On February 8th, financial advisors were provided with a deep dive into income investing strategies tailored for the current complex macroeconomic landscape during a live one-hour webinar hosted by AltsDb co-founder Jimmy Atkinson. The featured guest was Jay Hatfield, founder and CEO of InfraCap, a firm specializing in alternative investment strategies. The webinar, now available as an audio recording with an introduction by Andy Hagans, aimed to equip advisors with actionable insights to navigate market volatility and construct robust income-generating portfolios.
The session underscored the growing appeal of income investing, particularly among high-net-worth and ultra-high-net-worth individuals and their advisors. Atkinson opened the discussion by posing a fundamental question to Hatfield: "Why is income investing so popular?" Hatfield responded by emphasizing its crucial role in building a high-quality portfolio, especially for those approaching or in retirement. He illustrated this point with a personal anecdote about helping a friend transition to retirement. By constructing a diversified portfolio yielding 4% to 5% through a balanced allocation of bonds and equities, the friend gained the confidence that his income streams could cover his expenses, enabling him to retire without financial anxiety. Hatfield stressed that a reliable income stream provides not only financial security but also psychological comfort during market downturns, allowing investors to reinvest at lower prices and potentially higher yields. He believes these strategies are beneficial for all investors, not just those in later life stages.
InfraCap, recognized as a leader in the ETF industry, shared its perspective on the economic outlook for the coming year, particularly in the wake of a challenging 2022 that saw significant declines in both bond and publicly traded stock markets. Hatfield reflected on the firm’s accurate negative outlook for 2022, specifically concerning tech stocks and speculative assets like cryptocurrencies and meme stocks. This bearish stance was rooted in the Federal Reserve’s aggressive monetary tightening, which dramatically reduced the money supply. Hatfield detailed how the Fed’s open market operations, rather than solely interest rate hikes, led to a near 20% reduction in the money supply last year, a move he argued was the primary driver of pain across capital markets.
Looking ahead to 2023, InfraCap presented a more optimistic outlook, targeting the S&P 500 at 4,500. This bullish projection was attributed to several key factors. Firstly, the most significant portion of the Fed’s monetary tightening appeared to be behind them. Hatfield highlighted the Fed’s use of reverse repo operations, where it held $2.5 trillion, as a mechanism for absorbing liquidity. He suggested this substantial reserve could offset future balance sheet reductions, a nuance he found frequently overlooked by market participants.
Secondly, Hatfield argued that the typical recessionary environment that accompanies Fed rate hikes was unlikely due to post-pandemic tailwinds. He cited persistent shortages in housing and automobiles, coupled with a robust labor market, as factors mitigating the severity of a potential economic slowdown. This combination of a likely Fed pause in rate hikes and these underlying economic strengths formed the basis for InfraCap’s positive market sentiment. However, Hatfield cautioned that the market’s rapid ascent in early 2023 presented its own set of risks, advising investors to be mindful of the period following earnings seasons, when macro data and hedge fund activity can introduce significant volatility.
A key point of contention during the webinar was InfraCap’s view on inflation. Hatfield asserted that the Federal Reserve was "completely out to lunch on inflation," suggesting they were not utilizing the correct indicators. He presented InfraCap’s proprietary index, CPI-R, which he claimed had turned negative over the past four months, indicating deflationary forces at an annualized rate exceeding 4%. This index, he explained, differs from the Bureau of Labor Statistics’ (BLS) Consumer Price Index by using housing prices as a more timely predictor of the shelter component of CPI, bypassing the lagged estimates of owner’s equivalent rent.
Hatfield elaborated on the drivers of high inflation, identifying loose monetary policy, which fuels housing inflation, and energy price shocks as the primary culprits. He contrasted this with the Fed’s reliance on the Phillips Curve, which emphasizes the labor market’s role in inflation. According to InfraCap’s analysis, the labor market, aside from pandemic-induced anomalies, has historically been stable. In contrast, the goods market, heavily influenced by monetary policy, exhibits greater volatility. He pointed to the substantial increase and subsequent decrease in the monetary base in 2020-2021 and 2022, respectively, as evidence of this volatility. Furthermore, he noted the significant energy price shock experienced last year and its estimated 5% pass-through to core inflation. With housing prices now stabilizing or declining and energy prices, particularly natural gas, experiencing sharp drops, Hatfield believes deflationary forces are at play.
