On February 8, AltsDb co-founder Jimmy Atkinson hosted Jay Hatfield, founder and CEO of InfraCap, for a comprehensive one-hour webinar tailored for financial advisors. The session delved into income investing strategies, offering crucial insights into navigating the current complex macroeconomic landscape. This event, which also featured an audio version of the webinar with an introduction by Andy Hagans, provided a platform for financial professionals to gain a deeper understanding of how to construct robust portfolios designed to generate consistent income amidst market volatility. The full webinar is available for viewing on YouTube.
The Enduring Appeal of Income Investing
The webinar opened with a discussion on the persistent popularity of income investing, particularly among high-net-worth and ultra-high-net-worth individuals and their advisors. Jay Hatfield articulated that income generation forms the bedrock of a high-quality investment portfolio, especially for those nearing or in retirement. He illustrated this point with an anecdote about a friend who, after transitioning to an income-focused portfolio, gained the financial confidence to retire. This strategy, Hatfield emphasized, provides a crucial layer of stability and sanity, enabling investors to weather market downturns by knowing their expenses are covered and that opportunities exist to reinvest at lower prices and higher yields. This approach, he noted, is not exclusive to older investors but offers benefits to a broader spectrum of investors seeking to preserve and grow capital.
Navigating the Economic Landscape: A Look Ahead
The discussion then shifted to the prevailing economic environment, acknowledging the challenging year of 2022 for both bond and public stock markets, while alternative investments generally fared better. Hatfield provided a retrospective on his firm’s accurate bearish stance on the market in 2022, particularly concerning tech stocks and speculative assets like cryptocurrencies and meme stocks. This outlook was rooted in the Federal Reserve’s aggressive monetary tightening, characterized by a significant reduction in the money supply. Hatfield highlighted that the Fed’s actions, primarily through open market operations rather than solely interest rate hikes, effectively drained capital from the markets, impacting both bond and stock prices.
Looking ahead to 2023, InfraCap projected a top-decile target for the S&P 500 at 4,500. This bullish outlook was underpinned by the expectation that the bulk of the monetary tightening was behind them. A key, often overlooked, mechanism for this tightening was the Fed’s use of reverse repurchase agreements (repos), a tool that effectively absorbed liquidity from the financial system. Hatfield pointed out that the Fed’s ability to offset balance sheet reductions with reverse repos, totaling $2.5 trillion, was a critical factor in managing the money supply.
While acknowledging that the Fed might implement two more rate hikes, Hatfield stressed that significant rate cuts were not anticipated in the near term. However, he countered the conventional expectation of a severe recession, citing post-pandemic tailwinds such as housing and auto shortages, coupled with a resilient labor market. These factors, he argued, create a unique economic scenario where Fed tightening does not necessarily lead to the typical recessionary outcomes. The overarching sentiment for 2023 was one of a strong market rally, with an eventual pivot by the Fed to cutting short-term rates, and long-term rates expected to settle around 3%, which would be highly supportive of bond markets.
Inflation Dynamics and the Fed’s Policy Approach
A significant portion of the webinar was dedicated to Hatfield’s critique of the Federal Reserve’s approach to inflation. He posited that the Fed was "completely out to lunch" on inflation, arguing that they were relying on outdated indicators and failing to grasp the true drivers of price increases. Hatfield presented his firm’s proprietary index, CPI-R, which tracks real-time inflation and has shown a negative trend over the past four months, indicating deflationary pressures. CPI-R, he explained, is calculated using a methodology predating 1982, incorporating housing prices and accounting for the lagged effect of owner’s equivalent rent, which he believes misrepresents current shelter costs.
Hatfield identified two primary drivers of high inflation: loose monetary policy, which fuels housing inflation, and energy price shocks. He drew parallels to the 1970s, when similar conditions prevailed. He contended that the Fed’s reliance on the Phillips Curve, which links inflation to labor market dynamics, is misplaced. While acknowledging that labor market stability influences inflation, he asserted that it is not the primary driver of significant price surges. Instead, he pointed to the dramatic shifts in the monetary base – a substantial increase in 2020-2021 followed by a sharp decline in 2022 – as the cause of volatile housing and asset prices.
