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Risk/Reward Still Skewed Toward Risk: Mike Singleton, Invictus Research (Szn 5, Ep 9)

Last updated on April 24, 2023

This podcast episode was recorded on Thursday, April 6, with an actionable highlights clip previewing the following day’s non-farm payrolls released to premium subscribers that same day. The full podcast episode was then released to premium subscribers a day later. To get early access to podcast recordings and take advantage of a host of other exclusive benefits, sign up to become a premium member at our Substack or Supercast.

Mike Singleton of Invictus Research rejoins the podcast to discuss his pessimistic outlook for the economy, why he’s concerned about credit risk, and why the Federal Reserve should end up cutting rates before too long.

Content Highlights

  • The outlook for risk assets is still not constructive (2:40);
  • Fed rate hikes are very close to a peak, if not there already (4:43);
  • Economic conditions point to stubborn inflation (7:09);
  • Inflation may not need to return to the Fed’s 2% target for there to be rate cuts (11:00);
  • The outlook for commodities prices is not particularly constructive either (15:59);
  • What to make of the banks? (21:14);
  • One leading economic indicator that Invictus likes, which is overlooked (or ignored) by the market at large (22:30);
  • The backdrop is still positive for short-term bonds (24:28);
  • Leading indicators for the yield curve include bank lending standards, which right now suggest a steepening… (26:13).

More About the Guest

Not investment advice.

Quick Highlights From Our YouTube Channel


Nathaniel E. Baker 0:04
This podcast episode was recorded on Thursday, April 6, and a highlight clip of the most actionable items was released to premium subscribers that same day. In this case, the actual Highlights included a preview of last Friday’s non farm payrolls. So this is something that only premium subscribers got. In fact, that part has been cut from this recording that you are about to hear. Because it’s no longer timely, and no longer relevant. But to become a premium subscriber, you can join us at the contrarian and sign up, or a contrarian thought As mentioned at the outset. Now, there is of course, still an awful lot in this episode that you’re about to hear that is still highly relevant, and is absolutely worth listening to. So without further ado, I will shut up and let you get to it. Here you go

Mike Singleton, Almost exactly a year ago, when you were on the first time, you told us that we should not buy what was then a dip, developing, especially in tech stocks. So one correct call for you. So now, of course a year later, we are curious as to what has changed — a lot has changed, including the fact that it doesn’t look like you shaved very much in that year, for those of you following along on video. But yeah, curious if you’re any more constructive now, for the outlook for risk assets, such as stocks, with all of your research that you do in the economic cycle, and things like that?

Mike Singleton 2:51
So the short answer is no. But for different reasons than the last time we talked, the last time we talked, inflation was beginning to accelerate, and the Fed was starting to become very, very hawkish. And the reason it wasn’t a good idea to buy the dip at the time is because the Fed was getting ready to embark on the most aggressive rate hiking cycle since Paul Volcker. And a lot of the large cap us indexes have considerable duration risks, because there’s a lot of growth and a lot of tech. And so as interest rates went up a lot of those long duration assets. You mentioned, tech stocks went down really quickly. And sort of the indexes as a result, we think that the risk for risk assets now is a little bit different. We think the Fed is probably toward the end of a tightening cycle, maybe they get another 25 or 50 basis points. But we’re clearly closer to the end than to the beginning. We think the risk now is credit risk is the risk that economic growth slows in a nonlinear way. And that’s also a bad backdrop for risk assets. But in terms of the market internals and who tends to get hit the hardest. It’s a little bit different.

Nathaniel E. Baker 3:56
Right, talk to me about this, this, what you’re picking up in terms of growth going down and slowing and why you think that’s the case?