The discussion then moved to specific asset classes for generating income. Hatfield reiterated his bullish stance on bonds, projecting the 10-year Treasury yield to settle around 3%. This forecast is supported by the aging global population, leading to increased demand for fixed-income assets from pension funds, and the relative attractiveness of U.S. bonds compared to global peers. He also highlighted the potential for significant demand from well-funded pension plans reallocating assets to bonds.
On the equity side, InfraCap favored high-dividend, large-cap stocks, citing their historical performance of nearly matching NASDAQ returns with significantly lower volatility and superior income generation. Their actively managed ETF, ICAP, aims to enhance yields through modest leverage and investments in preferred stocks, achieving yields well above the broader index.
Preferred stocks were strongly recommended as an attractive asset class, especially given current valuations. Hatfield noted that many preferreds are trading at a discount to their call price, offering the potential for equity-like returns in addition to attractive dividends. He emphasized the importance of active management in this sector to navigate risks such as interest rate sensitivity, default risk, and call risk, advocating for cumulative preferreds and focusing on investment-grade credits to mitigate default probabilities.
Master Limited Partnerships (MLPs) were also discussed, with Hatfield acknowledging past investor skepticism due to their previous growth-stock structure and high leverage. However, he highlighted the industry’s transformation, with companies now boasting well-covered dividends, retained earnings for asset acquisition, and reduced leverage. He believes energy prices are likely to remain supportive of MLPs, and their corporate structure (as opposed to K-1 partnerships) simplifies tax reporting for investors.
During the Q&A session, several technical questions arose. Regarding the yield curve, Hatfield predicted it would remain inverted for the next two years due to the Fed’s rearview-mirror approach to policy, though he did not foresee a catastrophic economic outcome. He anticipated the 10-year and 30-year yields to stabilize between 3% and 3.25% due to retirement booms and modest global growth.
On the financial sector, Hatfield expressed a positive view, particularly on regional banks that are less exposed to investment banking risks. He noted that the yield curve inversion, while challenging for some, actually benefits banks through widening net interest margins, and he did not anticipate significant credit problems given the resilient labor market data.
For blended growth and income portfolios, Hatfield suggested that younger investors with longer time horizons could allocate more to higher-yielding, potentially higher-beta assets like high-yield bonds and preferred stocks, while still maintaining a fixed-income component for diversification. He also advised against utilities and telecoms due to current valuations, favoring other income-generating equity sectors.
Clarifying yield metrics, Hatfield explained SEC yield as a standardized, expense-adjusted estimate, while distribution yield reflects actual payouts. He stressed the importance of the SEC yield being sufficiently above the distribution yield to avoid return of capital, ensuring that income is truly generated and not a return of principal.
In response to a question about publicly traded funds versus private funds, Hatfield acknowledged that public markets often trade at discounts compared to private markets, which he termed a "market inefficiency." He suggested that assets like preferred stocks, currently trading at discounts, offer opportunities for higher returns. He also cautioned about closed-end funds trading at premiums, which can exacerbate losses during market downturns, contrasting this with ETFs that trade closer to net asset value.
Finally, when asked why not simply opt for short-term Treasuries or CDs for yield, Hatfield acknowledged their safety but argued they forgo the opportunity for higher returns and the potential for capital appreciation through discounted securities. He posited that these higher yields from assets like preferred stocks are likely to be sustained, whereas short-term rates could decline, forcing investors to draw down principal to meet expenses.
The webinar concluded with a reminder that further information and resources, including the presentation deck, can be accessed through InfraCap’s website, infracapfunds.com. The session provided valuable insights for financial advisors seeking to navigate the current economic climate and build resilient income-focused investment portfolios.
