On February 8, AltsDb co-founder Jimmy Atkinson hosted Jay Hatfield, founder and CEO at InfraCap, for a comprehensive one-hour webinar specifically designed for financial advisors. The session delved into sophisticated income investing strategies, offering actionable insights tailored to the current and evolving macroeconomic landscape. The webinar has since been made available as an audio podcast, including an introduction by Andy Hagans, and a video replay on YouTube.
The discussion, framed against a backdrop of persistent economic uncertainty and the lingering effects of a challenging 2022 for traditional markets, aimed to equip advisors with the knowledge to navigate these complexities and construct resilient portfolios for their clients. InfraCap, a firm specializing in income-generating investment solutions, brought its expertise to the forefront, addressing key concerns for investors seeking yield and capital preservation.
The Enduring Appeal of Income Investing
Jay Hatfield opened the discussion by addressing the fundamental question of why income investing continues to hold such significant appeal, particularly among high-net-worth and ultra-high-net-worth individuals and their advisors. He emphasized that income generation is not merely a supplementary strategy but a cornerstone of a high-quality portfolio, especially for those approaching or in retirement.
Hatfield illustrated this point with a personal anecdote about advising a high school friend. This friend, having recently transitioned from a prior advisor, was initially unaware of his portfolio’s yield. Hatfield helped construct a diversified portfolio with a target yield of 4% to 5%, balancing bonds and equities. This strategic allocation provided the friend with sufficient income to cover his expenses, enabling him to retire with confidence. The ability to generate a predictable income stream, Hatfield explained, provides a crucial sense of security, allowing investors to remain calm during market volatility. Even in down markets, a consistent income stream allows for reinvestment at lower prices and potentially higher yields, a critical advantage for long-term wealth accumulation.
Navigating a Shifting Economic Landscape
The webinar took place following a turbulent 2022, a year marked by significant downturns in both the bond and public equity markets. While alternative investments generally outperformed traditional assets, the need for robust income strategies remained paramount. Hatfield offered his perspective on the economic outlook for the year ahead, contrasting the challenges of 2022 with his projections for the current year.
Hatfield correctly predicted a negative market outlook for 2022, particularly for tech stocks and speculative assets like cryptocurrency and meme stocks. His rationale was rooted in the Federal Reserve’s aggressive monetary tightening policy, which saw a dramatic reduction in the money supply. He highlighted that the Fed effectively withdrew nearly 20% of the money supply through open market operations, not solely through interest rate hikes, which was the primary driver of pain felt across capital markets and led to declines in both bond and stock prices.
Conversely, for the current year, InfraCap projected a top-decile target for the S&P 500 at 4,500. This optimism stems from the belief that the most significant portion of monetary tightening is behind the economy. Hatfield elaborated on the Fed’s use of reverse repo operations, a mechanism that has absorbed substantial liquidity. He noted that the Fed has approximately $2.5 trillion in reverse repo agreements, which they can utilize to offset balance sheet reductions. This complex mechanism, he suggested, is often misunderstood by the broader market.
While acknowledging that the Fed is likely to implement two more rate hikes, Hatfield does not anticipate significant cuts. Crucially, he pointed to post-pandemic tailwinds, such as shortages in housing and automobiles, and a robust labor market, as factors that may mitigate the severity of a recession typically associated with Fed tightening cycles. The combination of a likely pause in Fed rate hikes and these underlying economic strengths underpins his bullish outlook.
The Inflation Debate: A Divergent View
A key theme of the discussion was the differing perspectives on inflation. Hatfield expressed a strong conviction that the Federal Reserve is "completely out to lunch on inflation," arguing that they are not utilizing the correct indicators. His firm has developed its own real-time Consumer Price Index (CPI) index, CPI-R, which has shown a negative trend over the past four months, indicating deflationary forces at an annualized rate exceeding 4%.
Hatfield explained that CPI-R differs from the Bureau of Labor Statistics (BLS) methodology by using housing prices directly, rather than relying on owner’s equivalent rent estimates. Housing prices, he noted, predict the shelter component of CPI with a 70% correlation, with a 12-month lead. This forward-looking approach, he contends, makes CPI-R a more relevant indicator of actual inflation trends.
He identified two primary drivers of high inflation: loose monetary policy, which fuels housing inflation, and energy price shocks. He drew parallels to the 1970s, a period characterized by similar housing inflation and significant energy price spikes. In contrast, he argued that the labor market, while stable, is not the primary driver of accelerating inflation, contrary to the Phillips Curve model often cited by the Fed.
The current economic environment, he posited, is characterized by deflationary forces. Energy prices have fallen significantly, with natural gas down 75% from its highs. Housing prices are also experiencing declines. These factors, combined with moderating wage growth as real wages rise, suggest that inflationary pressures are abating. He criticized the Fed’s reliance on the Phillips Curve and its failure to account for the dynamics of goods and housing prices in relation to nominal wages.
