On February 8, AltsDb co-founder Jimmy Atkinson hosted Jay Hatfield, founder and CEO at InfraCap, for a comprehensive one-hour webinar tailored for financial advisors. The session, which has been made available as an audio podcast and a YouTube video, delved into nuanced income investing strategies designed to navigate the complexities of the current macroeconomic landscape. Andy Hagans provided a brief introduction to the program.
The webinar, sponsored by Infrastructure Capital Advisors (InfraCap), a prominent entity in the ETF industry, aimed to equip advisors with actionable insights into building portfolios that generate consistent income amidst economic uncertainty. Jay Hatfield, with his extensive background in finance and investment management, shared his firm’s economic outlook, detailed the advantages of a balanced portfolio, and outlined preferred asset classes for income generation.
The Enduring Appeal of Income Investing
Jay Hatfield opened the discussion by addressing the persistent popularity of income investing, particularly among high-net-worth and ultra-high-net-worth individuals and their advisors. He emphasized that income generation is fundamental to constructing a high-quality portfolio, especially for those nearing or already in retirement. Hatfield illustrated this point with an anecdote about a friend who, after a portfolio review and restructuring, was able to confidently plan for retirement due to a diversified portfolio yielding 4% to 5%. This income stream provided a crucial buffer against market volatility, enabling reinvestment at lower prices and offering peace of mind. Hatfield posited that a reliable income stream is not merely for retirees but offers a degree of stability for all investors, allowing them to navigate market downturns with greater resilience.
Economic Outlook: A Shift in Perspective
The conversation then shifted to the prevailing economic conditions. Hatfield acknowledged the challenging year of 2022 for both bond and publicly traded stock markets, noting that alternative investments generally performed better in comparison. He explained his firm’s negative market outlook for 2022, particularly concerning tech stocks and speculative assets like cryptocurrencies. The rationale behind this cautious stance was the Federal Reserve’s aggressive monetary tightening, characterized by a significant reduction in the money supply. Hatfield estimated that the Fed withdrew nearly 20% of the money supply through open market operations, a move that exerted downward pressure on both bond and stock prices.
Looking ahead to the current year, InfraCap projected a more optimistic scenario for the S&P 500, setting a top-decile target of 4,500. This bullish outlook was predicated on several factors. Primarily, the most aggressive phase of monetary tightening was believed to be behind them. Hatfield highlighted the Fed’s use of reverse repo operations, a mechanism for withdrawing liquidity, which he suggested was a critical but often overlooked aspect of monetary policy. He noted that the Fed had approximately $2.5 trillion in reverse repo agreements, which could be utilized to offset balance sheet reductions.
Furthermore, InfraCap anticipated that the Fed would likely implement only two more rate hikes and would refrain from cutting rates in the near term. However, they did not foresee a significant recession, attributing this to post-pandemic tailwinds such as housing and auto shortages, which typically experience sharp declines during economic downturns but were currently exhibiting resilience. A strong labor market, a rare phenomenon during periods of Fed tightening, also contributed to this optimistic view. The core of their bullishness rested on the expectation that the Fed would eventually halt its rate hikes, creating a more favorable environment for investors.
Inflation Dynamics and Monetary Policy Critiques
A key theme emerging from the discussion was Hatfield’s strong critique of the Federal Reserve’s approach to inflation. He asserted that the Fed was "completely out to lunch on inflation" and was not utilizing the correct indicators. InfraCap maintains its own index, CPI-R, which measures inflation based on historical methodologies prior to 1982, incorporating housing prices rather than relying solely on the Bureau of Labor Statistics’ (BLS) owner’s equivalent rent estimates. Their CPI-R index had shown a strong negative trend over the preceding four months, indicating deflationary pressures at an annualized rate of over 4%.
Hatfield argued 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 of significant inflation driven by similar forces. In contrast, he contended that the labor market, while important, was not the primary driver of high inflation, citing the Phillips Curve as a flawed model for understanding contemporary inflationary dynamics. The dramatic increase and subsequent decrease in the monetary base—up 70% in 2020-2021 and down 20% in 2022—was seen as evidence of volatile monetary policy leading to volatile asset prices.
The deflationary forces identified by InfraCap included negative housing price trends and a significant decline in energy prices, particularly natural gas, which had fallen 75% from its highs. Hatfield explained that when goods prices rise, nominal wages increase to maintain living standards. Conversely, as inflation plummets, real wages rise, leading to a slackening demand for nominal wage increases. He criticized the Fed for ignoring these dynamics, believing their continued rate hikes were misguided.
