Last updated on May 16, 2022

Mike Singleton of Invictus Research joins the podcast to discuss why the current sell-off is not a buying opportunity for stocks.

Content Highlights

• Many contrarians currently believe sentiment is too bearish, meaning the market is due for a run for strong performance. Their conclusion is likely wrong (3:28);
• Regardless of what investors say in surveys, the key question is whether they have money on the line — and how much (5:50);
• Right now retail exposure to stocks is at all-time-highs, while institutional investors have cash at low levels (7:27);
• What about the economic fundamentals, which are mostly in good shape? (10:09);
• The Fed actually has credibility when it comes to tightening interest rates — and is not just ‘jawboning’ the market (12:58);
• This is partly because the Fed does a lot more communicating than it has in the past (16:40);
• Inflation has likely peaked and will start to slow, though not by enough to let the Fed ease rates (24:02);
• Background on the guest and ‘origin story’ for Invictus Research (26:54);
• What part of the business cycle are we in now? (33:23);
• What does that mean for asset classes? (35:34);
• ARK Innovation ETF (ARKK) “has been a terrific place to look for shorts — quick discussion of Cathie Wood and her predicament” (38:03);
• Bonds will become an opportunity when the Fed ‘breaks something’ and there are indications that may be happening now (40:40);

More Information on the Guest:

• Twitter: @InvictusMacro;
• Website: Invictus-Research.com.

Quick Highlights from our YouTube Channel

Transcript

Nathaniel E. Baker
Mike Singleton of Invictus Research. Thank you for joining the contrarian investor podcast day. We are here to talk about markets and investing Of course, and these last couple of days, weeks months have been a tough time for stocks. We have tech now in a bear market, consumer discretionary stocks in a bear market, broader indexes are in a correction. And we just had first quarter GDP print negative for the first time since I don’t even know when probably since the height of the COVID crisis. So now this audit, that setup is typically something where contrarians and especially value investors like to use for bargain hunting, and for selective, selectively investing and buying stocks, but you aren’t buying it. And your long term, medium term outlook is more bearish despite these flashing buy signals. Tell me about that.

Mike Singleton
All right, well, first, thank you for having me that and I think I think I’ll probably take the perspective of positioning and why that’s important for this one, because I think a lot of contrarians believe that the street and the investor class generally is too bearish. And that because they’re bearish, that’s at least some supporting evidence that the market should be due for a run of strong performance here. And I think I think actually BusinessInsider just came out with sort of a contrarian headline that said, everyone’s worried about a recession, which means strong, you know, strong stock performance ahead or something to that effect, right

Nathaniel E. Baker
if Business Insider is saying this, they’re almost as bad as Barron’s. So that is, if anything is another sell signal. But go ahead.

Mike Singleton
Right, though, the old magazine cover test.

Nathaniel E. Baker
Yeah, exactly

Mike Singleton
So maybe the first thing I would point out is that I think people use the word recession flippantly in this business, because interestingly, the truth is nobody actually knows what a recession is. I don’t know what it is. Wall Street doesn’t know what it is. recessions are declared by a government agency called the National Bureau of Economic Research. And they’re declared months after they actually happen. So markets don’t really trade on recession fears. It’s sort of a misconception they trade on the growth cycle. So slowing growth, not technically a recession, sort of a semantic distinction there. But if you want evidence, that’s true. You can just look at the year over year rate of change in the s&p 500. versus any year over year measure of growth, we use the isn manufacturing PMI quite a bit, but they look exactly the same. Why? Because growth is the primary driver of asset market returns or stock market returns. So, you know, in principle, you should let the growth cycle drive your asset allocation decisions, not the headlines about recession risk. But back to my original point about positioning. Why do we care about positioning in the first place? Why did contrarians care about positioning in the first place. And it’s because when people are too bearish, and they don’t have enough stocks and the market goes up, they have to buy or cover the shorts, which pushes the market up higher when investors are too bullish. And they’re overextended in terms of in terms of taking risks, when vol spikes, they have to take risk down, which exacerbates the sell off. So in short, when positioning is really lopsided, one way or the other, that’s when nonlinear moves in price tend to occur. So obviously, contrarians or just investors in general, good investors want to be positioned on the right side of these nonlinear moves in price, or at least avoid being on the wrong side. But the underlying logic of everything I just said is people actually have to have money on the line, right? Whether people say they’re feeling bullish or bearish or not, is sort of irrelevant. What’s relevant is how they’re actually positioned. If things get bad enough in this case, could they would they have to unwind their positions would they have to sell, you know, thus exacerbating the downside? That’s, that’s really what we care about. A lot of investors right now. You know, Contrarian investors or people that just observe sentiment are citing the AAA I survey numbers, because I think as everyone knows, the most recent readings has shown investors to be very, very bearish, but in our view, and Victus, the surveys do not carry a lot of economic weight. Anyone can say they’re bearish or worried about the economy. I mean, actually, I can tell you if I had a ton of exposure to equities right now i I’d probably be even more worried about the economy. So in any case, Invictus, we try to pay more attention to how investors are actually positioned, not what they’re saying about, you know, how they’re feeling, which is sort of a fluffier thing that’s more difficult to measure. So we look at things like the Feds flow of funds, data Commitment of Traders report for hedge fund positioning, and a lot of options data