Furthermore, Hatfield argued that the Fed underestimates the "bleed-through" effect of energy price shocks into core inflation, estimating it at approximately 5%. With energy prices, particularly natural gas, having fallen significantly, and housing prices beginning to decline, he believes deflationary forces are at play. This decline in goods prices, he explained, should eventually lead to moderating wage growth, as workers’ real wages increase. However, he criticized the Fed for ignoring these dynamics, leading to a policy stance that he believes is misaligned with the current economic reality.
Implementing a Balanced Income Portfolio
The webinar then transitioned to practical strategies for building balanced income portfolios. Hatfield emphasized the importance of a diversified approach, incorporating both fixed income and equity income components.
Fixed Income Alternatives
For fixed income, Hatfield highlighted several asset classes, ordered by their correlation to U.S. Treasuries and the stock market:
- U.S. Treasuries: Currently offering attractive yields, they provide a foundational level of safety.
- Municipal Bonds: Offering tax advantages, they present a slightly lower correlation to Treasuries.
- Corporate Bonds: With yields around 5.4%, they are becoming increasingly appealing.
- Preferred Stocks: These are a particular focus, with average yields around 6%. Hatfield noted that by looking beyond the cap-weighted index (which is heavily weighted towards financials), investors can access significantly higher yields, with InfraCap’s REIT preferred fund yielding over 7% and another fund approaching double digits. These offer modest stock market risk, typically half that of common equities.
- High-Yield Bonds: Yielding around 9%, they offer lower correlation to the stock market than preferreds.
- Senior Loans: While offering decent yields, they present lower beta to the stock market and less interest rate risk.
Hatfield recommended exposure to all these asset classes for a well-rounded bond portfolio, especially given the recent run-up in Treasury prices.
Equity Income Strategies
On the equity side, Hatfield discussed several income-generating asset classes:
- Utilities: While historically stable, he noted they are currently considered overvalued based on their yields.
- REITs (Real Estate Investment Trusts): Depressed last year due to pessimism about cap rates, REITs are now seen as attractive with potential for recovery.
- Telecom: Stocks like AT&T and Verizon offer good yields after recent pullbacks.
- MLPs (Master Limited Partnerships): Hatfield expressed strong favor for MLPs, describing them as a significantly improved asset class due to better capitalization and more disciplined dividend coverage.
- High Dividend Yield Stocks: InfraCap’s large-cap dividend fund, ICAP, targets yields well above the S&P 500’s 1.7% dividend yield, aiming for a 4-5% yield.
- S&P 500: Currently yielding around 1.7%, it is considered fully valued for income generation purposes.
He presented a hypothetical portfolio illustrating that a 30/70 stock/bond allocation could yield around 4.67%, with allocations shifting towards fixed income or equity income potentially pushing yields to 6% or even 7%.
Deep Dive into Preferred Stocks and MLPs
Hatfield elaborated on preferred stocks, strongly recommending them, especially for clients without prior exposure. He highlighted that listed preferreds are callable at par, making them particularly attractive when trading below par, offering potential for equity-like returns in addition to good dividends. His firm’s flagship fund, PFFA, offers yields well over 9% and has demonstrated superior performance compared to other preferred stock ETFs. He also discussed the risks associated with preferreds, including interest rate risk, default risk, and call risk, emphasizing the importance of active management.
Regarding MLPs, Hatfield addressed potential investor "PTSD" from past experiences. He explained that the asset class has undergone significant reform, with companies now focusing on well-covered dividends, retaining earnings for growth, and share buybacks, reducing leverage and making them a more stable investment. He also noted the inconvenience of K-1 tax forms for direct MLP investments and highlighted InfraCap’s corporate structure for its MLP fund, which provides capital gains treatment and avoids K-1s. With projected strong energy prices for 2023, he sees continued support for MLPs.
Yield Metrics and Market Valuations
The Q&A session addressed technical aspects of yield metrics and market valuations. Hatfield clarified the difference between SEC yield and distribution yield, emphasizing that SEC yield, a standardized measure, helps investors avoid "return of capital" notices and ensures that distributions are adequately covered by the fund’s income. He also commented on the valuation of publicly traded funds compared to private markets, suggesting that while private market valuations might appear higher, inefficiencies in public markets, such as the discounted trading of preferred stocks, present significant investment opportunities. He concluded by reiterating that while short-term treasuries and CDs offer safety, they may not provide sufficient returns or growth potential compared to actively managed income-generating asset classes.
The webinar concluded with a reaffirmation of InfraCap’s commitment to providing robust income strategies, inviting financial advisors to visit their website, infracapfunds.com, for more information and resources.
