On February 8, financial advisors were provided with a comprehensive overview of income investing strategies tailored for the current economic climate during a live, one-hour webinar hosted by AltsDb co-founder Jimmy Atkinson. The featured guest, Jay Hatfield, founder and CEO of InfraCap, a firm specializing in alternative investment strategies, delved into how investors can navigate a landscape marked by persistent inflation concerns and shifting monetary policy. The webinar, which also included an audio version for broader accessibility, was sponsored by Infrastructure Capital Advisors (InfraCap) and offered insights into building resilient portfolios focused on generating consistent income.
The session addressed a growing demand among high-net-worth and ultra-high-net-worth individuals for income-generating assets. Hatfield underscored the fundamental role of income investing, particularly for those nearing or in retirement, emphasizing its capacity to provide financial stability and peace of mind amidst market volatility. He illustrated this with a personal anecdote about restructuring a friend’s portfolio to achieve a 4-5% yield, enabling a comfortable retirement. This strategy, he argued, allows investors to reinvest dividends at lower prices during market downturns and provides a buffer against stock market fluctuations.
Economic Outlook and Monetary Policy Insights
Hatfield began by offering his firm’s economic outlook, which was notably negative on the broader market in 2022, particularly concerning technology stocks and speculative assets like cryptocurrencies and meme stocks. This bearish stance was rooted in the Federal Reserve’s aggressive monetary tightening. He detailed how the Fed’s reduction of the money supply, primarily through open market operations, effectively withdrew liquidity from capital markets, impacting both bond and stock prices. The reduction in the U.S. monetary base by nearly 20% in 2022 served as a primary driver of market pain.
Looking ahead to 2023, InfraCap projected a more optimistic scenario, setting a top-decile target of 4,500 for the S&P 500. This bullish outlook was predicated on several key factors. Firstly, the firm believed the most significant portion of monetary tightening was behind them. Hatfield highlighted the Fed’s use of reverse repurchase agreements (repos) as a mechanism to absorb liquidity, noting that the substantial $2.5 trillion in reverse repos provided a buffer against further balance sheet reduction.
Secondly, while acknowledging the Fed’s intention to raise rates two more times, Hatfield suggested that the central bank would likely pause further hikes thereafter. Crucially, he posited that the economy might avoid a severe recession, a departure from typical tightening cycles. This resilience is attributed to post-pandemic tailwinds, including persistent shortages in housing and automobiles, coupled with a strong labor market – a rare occurrence during periods of Fed tightening. The prevailing sentiment among many market participants, he noted, was that the Fed’s aggressive stance would eventually ease, creating a favorable environment for equities.
Inflation Dynamics and the Fed’s Approach
A significant point of contention for Hatfield was the Federal Reserve’s assessment of inflation. He expressed strong disagreement with the Fed’s prevailing narrative, asserting that inflation was not only decelerating but that the economy was, in fact, experiencing deflationary forces. InfraCap’s proprietary index, CPI-R, which calculates Consumer Price Index (CPI) using pre-1983 methodologies with a greater emphasis on housing prices and less reliance on owner’s equivalent rent estimates, had turned negative over the preceding four months, indicating an annualized deflationary rate exceeding 4%.
Hatfield argued that the primary drivers of high inflation are loose monetary policy, which fuels housing inflation, and energy price shocks. He contrasted this with the Fed’s focus on the Phillips Curve and the labor market, which he believes are less significant determinants of sustained high inflation. The dramatic expansion of the monetary base in 2020-2021, followed by a contraction in 2022, created volatile asset prices, and coupled with energy shocks, contributed to inflationary pressures. However, with energy prices declining significantly (natural gas down 75% from its highs) and housing prices beginning to moderate, he contended that the conditions for high inflation were dissipating.
He further criticized the Fed’s adherence to outdated economic models, suggesting they were "completely out to lunch" on inflation. The lagged nature of official CPI reporting, particularly the shelter component, creates a distorted picture, making the reported figures appear "sticky" even as real-time indicators signal deflation. This disconnect, he warned, could lead to market misinterpretations and unwarranted hawkishness from the Fed.
Strategies for Income Generation
Hatfield outlined several asset classes suitable for income-focused portfolios, emphasizing a balanced approach that blends fixed income and equity income.
Fixed Income Alternatives
For fixed-income investors, Hatfield highlighted several alternatives to traditional Treasuries, arranged by their correlation to government bonds and the broader stock market:
- Treasuries: Currently offering decent yields, they remain a foundational element for capital preservation.
- Municipal Bonds: Providing tax advantages and lower interest rate risk compared to government bonds.