Nathaniel E. Baker
Okay. That’s interesting.

Mike Singleton
Yeah. So right now, in terms of positioning, there are really two measures that stick out to us. First, you know, backup for a second, you could divide the investor world into two classes of investors. On the one hand, you’ve got individual investors like you and me. And on the other hand, you’ve got institutional investors like pension funds, and endowments, and we can do our best to sort of look at them separately. So according to the Federal Reserve data, retail exposure to stocks is currently at all time highs, ever, as long as we have data going back to the 1940s, household exposure to equities is upward of 40% right now. So that’s a lot. That’s retail exposure, we can also use the Fed data to back into a proxy for how much cash institutional investors have on the sidelines, which would be another measure of positioning, right, what percent of their equity portfolios are actually sitting in dollars rather than equities. This would be a little easier if we could show you on a chart, but you just have to —

Nathaniel E. Baker
what is it now in the cash versus equities?

Mike Singleton
so among institutional investors right now, cash is about a 5% allocation. And this is a low level relative to history. We know from looking at prior periods of real financial stress, you know, the.com, bubble and the great financial crisis, and, and so on. We know that during periods of financial stress, the cash balances can move up to 10% or 15%. Pretty easily. So you know, none of this is to say that retail exposure to equities or institutional exposure to equities needs to be cut in half right now or over the next few months. It is to say that right now, investors as a whole, no matter which class are overweight risk, and they’re overweight stocks, and that increases the probability of nonlinear moves to the downside.

Nathaniel E. Baker
Just to jump in, I mean, the stock market, you need to invest cash for it to move upward. And if nobody has cash to invest, if it’s already allocated, then how is it going to move up? Right?

Mike Singleton
Right, exactly. That’s the underlying, that’s the underlying logic. And that’s why we look at positioning data rather than sentiment data, because I can be fully invested. And also nervous about the economy and also have my sentiment be bearish, especially if my mandate is to be fully invested. Right. And typically, after a long bull market, more and more investors have mandates to be fully invested, because the ones that haven’t been fully invested has underperformed over a long period of time. So they get pressure from their limited partners to start, you know, running with more. I don’t want to call it any investors by names. But if you follow hedge fund letters, you know that this is a relatively common theme among bottom up stock pickers. Sure, sure, sure. But anyway, I mean, in conclusion to the original point they do that recessions can’t have happen when people are bearish is kind of silly positioning by itself can’t drive multi months, multi quarter moves and asset prices, really the economic fundamentals are what do that. But second, people aren’t really bearish. If you look at the hard data, so I think making the case that, you know, there can’t be a recession, because people are too bullish it sort of both premises of that statement are off.

Nathaniel E. Baker
let’s talk about the underlying fundamentals. So the economic fundamentals, I mean, we have unemployment at, I don’t about record lows, but close to it, almost full employment, consumers appear to be in good shape, again, based on surveys. And okay, inflation is running hot. But there are, but the real estate market, again, higher mortgage rates cutting into it, but it’s pretty good. And so and those are typically things that would lead to a slowdown in the economy if they were the other way. So what what can end the economic expansion, if not that?

