. I published Street Freak in 2011. I published another book, All the Evil of This World last year. I write for Bloomberg. I write for Forbes. So I’m basically a full-time writer now.

Jay: Yeah, so you’re writing is excellent, and we’ll talk a little bit more about your books maybe a little bit later. So that’s a pretty cool story. I think that you know, I’ve been on floors like that, and also on the client side, where when you have a broker or a trader that writes just a little Bloomberg thing every day and sends it out, and some guys are super boring, so you don’t pick up any following. But I guess you had some success there.

So you mentioned that you had to learn a little bit more about high-level investing when you came out, and at the same time, were you concurrently trading your own capital while you started writing your newsletter full-time?

Jared:  Actually, in the beginning, no. In the beginning, I really wanted to focus on

the newsletter and idea generation. And I basically had my capital in two or three positions that were pretty static. And then, what I discovered in about 2012 was that my ideas were good. And I thought that they would carry a lot more weight if I was investing alongside my own ideas.

And then around 2012, in The Daily Dirtnap. I really started to build a model portfolio, and I traded alongside the newsletter. Now keep in mind, first I have to publish and give people time to put the position on, then I trade. So I trade after everybody, just from a compliance standpoint.

But since 2012, every idea has been backed up by actual capital, and I think that gives the newsletter a really authentic quality because I trade like an absolute return hedge fund manager, and I trade in a very aggressive way. And to a certain extent, the newsletter is a little bit of a diary. It describes my ups and downs as I’m investing, and I have plenty of downs to go with the ups. So like I said, it gives the newsletter a really authentic quality.

Jay: Yeah. Absolutely. There’s nothing better than that alignment of interest, which you don’t actually see a lot in the financial publishing world. There’s a lot of talking heads and pundits that talk about markets, and they can do it all day long. But then you ask them if they’re creating their own ideas, and most of them aren’t, which is shocking.

So maybe you could give us a little bit of some detail on your investing framework. I know you come from a trading background. How do you look at markets? There’s many of different ways to make money in the markets, obviously. So, I’m just curious as to what your investment methodology is like.

Jared:  Well, coming from a market-making background, one of the things that was explained to me when I first started running the ETF desk was that the flow has informational value. And nobody really explained to me what that meant, so I had to figure it out on my own. But what that meant to me over time was usually it paid to do the opposite of what everybody else was doing.

So this is a really generic example, but if there’s panic in the markets, a terrorist attack, something like that, and everybody’s selling, it usually was a good idea to take the other side of that flow unhedged, and that was profitable to do that. So, I sort of grew this mean reversion mentality of fading extremes and sentiment.

And so really, my whole investment methodology is based around sentiment. I’m sort of an armchair economist. I’m sort of an armchair financial analyst. But the one thing that I do better than anyone else is I measure and read and interpret sentiment. So I spend a lot of time, especially– back in the early days, like in ’08, ’09, I spent a lot of time on blogs, but blogs aren’t as important nowadays. Now, it’s really Twitter. Probably 30% of my day is scrolling through Twitter and figuring out where sentiment is on various stuff. And also, talking to people.

For me, every piece of information I get is a piece to this sentiment puzzle. If somebody sends an email to me, and they’re really bearish on something, then I have to think is this somebody that’s a smart guy, or is he not a smart guy, and what’s his position and how does he feel about it? So, it’s all part of this mosaic that I build around sentiment.

Jay: That’s very interesting. You’ve been known to be a contrarian investor at times, and I see some of the stuff you put out on Twitter. It’s pretty thought-provoking, to say the least.  And so, when you’re putting together this sentiment mosaic, so to speak, as you just said, how often do you then, thereupon, find ideas? Is it literally just when they present themselves, or is it several times a year you find where all the stars align, and it’s trade worthy?

Jared:  I wouldn’t say it’s several times a year. I would say my really, really good ideas are probably two or three a year that are high expected value trades. Keep in mind that when I started trading, I was in business school, and it was during the dot-com bubble. I was investing in 1998, 1999, and I was a contrarian, really, from the very beginning.