- Corporate Bonds: Yielding around 5.4%, they present an attractive option for income generation.
- Preferred Stocks: A key area of focus, with average yields around 6%. Hatfield noted that by looking beyond financials (which dominate cap-weighted indices), investors could achieve significantly higher yields, with InfraCap’s own REIT preferred stock fund yielding over 7% and another fund nearing double digits. These offer modest stock market risk, typically around half that of common equities.
- High-Yield Bonds: Currently attractive at 9%, these offer lower correlation to the stock market than preferreds, providing diversification benefits.
- Senior Loans: Offering lower beta to the stock market and decent yields, though not as compelling as other options.
Hatfield recommended a diversified approach across these fixed-income classes, suggesting that even younger investors benefit from a fixed-income component for rebalancing purposes. He projected a potential yield of 4.67% for a 30/70 stock/bond portfolio, escalating to 6-7% with a higher allocation to fixed income.
Equity Income Strategies
On the equity side, Hatfield identified several sectors and asset classes that offer robust income potential:
- Utilities: While historically a source of income, Hatfield considered them overvalued based on current yields.
- REITs (Real Estate Investment Trusts): Depressed by pessimism in 2022, REITs are now viewed as attractive, with potential for recovery as cap rates normalize.
- Telecom: Stocks like AT&T and Verizon offer good yields due to recent price declines.
- MLPs (Master Limited Partnerships): Significantly reformed from their past structure, MLPs are now better capitalized with well-covered dividends, lower leverage, and a focus on retaining earnings for growth and share repurchases. Hatfield expressed a strong liking for this asset class, noting its improved financial health and potential for total return beyond just income.
- High Dividend Yield Stocks: InfraCap’s flagship large-cap dividend fund, ICAP, aims for yields above 7% by employing modest leverage and investing in preferred stocks, significantly outperforming the S&P 500’s 1.7% yield. These stocks have historically delivered competitive returns with lower volatility.
Specific Investment Recommendations
Hatfield elaborated on InfraCap’s specific offerings and convictions within these asset classes. He strongly recommended preferred stocks, particularly for clients lacking exposure. He noted that many preferreds are trading at a discount to their par value, offering potential equity-like returns upon redemption while providing substantial dividends in the interim. InfraCap’s flagship preferred stock fund, PFFA, boasts a yield well over 9% and trades at a discount to its call price, presenting an opportunity for capital appreciation. The fund emphasizes cumulative preferreds and actively manages credit risk, aiming for default rates comparable to investment-grade bonds.
Regarding MLPs, Hatfield addressed past investor concerns stemming from high leverage and volatile energy prices. He assured that modern MLPs have corrected these issues, offering well-covered dividends and reduced leverage. His firm’s corporate MLP fund avoids the K-1 tax complexities associated with direct MLP investments, offering capital gains treatment instead. With energy prices expected to remain robust, MLPs present a compelling income and total return opportunity.
Q&A and Future Outlook
During the Q&A session, Hatfield reiterated his views on the yield curve, expecting it to remain inverted for approximately two years due to the Fed’s rearview-mirror approach to monetary policy. However, he anticipates the 10-year Treasury yield settling around 3-3.25% due to global demand from aging populations and pension funds, as well as modest global economic growth.
On the financial sector, he expressed a positive outlook, particularly for regional banks benefiting from the yield curve inversion, which expands their net interest margins. He dismissed fears of widespread loan write-offs, attributing this to an overestimation of potential unemployment.
Addressing the distinction between yield metrics, Hatfield explained SEC yield as a standardized, expense-adjusted estimate, contrasting it with the distribution yield, which represents the actual payout. He stressed the importance of funds having an SEC yield that adequately covers their distribution to avoid return of capital.
In response to a question about publicly traded funds versus private market valuations, Hatfield acknowledged that private markets often exhibit higher valuations, potentially due to less liquid and more subjective marking practices. He noted that publicly traded alternatives, accessible via ETFs and closed-end funds, can offer attractive opportunities, especially when trading at discounts.
Finally, when asked about the merits of short-term Treasuries and CDs for yield, Hatfield acknowledged their safety but argued that they forgo the opportunity for higher, more sustainable returns offered by assets like preferred stocks and MLPs, especially considering the potential for declining short-term rates.
The webinar concluded with a strong emphasis on the enduring importance of income investing, particularly in navigating uncertain economic times. InfraCap’s insights provided financial advisors with a framework for constructing diversified portfolios that can generate consistent income while potentially capturing capital appreciation, even amidst evolving macroeconomic conditions.