Mike Singleton
I think that’s exactly right. I think that’s exactly right. So in terms of the fundamental economic setup, maybe I’ll start with what’s going on organically, and then I’ll move to the bigger picture with the Fed. So it helps to take a step back and look at what was happening last year. So last year, we had a great one, we had a great market, but the reason we had a great market is because we had a great organic economic situation. We were going into the reopening, you know, you know, the vaccines had just come out we were comping 2020 which was like the year the Earth Stood Still because of the lock downs. So that’s that’s a very attractive setup, right? growth was going to be high no matter what and of course, it was real GDP printed 4.2% consumer spending was up 30% And we’re coming off of some, you know, super hot fiscal stimulus, monetary conditions were super accommodating. Right, interest rates were pinned at zero. You know, the the QE was large enough that I’m gonna get the number wrong $100 billion a month or something like that. And you know, that’s a cocktail for tremendous performance from risk assets. And that’s exactly what we saw, right? And this year 2022 is sort of the opposite story, because all those things are sort of reversing. Right. So we, we had the reopening setup before now we’re comping the reopening right to the base effects went from being super easy last year to super challenging this year. I mean, arguably, the most challenging base effects, since I think as far back as I have data anyway. So the organic situation is much different. We’re not going to get any sort of fiscal stimulus like we saw over the last few years, in part because there’s no impetus for it right? There’s no COVID issues right now. And too stimulating works out of a deflationary, it helps resolve deflationary issues. But it doesn’t help resolve inflationary issues, it actually makes them worse, because the whole idea of stimulating is to sort of bump up aggregate demand. So what was a fiscal tailwind will now become fiscal drag? It will be a fiscal headwind. And of course, the Fed has committed to sort of draining liquidity out of the system and tightening monetary conditions. And I’m happy to talk about some controlling contrarian views as regards to that if you’d like to,

Nathaniel E. Baker
yeah, let’s get into that. Because, I mean, so far, they’ve only They’ve only done one, an interest rate hike of 25 basis points, which is basically a small so that they can do, they’re talking now about 50 or even 75, and the next meeting in a couple of weeks, but, you know, people have said that and guests on this show have said this, that it’s just jawboning. And, and not only that, but they point to the history of it, like the Powell fed before is reversed course, when markets went against them against it back in the fourth quarter of 2018. And so we Yeah, what do you make of all that? Um,

Mike Singleton
so I think yeah, like you said, there’s this notion that the Fed has just started tightening, that it’s only tightened a little bit because Fed funds is still between 25 and 50 basis points. That’s the corridor. It’s really easy to say things like, you know, the Fed has no credibility that said, you know, whenever raise rates, the Fed can just sort of be the punching bag. Yeah, I enjoy that too much. But to say that the Fed can’t tighten or won’t tighten or hasn’t tightened. It’s not really true. And it sort of misses the point of how the Fed actually tightens policy. So first, maybe it’s helpful to take a step back. What is the ultimate goal of tightening monetary policy is to make business conditions fundamental business conditions, more challenging in order to slow aggregate demand and ultimately reduce inflation and inflation expectations, right? Inflation is a result of supply and demand for goods and services by reducing demand you reduce the price level. So how does that manifest? Well, it manifests through things like higher mortgage rates, which you mentioned earlier, that makes buying a home more expensive, it reduces demand for new homes, it reduces it reduces demand for things that go along with homes like home furnishings, which is obviously a very big industry, it drives a lot of spending. Higher rates across the Treasury curve also mean higher cost of debt for the private sector, as well as the public sector, right. Tightening also frequently coincided with widening credit spreads, which we’ve seen a little bit of, but it hasn’t been terrible. So what you end up getting is higher private sector borrowing costs, as credit risk is repriced higher alongside the benchmark rate, a stronger dollar is another classic sign of tightening that also tends to reduce business activity because, well, it makes international finance more expensive for foreign counterparties. Right. So as the dollar becomes more expensive to their own currencies, it becomes harder for them to service or dollar denominated obligations. For example, interest payments on Euro dollar debt are the cost of commodities, right? As the dollar becomes more expensive, you have to buy oil in dollars. So if you’re, you know, the European Union, or Japan or whatever you’re, you’re paying in something that you have to convert into dollars, which is more expensive to buy oil, which by the way right now is going up on its own. So the stronger dollar makes it even more challenging. A flattening yield curve is another symptom of tightening makes spread lending less attractive to capital providers. So anyway, what all these things have in common, they’re measures of tightness that can be measured in real time because they’re either tradable assets or derivatives of tradable assets. And that means one that observable in real time and to that they’re discounting mechanisms, because they’re pulling forward expectations for future rate hikes. I think the mistake that a lot of strategists are making right now is they’re just looking at indicators like the Fed funds rate or the size of the Fed’s balance sheet. So they’re saying, hey, Fed funds is still super low relative to history, the size of the balance sheet is at all time highs. That means that there hasn’t really been any tightening. But that’s kind of analogous to just looking at reported economic data, like looking at, you know, q4 GDP. I mean, I realized that the q1 Advanced estimate came out this morning, but it’s like looking at GDP for q4 of last year and saying, Oh, it’s 5.5 point 6%. And ignoring the fact that a lot can change in three months. And, you know, that was a while ago. So if you’re just looking at Fed Funds, you’re just looking at the balance sheet. It’s always going to lag what’s actually happening in real time. Just like with any reported economic data, I think the reason this is confusing for a lot of strategists maybe is that back in the old days prior to think it was the 9495 Hiking cycle, the Fed did not prioritize communications nearly to the same extent that it does today. So bankers would come into the office and they’d realize, Oh, hey, the Fed, bumped up rates 25 basis points last night. Today, the Fed is constantly communicating with investors and updating its use. You know, that’s all to say 25 or 30 years ago, the Fed funds rate was the primary way that the Fed tightened. And it was probably the best way to measure monetary tightness in real time. Today, the Feds first tool for monetary policy is communications and sort of letting the market tighten by itself and actually doing anything, right like raising the Fed funds rate, or running off the balance sheet that kind of comes second. And the reason that this is really important is that from an asset allocation perspective, Fed policy is super important. And looking into our process, that Invictus there’s really only three things that matter in Fed policy, monetary conditions, is one of them first, because the ease or tightness of Fed policy has an immediate impact on discount rates, which has, you know, sort of a huge impact on long duration assets in particular, which we’ve seen in sort of the crash and, you know, our and Internet stocks and pretty much anything with high terminal value relative to its current cash flows, or to biotechs gotten gotten whacked. That’s where you’ve seen the worst weakness and this market. But the second reason we care about monetary conditions is it has an impact on real economic conditions, like we talked about earlier, and eventually it hits the growth cycle. So right, maybe that’s a good place to stop.