I never bought into the dot-com bubble. I didn’t buy one tech stock. In ’98 and ’99, I was buying things like Texaco and Philip Morris, and I was investing in value when everybody else was doing the complete opposite. And that served me well. So like you said, you see my stuff on Twitter or whatever, but basically I’m fading extremes and sentiment, which being a contrarian, like a really true contrarian, is a very lonely place because when you say something that is that far out of consensus, people actually laugh at you. They make fun of you.

So, when I was saying in 2013 that Canada had a housing bubble, it was so far out of consensus that it was a very unpopular position to hold. Now, pretty much everybody assumes that they have one, and it’s just a matter of time until it pops. But there’s a bunch of examples like that

Jay: Right. Yeah, you’re right. It is lonely being there on the other side, and people get emotional about it, too. Some people get pretty nasty.

So speaking of bubbles, let’s talk a little bit about the markets right now, and I want to hear your thoughts on it. Obviously, valuations in the US are extremely high by any sort of metric. And it is one of these things where if we had this discussion a year ago, it’d be probably the same discussion about the markets and from the value camp, you probably were sitting on your hands for the last 18 months or even longer. A lot of the momentum guys made a lot of money in this big rally that seems to never end.

But again, being a contrarian, I’m interested to hear your view because it’s a head-scratcher for a lot of people, and it’s one of these things where active managers are feeling a lot of pressure because again, there’s not a lot of opportunities, but yet they have to somehow come up with their returns. So what are your views on the market right now? What might bring this bull market to an end?

Jared:  Yeah. It’s kind of– I mean, obviously valuations are super high. And the thing about valuations now, it’s not just the valuations of the most expensive stocks. All stocks are expensive.

I was looking at McDonald’s earlier today. McDonald’s is up 50% in the last year. It’s trading at 25 times for it, and McDonald’s, as a company, is a mess. The business is a mess. Their menu is too big. The whole thing is a mess. And it’s basically a staples company that should be trading at six to eight times, and it’s trading at 25 times. And as you go through the S&P 500, every single stock is like that. There’s no place to hide.

And then on top of that, you have this phenomenon of volatility suppression, where people continue to pile into short vol strategies, which in a self-reinforcing process, actually makes volatility lower. And as it was explained to me a couple of months ago, the reason people keep doing that is because the Sharpe ratio of those strategies is so high. If you’re short volatility, and vol is 0 or 1 or 2, that Sharpe ratio is basically infinite. So those trades continue to attract more sponsorship, right?

So the question is what brings this all to an end? And I think that people will get really focused on there being a concrete catalyst. For example, a war in North Korea, that would be a possible catalyst that would bring the bull market to an end. It usually doesn’t work out that way.

If you think about what happened in the last two bubbles, the dot-com bubble and the housing bubble, was there really an event that pushed the market over the edge, like one catalyst? There really wasn’t. It was just the marginal asset just got too expensive, and buyers turned into sellers.

And the best cure for high prices is high prices. So that will happen eventually. Your or I cannot predict when that will happen. All we can do is we have two choices. Either we can continue to play this game and pick up nickels in front of the steamroller– which by the way, if you’re managing money, if the music’s playing, you got to dance, right? But if you’re not managing money, if you’re a private investor like me, and you have the luxury of being on the sidelines or in stuff that’s remote from this trade, then you just do that, and you just try to stay out of trouble.

Jay: You bring up an interesting point on volatility. I mean, I think, again another head-scratcher, and like you were saying, the Sharpe ratio on that short because of the positive carry, I think it attracts a lot of people that don’t even know how that instrument trades, and so you see a lot of people retail piling into that XIV ETF, which it pays that nice positive carry.

But at the same time, I don’t– again, a lot of people don’t understand the mechanism. So while it may be attractive, it could also draw it out, as we’ve seen very sharply when there’s certain events or data points. But from an overall perspective, would you be one way or the other on vol right now?