Mike Singleton 4:04
So it’s a it’s a good question, like we mentioned in 2022, the Fed increased interest rates really, really quickly when they caught an interest rate shock. Now, there’s considerable debate about the leads and lags in terms of when interest rate policy tends to hit the real economy. We know that Milton Friedman says that there are long and variable lags. And everyone seems to agree on that. But no one seems to agree on exactly how long and how variable those lags tend to be. And because this is something that we’ve done, a significant amount of work on. Most of our research tends to suggest that the lead is about 16 to 18 months. And you know, you can draw confidence intervals around that, but they’re actually a little narrower than you might expect. So what that suggests to us is that the bulk of the of the hiking cycle isn’t going to flow through the real economy until the back half of 2023 and the beginning of 2024. And that’s if rates have peaked, right, and technically our view and because right now what we’re telling clients is that our view on monetary policy or interest rates is neutral, we’re not really willing to make a bet, higher or lower. But I will say the more data that comes in, the more it looks like interest rates if future the cycle,

Nathaniel E. Baker 5:13
okay, now you say that and you touched on this in your, in your the video that you guys do, you did, uh, I don’t know if it’s quarterly or monthly. I’ve picked up on this as well, which is the action in the bond market. And the bond market, especially the short end of the curve seems to be pricing in rate cuts. So tell me talk to me about that. Do you think the bond market is wise to this? We’ve seen hopes of a Fed pivot before many times never quite reflected in the bond market like this. I don’t think?

Mike Singleton 5:44
That’s a good point. So first, maybe it’s worth talking about what drives the bond market. And I think bond market junkies will know this. But there are certainly a lot of stock jockeys that won’t, the Fed funds rate really drives the majority of the price action in the bond market. When you look at the relationship between the Fed funds rate and short rates, you think, the three month six month one year, the two year there tends to be a 98% Correlation plus between the Fed funds rate and the short rates. If you go out to the very long end of the curve, a lot of people will say, well, the long end trades on growth expectations. That’s true. It trades about 20% on growth expectations, the other 80% is still the Fed, right? So when the Fed is hiking, almost all the time, long term rates are going up just like short term rates. Mortgage rates tend to trade with the 92% correlation to the Fed funds rate corporates, trade with about an 82% correlation. So it’s not quite as close but still really, really close. Right? It’s, it’s, it’s still driving the majority of the price action by a pretty wide margin. So it’s really important to get a grasp or to get a feel for Fed policy and where you think it’s going if you’re trying to make a call on anything interest rate sensitive. So I said earlier, that our view on monetary policy right now is neutral. And I know that’s a super boring and disappointing call. But the point that I’m trying to make is that there’s not a good risk reward betting either way right now. So on the one hand economic conditions, economic conditions are what the Fed is supposed to be reacting to seem to suggest that the Fed would under ordinary circumstances hike, right? We’ve got services, inflation, comping, 68%, annualized. That’s two thirds of consumption. So that’s obviously multiples of trend. It’s not showing in terms of momentum, any serious signs of declining, right. If you look at the three month annualized rate of change, it’s still clipping pretty fast. And then you’ve got durable goods inflation, which has since June of 2022. been the primary driver of disinflation and durable goods are big, expensive, Financeable frequently financeable household items like cars or refrigerators, refrigerators or washing machines or furniture.

Nathaniel E. Baker 7:53
And lawn mowers, which appears to be going on in your background.

Mike Singleton 7:58
Yeah, I apologize for that

Nathaniel E. Baker 8:00
It’s quite alright

Mike Singleton 8:03
But in any case, durable goods inflation, well continues to move lower. If you look at sort of shorter term measures of inflationary momentum, again, like maybe just three month annualized rate of change, that appears to be picking its heads back up, which is not what the Fed wants to see, right. They don’t want to see durable goods, inflation picking back up against the backdrop of 60% services inflation. So you would think that that means the Fed would probably hike just given the way economic conditions look right now. But the reason that we’re neutral despite that is really the two year. So we have a number of models, and leading indicators for monetary policy. But one of the simplest and the most reliable is just looking at the two year relative to the Fed funds rate. And historically, the two year Treasury yield tends to lead the Fed funds rate with I think over a 98% correlation. You’re splitting hairs at some point by about three months. And so right now, the two year is taking a dive. It was a there was a four sigma move lower in the two year yield after the Silicon Valley Bank debacle. I personally don’t have a good fundamental explanation for what happened what drove the biggest move we’ve seen in interior yield since 1987. So I don’t know how many years that is, but 4040 years something like that. A long long time.