Nathaniel E. Baker
Yeah, let me let me go back real quick on this, because that’s a really interesting point about communication. And the Fed. Actually, they didn’t Powell, they didn’t have press conferences prior to like, what was maybe 10 years ago or so. Like Bernanke, I don’t think they just it wasn’t a policy of theirs to have press conferences, to take questions from media. And as far as all these other fed speakers that they wheel out all the time to who knows how much of their speaking on their own versus how much is is dictated to them? You know, that’s that’s another thing that definitely moves markets, has there been any communication from the Fed? That you know, of of that you’ve seen, that’s documented this that said, we are going to dictate policy by our public statements, in addition to the movement of interest rates?

Mike Singleton
I don’t remember exactly where the minute or where the comments were off the top of my head. But I know that Fed officials have said things like the minutes are a communication tool, right? Like it’s not meant to be, you know, a look inside each member of the Feds brain. It’s meant to be something that investors can look at, to get a feel for what the side wants them to think. I’m not sure how widely known that is, but it is documented somewhere.

Nathaniel E. Baker
But that’s the minutes those only come out for after every meeting

Mike Singleton
Right that comment was in reference to minutes, right.

Nathaniel E. Baker
I mean, but there’s other comments, you know, like Powell at his press conferences, and these other guys at all their speaking engagements and things. So what to what extent is that you think also driving the whole policy?

Mike Singleton
No, I mean, big time, I think you can see like, you know, Bullard will say something bullish and you know, the markets will react very quickly. Exactly. And I think to imagine that the Fed doesn’t know that the markets are pricing that in and that, you know, mortgage rates don’t respond to comments like that, of course, the Fed knows that they’re not done. And there’s a I think there is a truth that in the end, maybe the Fed is dumb. They’re not dumb at all. They know exactly what they’re doing. And I think sometimes they make mistakes, but the mistakes aren’t being made, because, you know, they’re stupid, or they’re ignorant. Yeah, you know, the mistakes are made, because they’re, you know, human beings.

Nathaniel E. Baker
Really interesting. Yeah. And, like all I’m not a super fed watcher, but all the all the recent commentary has been very hawkish, most notably by Powell himself. His last comments before the blackout period, where he basically penciled in a 50 basis point rate hike. So yeah, so it does seem that that is that is something, but that’s just for the near term. Now, what do you think about the longer term as far as like interest rate policy?

Mike Singleton
So maybe I’ll start with over the intermediate term, because everyone focuses a lot on what Jay Powell says about what they’re going to do with the next meeting. And I think that is very important. And I think that there’s certainly a cottage industry of Fed watchers that are very good at dissecting the tone of what the various Fed officials are saying. And Victus we are more interested in what the markets are telling us. Because I don’t have a CIA degree and investigated, you know, body language or anything like that. That’s not my forte anyway.

Nathaniel E. Baker
Too bad! That would make for a really interesting guest, by the way, but go ahead. Sorry.