Jared:  Well, I mean, yes, you would be long vol, but you want to do it in a way that you minimize your beta, right? And so, some people are selling at the money straddles and buying variants, but there’s no such thing as free convexity, right? Free convexity does not exist. You have to pay for it.

I have a tiny amount of tail risk exposure. I did it just to make myself feel better. I personally am not putting on crash trades. I think that it’s better to try to build a portfolio, a diversified portfolio, and sort of stress test it, and say, okay, this will behave well in the event of a dislocation. Do you have a crash-proof portfolio? I think that’s a smarter thing to do than to just go around and buy a bunch of tail risk and wait for the crash

Jay: Right. Absolutely. So, given where markets are now and focused on this region of the world, which is Asia, it seems to make sense. If you’re trading on a global portfolio or if you’re just a private investor, really, if you’re long the US right now, you should probably take some chips off the table and look elsewhere.

Do you look internationally? I mean, I know you, obviously Canada, you have that call there on the short. But is there anything over in this part of the world that you look at that interests you?

Jared:  Well, keep in mind, I find the US to be so unattractive. US equities are 10% of my portfolio, and that’s actually up from a couple weeks ago when it was zero. So, no. I’ve been a big emerging markets bull since early 2016. I’ve gone on the record saying that a bunch of times.

I think EM, the momentum is getting a little frothy here, but I still think if you were to buy EM, just pin the tail on the donkey, just blindfolded, and waited five to ten years, you’d still be happy, even here. I think the dollar is going to rally a little bit in the short term.

In terms of Asia, I’ve been super focused on Japan since 2012, and if you look at the way the market is behaving, the inverse correlation between bond yields and dollar yen is, I mean, it’s approaching one. The correlation is picking up dramatically, and it’s all because of the BOJ targeting the yield curve, so whenever you have a duration sell off globally, and there’s pressure on JGBs, then the yen sells off. And you’ve seen dollar-yen go about four big figures in the last week, just in this duration sell off.

If you have any kind of short duration view, whether you think that central banks are suddenly going to get more hawkish, or they’re going to move away from inflation targeting, or any of that stuff, then dollar-yen is the best way to express it, and also Quanto Nikkei, right?

I don’t spend a great deal of time on China. China is hard for me. It’s hard for me to annualize. I think as part of EM, it’s 40% of the basket, which I think sometimes you’re happy about that, and sometimes you’re not. Right now, I think you’re happy about that. So even just as part of buying EM or BWO, I’m happy to take the China exposure.

Jay: Yeah. I think I think you’re right with the 5 to 10 year scenario, where if you just threw it in there and woke up ten years later, you’d probably be pretty happy, I would guess, with that EM exposure.

One sort of buzzy topic that I’ve seen you tweet about as well is crypto, obviously. I have to ask you because you have this contrarian view. We’ve seen a wild ride this week, obviously, with what happened in China. I think it’s down over 30% now, and then Jamie Dimon, obviously, 48 hours ago came out saying it was a complete fraud. Thoughts on cryptocurrencies, Bitcoin, in general?

Jared:  Yeah, I’m a lot closer to Jamie Dimon’s view. I don’t think it’s a fraud or a scam or anything, but I think it has a lot in common with the dot-com bubble. Having lived through that, I think it has a lot in common with that, and Bitcoin is really similar to dot-com stocks.

If you think about an internet stock in 1999, where it doesn’t pay any dividends, it doesn’t have any cash flows, and the terminal value could be infinite, based on the psychology at the time. The psychology was the internet was very new, so the internet is the future. So, if you have an internet radio company, that terminal value in the DCF could be trillions. People just put huge, imaginary numbers on it.

And there’s really no way to value Bitcoin on any kind of supply-demand framework, so we have John McAfee saying it’s worth $500,000 or a million dollars, right? And so those kinds of outlandish valuations, it’s a direct parallel to dot-coms in 1999.