The Role of Bonds and Equity Income
InfraCap’s outlook for the bond market was positive, projecting the 10-year Treasury yield to settle around 3%. This forecast was supported by several factors. Firstly, the aging global population and the substantial growth of global pension assets, estimated at $52 trillion (150% of U.S. GDP), were expected to create significant demand for bonds. As pension plans seek to meet their return targets, they are likely to reallocate capital towards fixed income. Secondly, U.S. bonds were considered attractive on a global basis, offering higher yields compared to many developed economies. This global demand, coupled with the expected moderation of long-term rates, suggested a favorable environment for bond investors.
On the equity side, Hatfield advocated for a focus on income-generating assets. He highlighted large-cap dividend stocks, noting their historical performance, which has delivered returns comparable to the NASDAQ with significantly lower volatility and superior income generation. InfraCap’s own large-cap dividend fund, ICAP, utilizes a combination of low leverage and preferred stock holdings to enhance yield beyond that of the benchmark index.
Preferred stocks were presented as a particularly attractive asset class, especially given their current trading levels. Hatfield pointed out that many preferred stocks were trading at discounts to their call price, offering the potential for equity-like returns while providing attractive dividends. He emphasized the importance of active management in this space to avoid securities trading above par and to focus on cumulative preferreds with a low probability of default, citing a historical default rate for listed preferreds comparable to investment-grade bonds.
Master Limited Partnerships (MLPs) were also discussed, with Hatfield acknowledging past investor skepticism due to their historical structure as growth stocks with high leverage. However, he noted that large-cap MLPs have since reformed their business models, focusing on well-covered dividends, retained earnings, and reduced leverage, making them a more stable income-producing asset class.
Building a Balanced Portfolio
Hatfield stressed the importance of a balanced portfolio, suggesting that even younger investors should incorporate a fixed-income component for rebalancing purposes. He presented hypothetical portfolio yields, demonstrating how increasing the allocation to fixed income could significantly boost overall portfolio yield, reaching 4.67% for a 30/70 stock/bond allocation and potentially 6% to 7% for more conservative allocations. He also underscored the necessity of equity income from dividend-paying stocks to achieve target yields, as the S&P 500’s current yield was considered insufficient on its own.
Q&A Session Highlights
The webinar concluded with a lively Q&A session, addressing several key concerns from the audience:
- Yield Curve Outlook: Hatfield reiterated his expectation for an inverted yield curve to persist for approximately two years, driven by the market’s anticipation of Fed actions outpacing the Fed’s own pace. He projected the 10-year Treasury yield to stabilize around 3% to 3.25% due to the retirement boom and modest global growth.
- Financial Sector View: InfraCap expressed a positive outlook for the financial sector, particularly regional banks. They believed fears of widespread loan write-offs were overblown and that the steep yield curve was beneficial for banks’ net interest margins. They also saw potential in riskier investment banks as the market anticipates the Fed’s pause.
- Blended Growth and Income Portfolios: For younger investors with a longer time horizon, Hatfield suggested a portfolio with a higher allocation to riskier income-generating assets like high-yield bonds and preferred stocks, coupled with a reduced allocation to traditional Treasuries. Equity income from MLPs and REITs was also recommended for their total return potential.
- Yield Metrics: Hatfield clarified the distinction between SEC yield, which is a standardized, expense-adjusted estimate, and distribution yield, which represents the actual payout. He cautioned against funds that report high distribution yields but low SEC yields, indicating potential return of capital rather than true income generation.
- Public vs. Private Market Valuations: He acknowledged that private market valuations often appear higher than public market valuations, attributing this to market inefficiencies and investor sentiment. He noted that opportunities exist in publicly traded assets that are trading at discounts, such as preferred stocks and certain REITs.
- Short-Term Treasuries and CDs vs. Other Income Assets: While acknowledging the safety of short-term Treasuries and CDs, Hatfield argued that they may not provide sufficient returns for investors seeking higher income or long-term growth. He suggested that assets like preferred stocks and MLPs offer potentially higher and more sustainable yields with manageable risks.
The webinar concluded with a reiteration of InfraCap’s commitment to income investing strategies and an invitation for financial advisors to visit their website, infracapfunds.com, for further information and resources. The recording and presentation deck are expected to be made available to attendees.