Mike Singleton
But I can tell you exactly what the markets are pricing in, in the markets tend to be tend to be smarter than any one individual analyst. And I can tell you that right now. Basically since November, the Fed has been, or the markets have been pricing in an aggressively more hawkish fed basically in a straight line, you can see, you know, monetary conditions ease very slightly when Russia invaded Ukraine. My projection on that is that maybe the markets thought, if there’s a conflict that really involves the US, the Fed won’t want to tighten to won’t want to be too restrictive. But that that was over and done within a few weeks, and the markets continue to price in tighter monetary conditions. So, you know, I think eventually the federal breaks something intermediate term view is that the Fed will continue to tighten until the markets tell them loud and clear. Hey, you’re breaking something and the Fed says we have to stop over the very long term. Well, I have less of a view on how you know whether the Fed will be restrictive or less restrictive, stricter relative to the so called neutral rate. Right. I do have a view that rates in general will probably go down over the long term.

Nathaniel E. Baker
That’s pretty close. Yeah, I mean, it just depends on how long term you’re talking about.

Mike Singleton
Right. And I could be totally wrong. Nothing. I say that super long term is really investable because we pay such close attention to the market. But you know, what are what drives rates over the long term? What’s the like the 30 year? Well, it’s real growth and inflation, right? And so if, over the last 40 years, real growth and inflation have been trending downward, right, productivity growth has been trending downward. More importantly, really, demographic conditions have been trending downward fertility rates, growth in the labor force and so on America, like most developed markets has been aging. So if you’re gonna make the case, and that’s that’s disinflationary as well, I mean, slow rising demand means slower growth and slower inflation. So I think if you’re gonna make the case for higher rates, you have to make the case that both growth, or either growth or inflation will trend up, I think the case that people are making for higher rates right now is that, you know, we’re gonna see a sort of a secular inflation take hold. And I can tell you that that’s not my view right now. But you know, if I get enough evidence that that is what’s happening, I’ll change my mind.

Nathaniel E. Baker
Oh, that’s interesting, because you would think that the Fed would need inflation to be high for them to continue to want to raise rates, right. And if we were coming off of these lower base, well, we had the lower base effects. But now we’re back up to high base. So you figured like the year over year, CPI print wouldn’t shouldn’t be that dramatic anymore, or maybe starting in a couple of months.

Mike Singleton
Right, our expectation, you know, it always feels dangerous to call top. Yeah, our expectation at Invictus is that we should start to see decelerating CPI prints in year over year terms. In other words, that 8.5 8.6% print from, I guess it was March, that should be the high point. And we expect it to decline to you know, cook, calling an exact bottom is also kind of a fool’s errand, but maybe call it three or 4% by the end of 2022. So it’ll still be high relative to history, probably high enough to keep the Fed, you know, not easing at least if it’s not tightening. But then from there, it’ll, you know, lower highs and lower lows until it gets back to around 2%. That’s our expectation. Okay.

Nathaniel E. Baker
That’s really interesting. Okay, you unwrapped a bunch of stuff here for us. And I want to get into some more details on this, what this means in terms of asset allocation. With the understanding, of course, neither of us are providing any investment advice, do your own research, make your own decisions, but I want to first take a short break and come back. If you are a premium subscriber. Don’t go anywhere. Don’t touch the dial. You will not get the break. We’ll be right back.

Nathaniel E. Baker
Welcome back. Everybody here with Michael Singleton of Invictus. Research. That means unbeaten right.

Mike Singleton
Yeah, unconquerable, something to that effect.

Nathaniel E. Baker
I knew it. Okay. And so this is a segment of the show where we ask our guests to tell us a little bit more about themselves, how they came to this station in life. I call this the origin story, to put things in Marvel terms of how they came to investing. So yeah, take us away. And tell us about how it all began and how it all led to your current station in life.

Mike Singleton
Okay, so maybe I’ll start with college, I attended the University of Notre Dame and you know, sort of a funny story as a freshman before the football games, I would sell cigars at the football tailgates. Right. And that was probably the best job ever in terms of, you know, how much money you can make per hour.

Nathaniel E. Baker
Not beers, cigars?

Mike Singleton
Yeah, just cigars, not beers,

Mike Singleton
Can you smoke in the stands there?

Mike Singleton
No it was at the tailgate.

Nathaniel E. Baker
Oh, I’m sorry. The tailgates. Right, sure. Go ahead. Okay.