Nathaniel E. Baker 9:23
Sending our thing has been 40 years since 1987. I think it’s only been on quote only been 37 years. If my maths are correct, but yeah, so close enough, but you Geez Alright, because I remember 1987 Not well, but I do but anyway,

Mike Singleton 9:35
it’s a move that very few people having their models

Nathaniel E. Baker 9:38
and and I mean, current US been candidature have just been risk off. Right. Well, we

Mike Singleton 9:43
know that I think the explanation that a lot of people were giving as well as the short covering, right, it was a big squeeze. And that and we know that positioning was very lopsided. The street was extremely short. to your to your bills, if you’re just looking at you know, its commitment of traders report and what they’re buying I mean, what they’re selling, there was a big, big, big short position. And there’s still a big short position. But it hasn’t moved back up. Right in our view at Invictus support or resistance is between 4.1 and 4.2%. We saw the two year tried to retest that level on the upside and it broke down again. And right now the divergence between the two year Treasury yield in the Fed funds rate is about 100 basis points. So what that suggests if you were to just look at the two year next to the Fed funds rate is that the Fed will have to cut by call it July, early July, right. And so that doesn’t really make any sense, given what economic conditions are, are right now. But at the same time that meeting 98% Correlation is not generally something we want to bet against.

Moderator 10:47
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Nathaniel E. Baker 11:00
Okay, fair enough, let me introduce something else into the equation here, which is inflation. And the Feds inflation target, obviously, is 2%. They’ve said they’re not going to change that. And they’ve been very vocal about price stability, and raising rates until inflation is been dealt with. And again, at the last Fed meeting, Powell, again, came out with some very strong rhetoric about the fight against inflation. So we could have all the signs everywhere, we could have them in the bond market, we could have them in the employment market. But the point is that we could have all this stuff going on. But we could still have consumer inflation well above 2%. And that would tie the Feds hands, wouldn’t it?

Mike Singleton 11:44
In a sense, in a sense. So I think I think one of the one of the projects that I’ve done over the last few weeks at Invictus is look back at prior hiking cycles and when the Fed is paused, because obviously, I think a big question right now and a very fair question is, can the Fed really pause interest rate hikes with inflation running in multiples of target? And if you look at history, the answer is yes, the Fed has done so many, many times. In fact, it’s done so more often than not. And the reason that the Fed pauses interest rate hikes is that they generally see signs of instability in the economy, right, a high risk of caught a nonlinear declining growth. And if you look back at history, typically the Fed cuts rates within six months of pausing rates, right. And so that’s generally when that nonlinear decline in growth, employment, whatever is manifesting, then they need to stimulate again. And so we don’t see any, when you look at the backward looking economic data, there are no real signs of instability or a big spike in the unemployment rate. When we look at our leading indicators there is and we expect that in the back half of 2023, we don’t know how privy the Fed is to leading indicators. But the point is, if they do pause interest rate hikes, historically what that means is, they’re seeing significant signs of risk in the economy. And we should take that seriously.

Nathaniel E. Baker 13:01
Right. But there’s still a disc. From when they paused when they cut. It still could take a little while. It sounds right.

Mike Singleton 13:10
About six months, if you just look at history, yeah,

Nathaniel E. Baker 13:13
right. Okay. So there’s that. But then also don’t forget the backdrop here, right? Inflation is transitory that whole thing the Fed had egg on its face still does from that. Just in general, when you say that inflation is transitory, while inflation continues to print these high numbers, just from a purely PR perspective, wouldn’t it kind of be very difficult to justify rate cuts, in light of all that, if inflation is still high?

Mike Singleton 13:43
I think it does. Although I think if you follow the politics of the Fed, the pressure toward trying to get them to pause is gradually becoming greater. And I’ll I’ll add that at Invictus, we try and stay away from the idea of what the Fed should do. Because we’re not we’re not policymakers, and no one will listen to our policy prescriptions at Invictus anyway, generally, what we’re trying to do is front run whatever we think the Fed will do, given the views that they’re expressing to the market at any given time. And so whether it’s appropriate or inappropriate to pause or to cut rates, we try not to think about that we try to think about what they’re communicating what indicators they’re looking at, and the weight of the evidence. And I’ll add right now, if you look at the FOMC dot plot, what they’re communicating is they’re not going to raise rates past or the you can say that the expectation of FOMC participants is that the terminal rate for the cycle was between 5% and 5.25%. Right. And I’m sure that they’ve considered whether or not that that might appear inappropriate politically, but that’s their base case right now. So it and you know, it is what it is.