Constructing a Resilient Income Portfolio
Hatfield then transitioned to the practical implementation of income investing strategies, emphasizing the benefits of a balanced portfolio. He outlined several asset classes that InfraCap favors for generating income, including:
- High Dividend Yield Stocks: Large-cap stocks with a history of consistent dividend payments, such as dividend aristocrats, offer a blend of income and potential capital appreciation with lower volatility compared to growth-oriented stocks. InfraCap’s ICAP fund, for instance, aims for yields well above the S&P 500 average by employing modest leverage and investing in preferred stocks.
- Preferred Stocks: These securities offer attractive yields, often higher than common stocks or bonds, and a degree of safety as their dividends are typically cumulative and prioritized over common stock dividends. Hatfield highlighted that preferred stocks are currently trading at a discount to their call price, presenting an opportunity for equity-like returns alongside income. The firm’s flagship preferred stock fund, PFFA, aims to capitalize on this by investing in deeply discounted preferred securities.
- REITs (Real Estate Investment Trusts): While acknowledging the pessimism surrounding some segments of the real estate market, Hatfield expressed a bullish view on REITs, particularly those focused on sectors like retail and office. He believes these assets are undervalued and poised for a recovery as market sentiment improves.
- Master Limited Partnerships (MLPs): MLPs, primarily in the energy infrastructure sector, have evolved from growth-oriented entities to more income-focused vehicles. Hatfield noted that modern MLPs are better capitalized, have lower leverage, and offer well-covered dividends, making them an attractive component of an income portfolio. InfraCap’s corporate structure for its MLP fund (AMZA) helps investors avoid the complexities of K-1 tax forms.
- Fixed Income Alternatives: Beyond traditional bonds, Hatfield discussed corporate bonds, high-yield bonds, and senior loans as avenues for income generation. He emphasized that preferred stocks, in particular, offer attractive yields with modest stock market risk, often exhibiting lower correlation to Treasuries than other fixed-income alternatives.
He provided a hypothetical portfolio breakdown, suggesting that a 30/70 stock-to-bond allocation could yield around 4.67%, with higher allocations to fixed income potentially reaching 6% or even 7% for more conservative investors. The key, he stressed, is to incorporate equity income components that provide yields significantly higher than the S&P 500’s current 1.7%.
The Future of Bonds and the Yield Curve
Hatfield’s outlook on bonds was also optimistic, projecting that the 10-year Treasury yield would settle around 3% to 3.25%. This projection is driven by several factors, including the aging global population, which is increasing demand for fixed-income assets, and the relative attractiveness of U.S. bonds compared to those in other developed economies. He noted that global bond markets often move in tandem, and U.S. yields are currently significantly higher than those in Canada and many European countries.
Regarding the yield curve, Hatfield anticipates it will remain inverted for the next two years. This inversion is attributed to the market anticipating the Fed’s actions, which he believes often lag actual economic conditions. However, he does not foresee this inversion leading to a severe recession due to the aforementioned post-pandemic tailwinds. Eventually, he expects the Fed to bring the curve back to a more equilibrium state, with long-term rates anchored by global demand for bonds and modest economic growth.
Addressing Key Investor Concerns
During the Q&A session, several critical questions from attendees were addressed. When asked about the speed of disinflation, Hatfield reiterated his belief that deflationary forces are at play, but acknowledged the lagged reporting of shelter costs by the BLS could create a perception of sticky inflation in the short term. He explained that while CPI might show higher prints due to this lag, the Personal Consumption Expenditures (PCE) index, which the Fed closely monitors, is less affected by this issue and is projected to fall below 3% by June.
On the financial sector, Hatfield expressed a favorable view, particularly on regional banks. He noted that their net interest margins are expanding due to the widening spread between deposit costs and lending rates. He believes that fears of widespread loan write-offs are overstated, especially given the resilience of the housing and auto markets.
When comparing pure income portfolios versus blended growth and income portfolios, Hatfield suggested that younger investors with longer time horizons could allocate more to higher-yielding, albeit riskier, assets like high-yield bonds and preferred stocks, while potentially reducing their exposure to Treasuries.
He also clarified the distinctions between yield metrics, explaining that SEC yield is an annualized estimate of income based on current portfolio holdings and expenses, while distribution yield represents the actual payout to investors. He advised advisors to seek funds where the SEC yield comfortably covers the distribution yield to avoid return of capital.
Finally, in response to a question about the attractiveness of short-term Treasuries and CDs versus preferred stocks, Hatfield acknowledged their safety but highlighted the missed opportunity for higher returns and potential capital appreciation offered by assets like preferred stocks, which are currently trading at discounts. He emphasized that for investors seeking to outpace inflation and generate substantial income, exploring these less conventional but robust income-generating assets is crucial.
The webinar concluded with a strong endorsement of InfraCap’s approach to income investing, emphasizing the firm’s deep understanding of macroeconomic trends and its commitment to providing well-researched, income-focused solutions for financial advisors and their clients.