Mike Singleton
Yeah, have a barbecue sandwich and a beer and a cigar. But like I said, That was a great job for me anyway. And so I decided pretty quickly that I wanted to do business. After Notre Dame I worked at a private investment firm called Broad Run Investment Management. It was a fabulous experience. I had a ton of autonomy from very, very early on, I got to lead my own investments. I got to travel to conferences. I got to talk with some of the smartest and Esther’s on the street. And let me tell you, I mean, some of the analysts out there are really geniuses, I don’t mean that metaphorically, they’re crazy, crazy smart. But what I noticed was that Wall Street was also very compartmentalized. And the research departments would have a guy covering industrial stocks and under guy covering commodities and other great covering technology. And so what I noticed is that a lot of these guys when they make a stock call and get it wrong, particularly on the buy side, and the sell side has its own sort of conflicts of interest that I’m not really addressing now. But when the biocide people would get stuff wrong, it was almost never because they were dumb, or they weren’t smart. It was usually because they were missing the forest for the trees, they’re missing the business cycle. Because they’re focused on their needs. They’re super focused on technology stocks, and so they weren’t paying attention to say monetary conditions, right? Or at least not until after monetary conditions had driven their stock down 80%. And ironically, if you’d asked a lot of these people individually, hey, do you believe in the business cycle, they’d be like, oh, yeah, of course, the business cycle exists, but it wasn’t their job. And so they didn’t have a means of integrating it into their process. So that was sort of the foundation for Invictus in terms of the ideas that we would do all the legwork around analyzing the business cycle, and we deliver it to you in sort of short, easily digestible videos in five or 10 minutes. We think of them as sort of a replacement for reading the business section of the newspaper. So, so often, I fall into this to you know, read the newspaper, read Bloomberg, read the journal or whatever, and you end up sort of reading it for entertainment value. And you don’t when you’re finished reading it, you don’t have anything useful to take away from it. For example, I was reading a Bloomberg article yesterday about those long that our, you know, our K goes capital guy, and what his motivations were for, you know, investing the way it did, and I think the author concluded that he had no idea. And I was, you know, when I finished, I was like, this was really entertaining. But this is more like entertainment news masquerading as business news. And people spend a lot of time reading the news every day, you know, 30 minutes an hour. And that’s what everyone tells you to do. But I think if everyone took five or 10 minutes to consume something more like Invictus understand where we are in the business cycle, what the implications are for for returns, you know, given where we are, that’d be a much better use of time than, you know, reading through the, you know, the entertainment section of the business section, or something to that effect. So that’s what we do at Invictus. That’s our goal.

Nathaniel E. Baker
Interesting. That’s funny, because that’s kind of really the impetus for this podcast was kind of the same. And, you know, I obviously have a long background in news and news writing and all that stuff. And so one of the things I, I try not to, I don’t think anybody should really read any news stories, they don’t need to other than for entertainment, the headlines tell you everything you need to know. Well, you have to be careful, though. Because the head you have to know what kind of story it is. And you have to know what kind of headline it is. Because a lot of times people are just pushing clickbait, not to mention any specific examples other than Business Insider. Anyway. So yeah, so I find that to be a very valid point. So Invictus, basically your idea is to kind of figure out the the business cycle and to identify that, and then base your the asset allocation around that.

Mike Singleton
Right. Yeah, exactly. So I think the business cycle is, you know, somewhat widely accepted idea. But I’ll, I’ll define it anyway. So you can think of the business cycle was the nominal growth cycle, right? And that’s primarily what drives returns with the stock market, the bond market, the commodity market, the forex market, right as the various business cycles. And you can decompose that into the real growth cycle and the inflation cycle. And so if you get those two things, right, well, first of all, cycle implies that something isn’t random. So something cycles, that means it trends and peaks and troughs, and then trends, and then peaks and troughs. And just that understanding is revelatory for a lot of people. And it was for me, because it means that you can sort of play the odds, right? Last year when, through the reopening, when we saw these sort of ridiculous reopening growth trends like 4.2% 30% for consumer, you know, with a very high degree of certainty, that growth is going to decelerate from there. There’s no economist in the world that thinks, you know, the US can sustain double digit real growth that the consumer can sustain 30% spending. No one thinks that and yet you had a lot of people at the time, you know, even if they weren’t using the language of the business cycle, sort of tacitly assuming that growth could continue like that forever, which is ridiculous. So anyway, that’s what we mean when we talk about the business cycle, the real the real growth cycle and the inflation cycle. And then the third thing that matters is monetary conditions if we talked about earlier.

Nathaniel E. Baker
So I guess this all begs the question, what part of the business cycle are we at now? I have added a bunch of the outset, but we’ve not implicitly so yeah, go ahead.

