On February 8th, financial advisors gathered virtually for a comprehensive one-hour webinar hosted by Jimmy Atkinson, co-founder of AltsDb, featuring Jay Hatfield, founder and CEO of InfraCap. The session, which also included an audio replay and an introduction by Andy Hagans, delved into income investing strategies tailored for the current complex macroeconomic landscape. The webinar, sponsored by Infrastructure Capital Advisors (InfraCap), aimed to equip attendees with insights into navigating volatile markets and building robust, income-generating portfolios.
The discussion began by exploring the enduring appeal of income investing, particularly among high-net-worth and ultra-high-net-worth individuals and their advisors. Hatfield emphasized that a strong income stream is foundational to a high-quality portfolio, especially for those nearing or in retirement. He shared an anecdote about helping a friend restructure their portfolio to achieve a 4-5% yield, demonstrating how a consistent income stream can provide financial security and peace of mind, even during market downturns. This income can be reinvested at lower prices or used to cover expenses, offering a buffer against stock market volatility. Hatfield also noted that income strategies are not solely for older investors but can benefit individuals across all age groups to varying degrees.
Economic Outlook and Market Projections
Hatfield provided a critical assessment of the 2022 economic environment, which saw significant declines in both bond and publicly traded stock markets. He attributed the downturn primarily to the Federal Reserve’s aggressive monetary tightening, which dramatically reduced the money supply. Hatfield specifically highlighted the Fed’s reduction of the money supply by nearly 20% in 2022 through open market operations, a move he believes was the driving force behind the pain felt by investors. This liquidity reduction, he explained, effectively siphoned capital out of the markets, impacting both bond and stock prices.
Looking ahead to 2023, InfraCap projected a top-decile target of 4,500 for the S&P 500. This optimistic outlook was underpinned by several key factors. Firstly, Hatfield suggested that the bulk of the Fed’s monetary tightening was likely behind us. He pointed to the Fed’s use of reverse repo operations, a mechanism to absorb liquidity, and its substantial holdings in this area, as a way to offset balance sheet reductions. This detail, he noted, is often overlooked or misunderstood by many market participants.
Secondly, while acknowledging that Fed rate hikes typically precede significant recessions and cooling housing markets, Hatfield identified post-pandemic tailwinds that could mitigate these effects. These include persistent shortages in housing and automobiles, coupled with a remarkably strong labor market—a rare occurrence during periods of Fed tightening. The combination of a likely pause in Fed rate hikes and these underlying economic strengths formed the basis for his bullish market call.
Inflation Dynamics and the Fed’s Stance
A significant point of contention and discussion during the webinar was the Federal Reserve’s approach to inflation. Hatfield expressed a strong belief that the Fed was "completely out to lunch on inflation," arguing that they were not utilizing the correct indicators. He posited that high inflation is primarily driven by two factors: loose monetary policy, which fuels housing inflation, and energy price shocks. He drew parallels to the 1970s, a period marked by similar shelter inflation and significant energy price surges.
Hatfield introduced his firm’s proprietary index, CPI-R, which calculates inflation using housing prices as a leading indicator for the shelter component of CPI, rather than the Bureau of Labor Statistics’ (BLS) lagged owner’s equivalent rent estimates. According to CPI-R, inflation had turned negative, showing a strongly negative annual rate of over 4% in the four months leading up to the webinar. This contrasted sharply with official CPI figures, which he argued were artificially inflated by the BLS’s methodology for calculating shelter costs.
He explained that the BLS’s shelter component, which accounts for a significant portion of CPI (42% of core CPI and 33% of headline CPI), lags real-time housing price movements. This lag, he contended, would lead to persistently high CPI prints even as actual inflation was decelerating. This discrepancy, he warned, could create market volatility as reported inflation figures might not reflect the underlying economic reality.
The Fed’s reliance on the Phillips Curve, which links inflation to labor market conditions, was also questioned. Hatfield argued that while the labor market can influence low to medium inflation, it is not the primary driver of high inflation, especially when compared to monetary policy and commodity shocks. He pointed out that real wages were rising due to falling inflation, which would naturally moderate demand for nominal wages, a dynamic he felt the Fed was overlooking.