And sure, there’s a legitimate pushback on that, is the rate of adoption is very low. Maybe 1% of 2% of people invest in it. Plenty more people could, but just the amount of initial coin offerings and sort of the– I’m a sentiment guy. Sentiment is just maxed. It’s obviously, sentiment is just maxed on this. So, I’m very bearish on it.

Now having said that, let me just jump in for a second. So, if you look at what happened with the.dot-com bubble in 1999 and 2000, the second wave of tech happened 10 years later. And all the promise of the internet was eventually realized, but it was realized in a handful of stocks, FaceBook, Amazon, Google, right? Those were hundred backers, okay?

So, I think Bitcoin is a legitimate technology. I think it’s a legitimate currency. But the second wave of it, which is going to happen 10 years from now when blockchain does get adopted in all the ways that people think it’s going to get adopted, that second wave is going to be much, much bigger, and that’s what I’m interested in playing. That’s when I’m interested in playing, when the price goes down to $100 or $300.

Jay: Yeah, that’s actually a very good way to look at it, the web 1.0, web 2.0. So when we see blockchain 2.0, that might be a trade of the lifetime there.

Any other interesting things that are on your radar, based on your sentiment gathering, at this point in the markets?

Jared:  Yeah, we’ve had a little bit of a perm just in the last week, but people got limit short dollars, just in the last week or two. Sentiment on that got maxed. The Euro got to 120. I think that the ECB of any central bank is probably the most likely to disappoint, and I think that’s stretched.

If you look at Canada and Australia, there’s all kinds of expectations for rate hikes. The interesting thing is that the Fed, right, the Fed for years, if you look at the Fed funds curve, the Fed funds curve is very steep, and people expected that there would be rate hikes and rate hikes and rates hikes, and that never came true.

Now the Fed funds curve is flat. People think that there’s going to be none, but guess what? In a couple of months, we’re going to have a completely new board of governors, right, that’s Trump-appointed, and possibly a lot more. hawkish. So, I think that expectations are way out of line with interest rates in the US dollar.

Jay: Yeah. It’s actually quite interesting with Fisher’s departure recently. When Fed Governors Board members just depart like that, it’s always is kind of scary, but I think–

Jared:  Well, I think people’s interpretation of that was totally wrong. That was viewed as a dollar bearish event because Fisher, on the Board of Governors, was the most hawkish–

But that’s the short-term view. The long-term view is who is going to be his replacement? And if you look at who Trump has appointed already, Marvin Goodfriend and Randy Quarels, they’re hawks, right, like Trump. Trump says he likes low interest rates, but Gary Cohn and Steve Mnuchin, the guys that are advising him on who to appoint for the Fed, they’re not going to put doves in front of him. They’re gonna put hawks in front of him. And I don’t think he can find a Republican to put on the board that is a dove. I just don’t think that’s possible. So I think the Fed just gets way more hawkish over the next year.

Jay: I think you’re right. That’s a good way of looking at it. Well Jared, thanks for sharing your market thoughts. Let’s talk about your newsletter and you also have a blog. The Daily Dirtnap, you write every day, which is quite impressive. I’ve read some of your stuff. I’ve seen some samples and this sort of thing. It’s pretty high level, and you do have that institutional background. Is your target institutional clients, or do you have a handful of high net worth as well that’s following you?

Jared:  Yeah. My target is people who consider themselves to be sophisticated investors, whether that’s institutional, buy side or sell side, or high net worth, and people who really like to think about markets on a daily basis. It’s like drinking from a fire hose. I put out a lot of content and really, the idea… I publish 225 issues a year.

Jay: That’s incredible.

Jared:  I don’t have 225 ideas. Like I said before, I have about two or three good ones, maybe five or six marginal ones. So, what is the rest about? The rest is about blowing your head off with thought-provoking stuff.

For example, I had an issue just a couple days ago that was talking about tech in general from a public opinion standpoint, talking about how people are turning against the tech industry like the way they turned against Wall Street in 2006.