Mike Singleton
Our review is clearly that real growth is slowing? I think it’s I think it’s hard, especially with the advanced estimate that just came out this morning. It’s hard to make the case that growth isn’t slowing, we expect it to continue to slow. The bigger question is around inflation. And, you know, we have our estimate for CPI, we told you earlier, we think that we’ve seen that sort of peek in the ear of your friend. I’ll say, though, that we would not invest in a disinflationary manner until we see confirmation from the asset markets. Right. So right now, we’re still seeing inflationary, you know, we’ve seen them go off a little bit the last few days. But really, I mean, we want to see trending. You know, a trending, I don’t know what the right word is relaxation of performance from these inflationary exposures. So we’d like to see things like breakeven start to make lower highs. We’d like to see oil start to make lower highs, we’d like to see energy stocks start to show relative underperformance. That’s what we mean by confirmation from the asset markets. Okay. And the reason is, the reason that we wait for that is we spend a lot of time thinking about the fundamental story and modeling and all that stuff. But the unfortunate reality is people including us at Invictus, model the economy incorrectly from the bottom up all the time. More often than not, right. But the market never gets the business cycle wrong. Never. The market is a reflection of the business cycle. So the business cycle keeps us honest, so to speak, if we get something wrong in terms of growth, or inflation by a quarter or by, you know, a few basis points, the market keeps us from getting it really wrong. And when the market tells us we’re wrong for long enough, we have to change your mind. So it’s sort of a risk management protocol. So okay, so what does that mean for asset classes? Right.

Nathaniel E. Baker
I mean, growth has gotten bludgeoned. And it doesn’t look like we’re anywhere near the part of the cycle that would indicate a return to growth stocks. Staples have done okay. For the most part, could they do more? You know, things like energy. cyclicals? I guess there are two you would think that? I don’t know. Yeah, well, that is the question. But so what does one do?

Mike Singleton
Okay, so earlier, we said that the three staples of our you know, investment outlook for right now are slower growth, which is being validated by the asset market. So, you know, we’re happy to invest that way, slower inflation, which is not yet really being validated by the asset markets, and tightening monetary conditions, which is definitely being validated by the asset market. So, good investing is all about leveraging where you can have conviction, right, and minimizing exposure to areas where you can’t have conviction. So right now, we would not be expressing a large view about inflation in our portfolio one way or the other, because it’s just not a place where we have super strong conviction yet. Energy. Right, I mean, yeah, exactly. So you know, it would be either like neutral or you know, depends on how you manage your portfolio, but we would be more confident expressing a view on growth. So shorting cyclicals going long defensive, something like that, right. The ratio of cyclical stocks to defensive stocks also tracks the growth cycle extremely closely. I mean, there’s virtually no situation where growth is declining precipitously and cyclicals are outperforming defensives, it just does not happen. So as long as growth is declining, defensive so think, you know, staples, large caps relative to small caps, utilities, large cap healthcare managed care providers, those should be outperforming exposures relative to certainly cyclicals but also defensive as a whole, tightening monetary conditions is also a view that we’ve been expressing for a while. And obviously the easiest way to to short that is or to express that view is to short long duration equities or to you know, underweight them. So we have a weekly trade ideas product, and

Nathaniel E. Baker
what are long duration equity, you mean bonds,

Mike Singleton
no long, long duration equities, really what we mean is equities where the high percentage of the valuation is located in the terminal value, right. So just as a sort of function of the way a DCF works, long duration, equities will have a lot of sensitivity to interest rate risk, and you know, what we call tightening monetary conditions, right? So that would be exposures like, technology tends to be faster growth, right? Naturally, biotechnology, a lot of those companies don’t really earn any revenue. I don’t want free cash flow. But the expectation is that, you know, eventually the hit big on something, and they do earn a lot of money, but it’s somewhere in the future. So they’re very sensitive to monetary conditions. ARC has been a terrific place to look for shorts. And, you know, I think it’s really funny. Ark is done terribly, of course, and people are very quick to blame that on Cathy woods. But the reality is, I don’t I mean, I haven’t done a real performance attribution on the ark funds. But people don’t seem to understand that. She invests in a very specific way she looked here, mate. Her mandate is essentially to invest in the fastest growing companies and that exposes her to Sector risk and style factors that are going to go through periods of insane outperformance and insane underperformance. Right, and it’s almost not a function of your stock picking skills at all. As long as she sticks with that mandate, she’s gonna have massive exposure to during that basically duration risk. And so the fact that she’s down so much, you know, maybe it’s a function of your stock picking skills, too. But no, no,

Nathaniel E. Baker
I think that’s perfectly fair. But where that goes, That thing goes belly up, is when you look at her comments about how she keeps doubling down on like how you know, the stocks, or the stock that they invest in, or, or an inflation hedge that grade, they’re going to do better. That’s a huge buying opportunity, blah, blah, blah. She’s been saying that the whole way down. And so that’s kind of like if she were just, I mean, who knows if she’s being honest, not whatever. But if she were just to say, look, this is what we do. There are times in the economy when this is better than others. And this has happened one of the poor times, you know, they’ll probably be, but then who knows? Maybe then she’d get out. And she hasn’t had that much and outflows has she?