Nathaniel E. Baker 14:48
Interest Interesting. Okay. So long term neutral, neutral on interest rates, and where does it leave other other asset classes? We touched on growth stocks, that’s that’s a little more there’s a lot more info off there, but what about certain things like industrial commodities, and oil? And typically those tend to kind of trail the economic cycle, don’t they?

Mike Singleton 15:10
Right. And so what is our long or long term outlook is not neutral on interest, I think the Fed probably will end up cutting. Anytime you see the labor market start to break, the Feds reaction function becomes pretty easy, because that means that slack is going to appear in the labor market services, inflation is going to come down really, really quickly. wage growth is going to come down really, really quickly. And the Powell your policy response is is easy, so to speak, it’s easier than it was in January of 2022. But of course, it’s the opposite. So you just decide we’ll probably start stimulating. We don’t know if that’s happening in the next three months right now or the next nine months. So we want to leave a little bit of a grace period for that time to react, respond to the data and whatnot. But if you had to say, you know, is any year will rates be 75 basis points higher or lower? We almost certainly guess lower.

Nathaniel E. Baker 15:58
Fair enough. Okay. Yeah. So now talk to me talking about oil and commodities.

Mike Singleton 16:02
Okay, so our outlook we say that our outlook at Invictus right now is deflationary. And we mean something specific by that we mean slower real growth and rate of change terms and slower inflation rate of change terms, it doesn’t necessarily mean negative inflation trends, it just means slower momentum is slowing. And so oil is the really the quintessential reflation airy asset, right? When does oil do best? It does best when growth and inflation are going up simultaneously. When does oil do worse? It does worse when they’re going down. So our high level outlook policy aside is that growth and inflation are both going to continue to decline. And so according to our back tests, that’s the time to look, opportunistically for shorts in oil. Obviously, OPEC just announced some bigger production cuts earlier earlier in the week. We thought we’ve thought a decent amount about that it doesn’t change our 12 month cyclical view on oil, generally, demand can move much more quickly than supply. And so if there’s going to be so for example, if we see unemployment go from 3.6% to four and a half percent, or 5%, that’ll mean considerably less oil consumption and producers won’t be responding fast enough to to offset the declines in price at that point.

Nathaniel E. Baker 17:12
Okay. What about China’s reopening now that people have argued that that’s a very bullish case for oil, and you don’t agree or you just don’t think it’s that important?

Mike Singleton 17:21
So we’re US focused at Invictus. That said, we do keep track of what’s what’s going on globally. And most of the data that we look at suggests that the Chinese reopening while maybe it’s going is going a little bit slower than people expected, and it’s not going to offset the economic gravity of what’s going on in the US. I mean, you can think about the economy as this tug of war between deflationary and reflationary forces, and there are reflationary forces out there on the margin, China being one of them, but in our view, there are considerably stronger deflationary forces. And so that’s how we would be positioning ourselves as investors.

Nathaniel E. Baker 17:56
Fair enough. Okay. Last question. Before we go to break, is there any chance of a soft landing still, in your view,

Mike Singleton 18:03
there’s always a chance, I think that the the odds are very low. If you look at all of the leading indicators, they’re all suggesting a rather dramatic decline in growth over the coming six to 12 months. And so you can only unless you’re using maybe an esoteric options strategy, you can really only position one way and we think that the weight of the evidence suggests that this is a time to be playing defense, not offense.

Nathaniel E. Baker 18:28
Okay, well, that’s not a very nice way to go into the break. But I guess Fair enough. Cool Mike Singleton of Invictus research, I want to come back and ask you some more questions and talk about some other stuff. So but we’re gonna first take a break. However, if you’re a premium subscriber, you do not get the break. Do not go anywhere, do not touch the dial. We’ll be right back. In fact, we already are. And to become a premium subscriber, visit the substack contrarian and sign up.