Despite his criticisms of the Fed’s policy, Hatfield did not anticipate a major recession. He projected that the Fed would likely raise rates two more times but would eventually pause. His forecast for the 10-year Treasury yield was 3%, which he believed would be bullish for bonds. The market’s recent rally, he suggested, was a reflection of investors beginning to align with his view that inflation was rapidly declining and the Fed’s policy was potentially misaligned.
Preferred Stocks and Income Generation
InfraCap highlighted preferred stocks as a particularly attractive asset class for income investors in the current environment. Hatfield explained that listed preferred stocks, trading around $25 par value, were offering significant discounts. His firm’s flagship preferred stock fund, PFFA, was trading at approximately 21, indicating a $4 discount to the call price. This discount, he noted, offered the potential for equity-like returns as the securities approach par, combined with attractive dividend yields, some exceeding 9%.
He emphasized that 90% of the fund’s holdings were cumulative preferreds, meaning that missed dividend payments would accrue and eventually be owed back to investors, providing a strong incentive for companies to maintain these payments. This structure, coupled with a low default rate historically comparable to investment-grade bonds, made preferreds a compelling option for income generation with managed risk.
Hatfield also pointed out the inefficiencies in the preferred stock market, where index funds might hold securities trading above par, a situation he considers risky as these could be called at par, leading to losses. His firm’s active management approach, he stated, aims to avoid such situations and focus on undervalued securities.
Master Limited Partnerships (MLPs) and REITs
The discussion also touched upon Master Limited Partnerships (MLPs) and Real Estate Investment Trusts (REITs). Hatfield acknowledged the past negative sentiment surrounding MLPs due to high leverage and growth-stock structuring. However, he noted that the sector has since undergone significant reform, with companies now focused on well-covered dividends, retained earnings, and share repurchases. He suggested that current energy price forecasts (ranging from $80 to $100) would provide strong support for MLPs.
For REITs, InfraCap expressed a bullish outlook, particularly on those that had been depressed due to excessive pessimism regarding capitalization rates and the long-term value of real estate. While acknowledging potential headwinds for office REITs, Hatfield reasoned that demand for office space would persist, even with hybrid work models, as employees often require better facilities when in the office.
Building a Balanced Portfolio
Hatfield reiterated the importance of a balanced portfolio, even for younger investors. He suggested that a 30/70 stock/bond allocation could yield around 4.67%, with higher fixed-income allocations potentially reaching 6-7%. He advocated for a diversified approach that includes both fixed income and equity income components to achieve desired yield targets. For investors seeking higher growth with moderate risk, he proposed increasing allocations to higher-yield bonds and preferred stocks while maintaining a reduced allocation to traditional fixed income.
The webinar concluded with a Q&A session where Hatfield addressed specific investor queries on the yield curve, the financial sector, asset class selection for blended portfolios, and yield metric distinctions. He reiterated his view that the yield curve would likely remain inverted for the next couple of years due to the Fed’s rearview-mirror approach to policy. He expressed a positive outlook for the financial sector, particularly regional banks, citing their exploding net interest margins.
When asked about the difference between SEC yield and distribution yield, Hatfield explained that SEC yield is a standardized, expense-adjusted estimate, while distribution yield represents the actual payout to investors. He emphasized the importance of ensuring that distribution yields are well-covered by the SEC yield to avoid return of capital and maintain the Net Asset Value (NAV) of investments.
In response to whether publicly traded funds were valued at a discount compared to private funds, Hatfield acknowledged that public market valuations for certain asset classes, like preferred stocks, had experienced significant discounts due to market volatility. He noted that this created opportunities for investors to acquire assets at a lower cost. He concluded by suggesting that while short-term Treasuries and CDs offered safety and yield, they might not provide the same level of long-term return and potential for capital appreciation as other income-generating asset classes, especially if interest rates were to decline.
For those seeking more information, InfraCap’s website, infracapfunds.com, was provided as a resource for learning more and contacting the firm. The webinar recording and presentation slides were made available to attendees, offering continued access to the valuable insights shared by Jay Hatfield.