Mike Singleton
No, you’re right. I don’t know. She has made some comments that don’t make sense to me economically. So I don’t know what that I don’t know what’s motivating that probably marketing.

Nathaniel E. Baker
Sure. Sure. Sure. Yeah. So anyway, yeah. That’s, that’s, that’s fascinating. Okay, so that would be alright, so you’re saying, you know, long utilities and and staples. Okay, let’s not. Yeah, I mean, that makes sense. Right. Now, what about what do we do anything with bonds? I mean, what about the, you know, the are those stocks? Look at all attractive for you. They’re like, where do you do that?

Mike Singleton
That’s a great question. And this is a this is a reason that we use the market to validate our ideas and our forecasts, it would make sense that in a risk off market regime, which I think we’re going through one right now, I think that’s fair to say, it would make sense that bonds would do well, right, because Treasury besides us dollars, Treasuries are the safest asset on Earth. Right. So if we were having this risk off economic market situation, why aren’t treasury bonds catching a bid? And the answer is because the Fed is tightening monetary conditions, it’s intentionally raising rates. And that has an impact on the entire curve. So I think bonds start to do better when the sounds self referential, so I apologize for that. But bonds start to do better when they start signaling to the side that they’ve broken, something in the Fed has to take its foot off the gas. So I know what it sort of sounds like saying for the 10. year, three years? I mean, yeah, I don’t think I’m of a mind that the Fed has already tightened a lot. I would be surprised to see rates surpass their 2018 highs. What’s my logic? Well, what governs leverage in any system? Or excuse me, what governs interest rates in any system? What’s the amount of leverage that the system can sustain? Right? So we have substantially more debt now than we did in 2018, which was the last policy cycle. So you would imagine that we could not be the interest rates our economy could sustain would be lower. That said, the Fed can still push rates higher, even when the market saying you’re breaking something, right? If they think that it’s that important to reduce inflation, we’re willing to break stuff. So that’s why we wait for validation is because I don’t know exactly what the Fed is going to do. I imagine, at some point, they’re going to ease up and bonds will start to outperform, but I don’t know exactly when that will be. So that’s why we wait for the market signal.

Nathaniel E. Baker
Although I think the last couple of days, I think bonds have done a little better here.

Mike Singleton
Right? There are some signals that that might be happening now. And there aren’t enough to say that it’s confirmed in our view, but looks like you’re starting to see the beginning of what we would call bear steepening, right, where, you know, the yield curve is steepening, but it’s not a reflationary steepening. It’s not a healthy steepening. It’s sort of a bearish deepening, where short rates are going down faster than long rates are short term bonds are outperforming long term bonds. very short, very short measures of yield curvature, like the three months to year are flattening a little bit. They’re making lower highs, again, to too early to say like, Hey, we’ve reached the breakpoint in the Feds reversing course. But these are things that we’re watching very closely, because that could signal an end to monetary conditions tightening so aggressively,

Nathaniel E. Baker
you know, what do you think the Fed will do in the next meeting?

Mike Singleton
I think what the markets are implying 50 or 75 basis points, probably one of those.

Nathaniel E. Baker
Okay, but definitely, if not 25?

Mike Singleton
I don’t think so. Yeah, that

Nathaniel E. Baker
would be Yeah, that’s definitely that would certainly be

Mike Singleton
at this point, when people say that the Fed has no credibility if the Fed did 25 I think that would reduce its credibility.

Nathaniel E. Baker
Right? Yeah. Yeah. Well, yeah, probably. If they use zero, that would really reduce that. Yeah, they can’t do that. That’ll be insane. Even though I agree. That would be bad. Ya know, like it. Yeah. Interesting. Very interesting conversation here. Michael Singleton. Thank you so much for joining me contrarian investor podcast today. In closing, maybe tell our listeners how they can find out more about you and about Invictus. I believe you’re on the social media. So yeah, what are those and I’ll put that in the show notes as well if you miss it, but Go ahead.

Mike Singleton
Sure. So, if you want to learn more about the Invictus product suite, take a look at Invictus dash research.com and follow me on Twitter. My handle is at Invictus macro.

Nathaniel E. Baker
Invictus macro. One word. One word. Very cool. Awesome. Well, thank you, Michael, for coming on. Thank you for your time. Thank you all for listening. And we look forward to speaking to you again next time.

Nathaniel E. Baker
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