Moderator 19:01
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Nathaniel E. Baker 19:51
By the way, you don’t need the . tech suffix to get to that website. will do the trick. And we also Have a sub stack that you can where you can sign up for the same prices, same benefits. Same details, contrarian So if you already have a sub stack account and use it, or have the app and use that that’s probably the best way to go. So or A whole bunch of benefits, including, of course, getting this episode, up to a week early, without ads, or annoying announcements. And you also get the daily contrarian briefing and podcast that is released every market day morning at 7am. This is a contrarian take on the events of the day ahead. And what is likely to move markets, such as economic data releases, earnings and other things. It is really good. And that is completely unbiased, of course. So check that out contrarian, or contrarian dot supercast dot tech. Now on with the show.

Welcome back, everybody here with Mike Singleton of Invictus research, Mike, this is a segment of the show where as you know, we usually talk about the guests background, but since you already supplied that the first time around, I’m not going to go over that again. But instead, I want to talk some more with you about the banks, you know, rather historic events here run on the banks kind of maybe nipped in the bud by the Fed there. Do you have any views on that?

Mike Singleton 21:42
I’ll find my answer by saying I’m not a bank analyst. When I look at the Feds political incentives, when I look at the terms of the bank term funding program, they all look very generous, it appears fairly obvious to me that the Fed is willing to step in and do whatever it takes to backstop the US banking system. In my view, fundamentally, it doesn’t look like we’re on the brink of a banking crisis. And it doesn’t look like the economic momentum has shifted, yet in a crisis like way. That said, the signs that we’re getting from the bond market are pretty bearish. And so And like we said earlier, I don’t know exactly why we’re getting those signals right now when we are. And so it’s not off the table, that there’s something lurking beneath the surface that that we don’t fully understand. But I’m Victor’s we want to have respect for the market signal.

Nathaniel E. Baker 22:26
Yeah, fair enough. Okay, cool. Talk to me, what are some of the other leading indicators that you watch that maybe people can do at home,

Mike Singleton 22:35
one indicator that we like looking at is what we call the fiscal impulse. And this is, this is a very long term leading indicator, at least in the US. And what it is, is it’s the year over year rate of change in the market value of gross federal debt. That’s a statistic collected by the Dallas Federal Reserve Bank. And if you look at the year over year change, it tends to lead the US growth cycle, which you can proxy with the isn manufacturing PMI tends to lead the US growth cycle by about 18 months. And that’s a very long term leading indicator, it doesn’t have a perfect correlation, but it’s giving you a very, very long lead time. So it’s very useful in our view.

Nathaniel E. Baker 23:13
And what is this again? How does this what is this exactly what does it track? And how does that work?

Mike Singleton 23:17
It tracks the impact of deficit spending on the growth cycle of investment spending, of deficit spending,

Nathaniel E. Baker 23:23
deficit spending, okay, right

Mike Singleton 23:27
Yeah, it’s a year over year change in gross federal debt, right. So you only increase federal debt when you’re deficit spending? Sure. So how does that flow through the economy and hit the growth cycle?

Nathaniel E. Baker 23:44
And so this this deficit spending increases, I thought this just continued to increase ad nauseam

Mike Singleton 23:52
it’s the rate of change, right? So deficit spending is always increasing, it seems that the rate of change of deficit spending is not, right. And so the rate of change right now coming off of all the COVID stimulus, and everything is quite negative, and so that’ll be a drag on the rate of change of growth.

Nathaniel E. Baker 24:09
Okay, okay. That’s interesting. All right. Can you see this, this leads the market by should say, the economy by 12 to 18 months, right.

Mike Singleton 24:17
And so, and you can think of the ISM manufacturing PMI, as more or less coincident with the performance of the stock market, but the stock market really leads by about two months. But in any case, this is a good leading indicator for both.