You’re seeing a lot of the same parallels, and I talked about what– you know, Equifax just got hacked. What do you think is the likelihood that Google and everybody’s search history, ends up on the internet? What happens to regulation then, right? There’s all kinds of implications.

So basically, my job on a daily basis is to get– “outside the box” is a very overused term. Well, I’ve had several people tell me they read my stuff to get them thinking about things they’re not thinking about.

Jay: Yeah, it’s definitely thought-provoking, and for the audience, it’s listening, and it’s actually–usually they’re well over a thousand words. It’s proper– I don’t know how you do that on a daily basis. It’s very impressive. So it’s high level, but I encourage the audience to check it out.

You also mentioned earlier that you, of course, wrote two books. The first one, Street Freak, based on your experiences at Lehman, which was great. And your second one was a fiction book, is that right?

Jared:  Yep.

Jay: So I’ve heard – I’m not an author, really, or anything – but I’ve heard friction is actually harder to write.

Jared:  It’s so much harder. It’s so much harder. It sucks.

Jay: But it’s also one of these things where I’ve spoken to a few guys that have written financial fiction, and they said that it’s a way that they can actually express their views without getting in trouble, about what’s really going on.

Anyway, so on that note, what else are you working on these days? Maybe you could share with the audience. Obviously, your Daily Dirtnap, which is your product. Are you writing any more books or working on anything else exciting?

Jared:  Yeah, I’m working on a third book, which I’ve put on hold for now, but it’s still there, which is intended to be really a very basic personal finance book. I mean, really basic. So think like Tony Robbins, Dave Ramsey, that kind of basic book, which I’ve always wanted to do. What can I say about it? I’m not going to say anything about it. It’ll be two or three years before it comes out, probably.

The other stuff I’m working on is really– well, also, I have a free newsletter from Mauldin Economics called The Tenth Man that comes out once a week. So, if you want to check out my stuff for free, you can read that.

But I’ve been working on my opinion pieces. I’m an editorial columnist at Bloomberg for “Bloomberg View.” They asked me to do that. It was a huge honor, and most of my stuff is financial opinion. I don’t wade into politics too much, but writing opinion pieces really makes me happy. And these pieces have an impact. Bloomberg is a huge platform. And so, when you write something about a company or a public official, it’s read and people take notice. So that is something I’m super excited about.

But yeah, keep an eye out for the new book in about two or three years.

Jay: Nice. Have you found that you have to tone down based on which outlet you’re writing for? I guess Bloomberg, you have to keep it a little bit more diplomatic, I suppose.

Jared:  The funny thing is that I try to tone it down, but they want me to tone it up. They actually like the crazy stuff.

Jay: That’s awesome. Well, Jared, it’s been such a pleasure. Last question is where can people find you, follow you, connect with you, and learn a little bit more about what you’re working on?

Jared:  So www.dailydirtnap.com is where you can learn about The Daily Dirtnap. My books are both on Amazon, Street Freak and All the Evil of This World. And if you want to check out the free newsletter, go to mauldineconomics.com.

Jay: Fantastic. Oh, and just real quickly, Daily Dirtnap. Maybe you can explain that to the audience, what that actually means.

Jared:  Yeah, when I was on the P Coast, in ‘99 and 2000, it was the surfer exchange. Keep in mind, people work west coast hours. They’re out of there at 1:00. A lot of those guys would go surf. Surfers have their own dialect, and “dirtnap” was the word they used when the market was going down. And these guys they would stand there on the floor, and they’d look up at the screen, and they’d be like, “Dude. The Spooz (S&P 500 futures) are taking a hell of dirtnap.”

And so that was the word on the P Coast, so I kind of stole it, and brought it back to New York, and now everybody says it.

Jay: That’s awesome. That’s great. Well, Jared, thanks again, and we appreciate your time and your insights.

Jared:  Thanks.

Jay:  All right. Take care.