Nathaniel E. Baker 24:29
Alright, well, back to bonds real quick. Do you think there’s more upside here at the short end of the curve? I mean, without I mean, obviously, this is a play on on interest rate policy, but

Mike Singleton 24:39
Should we be going long the two year now? Yeah. I think so. Well, I like I like bills and the two year note, generally because they still offer a relatively attractive yield rate between still between four and 5%. Depending on where you’re looking on the curve. They’re super liquid. Right? They’re nominally risk free, given the economic back Drop, it’s still pretty attractive. I mean, the yield curve looks like it’s starting to steepen again, but it’s still inverted. And so we don’t have any problem buying short term bills and notes here. We think that’s still a good risk reward.

Nathaniel E. Baker 25:10
Oh, that reminds me on the yield curve. You also had some you think the yield curve is going to widen again, right?

Mike Singleton 25:16
So generally, how do we think about the yield curve, the yield curve is a good measure of Fed policy today versus bond market expectations about growth in the future. So when the yield curve is inverted, what that means is that fed policy is tight relative to growth expectations. Generally, that’s what the Fed wants, right? The Fed uses an inverted yield curve to slow the economy to make lending less attractive to spread lenders, right, among, among other things. And so when does the when does the yield curve tend to steepen? Historically, it’s pretty simple. It’s when the Fed stops hiking interest rates. So and generally that happens, when the Fed starts to see trouble brewing on the horizon, you can see we’ve had a relatively quick steepening of the yield curve, specifically the twos 10s. There are some other measures that are still very, very inverted, like the three month tenure. But the twos 10s is inverted, excuse me steepening again, probably in anticipation of a Fed pause. And then not long after that a Fed cut, we actually have a few leading indicators to the yield curve as well. One of them is bank lending standards. Interestingly, bank lending standards tend to lead the twos 10s curve by about I’m going to forget it’s four or five quarters. But but in any case, it looks like bank lending standards are suggesting that we should see a steepening of the yield curve, if not now then in the next quarter or so. And it suggests actually, that we will need to see a rather forceful steepening of the yield curve. In other words, there will probably be considerable stimulus, despite what the Fed is saying, after the downdraft in this growth cycle is really started to commence. So, you know, we’re probably hesitant to say, you know, buy a steepen or right now, but that that’s clearly the next step in the business cycle

Nathaniel E. Baker 26:58
Rather than more inversion?

Mike Singleton 27:00
right. It’s just another way of saying, is the Fed closer to being finished hiking this cycle? Or is it you know, still toward the middle and we think, clearly whether or not there’s another hike or to laughter, the wind wiggles for a few months? We’re probably toward the end of this hiking cycle.

Nathaniel E. Baker 27:13
Right. Okay. Fair enough. All right. Cool. All right. Well, in closing, will you tell our listeners how they can find out more about you? And about Invictus research, I know you are a little active on the social media.

Mike Singleton 27:25
Sure. So my Twitter handle is at Invictus macro. Our website is Invictus dash, we aim to provide hedge fund quality research to anyone who wants it, we do so at a very affordable price. We might be raising prices in the next few months. But right now, it’s still very retail friendly. And something a little unusual, a little fun about our products is that they’re all delivered every video. So if you if you want to get the most recent economic data, if you want to get the most important market moves and how they fit into the context of the business cycle, back testing, different types of quantitative analysis explained and very accessible language, and using really accessible graphs and charts, then, then check us out. The daily guide is our flagship product. And it has a daily video. It is yeah.

Nathaniel E. Baker 28:12
Cool. You get that in your inbox? Or is there a way that you can? Exactly to channel or anything? No,

Mike Singleton 28:19
it’s sent right to your inbox every morning at 6am. And you click you click the link and you get seven minutes covering the most important economic data from the day before and a major market moves to.

Nathaniel E. Baker 28:30
Very interesting. Cool. All right. That’s That’s great. Awesome. Mike Singleton of Invictus research. Thank you, again for joining the contrarian investor podcast today. Great to have you as always looking forward to having you back again a year from now maybe sooner, and assessing this whole economic cycle and how it is all playing out across markets. Until then, we thank you for listening, and look forward to speaking to you again next time. See you then.

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