Jay D. Hatfield, Portfolio Manager InfraCap Small Cap, Income, MLPs and REIT Preferreds | S08 E05
Summary
Income Strategy: Emphasis on monthly Income Investing using preferreds, high yield bonds, and dividend stocks to provide stable cash flow and reduce drawdown risk.
Fixed Income Focus: Preference for public company credit via Preferred Stocks and High Yield Bonds (e.g., PFFA, BNDS) to capture higher yields (8-9%) with lower volatility than equities.
Covered Calls: Systematic use of short-dated Covered Calls to enhance income while avoiding return caps, writing selectively when positions approach targets.
Equity Income: Large-cap, small-cap, and pipeline dividend strategies generate high single-digit yields primarily from dividends, with calls as a supplemental income source.
Financials Opportunity: Bullish on Investment Banking & Brokerage driven by pent-up M&A, falling rates, and AI-related issuance; this positioning performed strongly.
Company Views: Positive on KKR despite market fears; cautious on TSLA due to valuation and growth concerns, preferring GARP and risk-managed income approaches.
Risk Management: Uses very low leverage and active risk controls; highlights differences from private credit and mechanically-run call-writing funds.
Macro Backdrop: Expects rate cuts given overstated inflation from shelter data; housing softness and money supply contraction underscore need for looser policy.
Transcript
And we're live. We're running a little bit late. Sorry folks. This is Value After Hours. I'm Tobias Carile joined as always by my co-host Jake Taylor. Our special guest today is Jay Hatfield from Infraap. He's going to tell us a little bit about How are you, Jay? >> I'm doing well. Thanks for having me on, Tobias and Jake. >> Pleasure. Tell us a little bit about Infra. >> We are a $3.5 billion money management company. We have six ETFs all focused on monthly income, three on the fixed income side, three on the equity income side. We also have a hedge fund and so uh we are um committed to providing great total return but also good income for investors who want to sleep at night and know that they have good stable income coming from their portfolios. What's the um attraction to income oriented strategies? Well, it's primarily helpful for people who I would recommend having it even when you're young, having some, but for older individuals who are looking forward to retirement in retirement. It can give you a good base load for your portfolio whereby you know a good percentage of your expenses are being covered by the income coming from your portfolio. And then [clears throat] you could have more growthy and risk growthier or riskier investments in the remainder of your portfolio because what you don't want is like during we haven't had one since 22 but during major drawdowns you don't want to have to be selling securities and taking losses and so nor do you want to be worried about that even if it doesn't happen [clears throat] and so it can provide a lot of solace um if you have fixed income that can be a lot less volatile than the rest of your portfolio. So you can also use it for rebalancing. This is what major pension funds do. So every quarter they say, "Oh, well my fixed income, you know, because the equities are down a lot, it rose from 40 to 45. So we'll sell 5% fixed income and buy 5% equities." So it can be a great way to buy at the bottom and sell at the top. force yourself to do that by um setting an allocation of fixed income and then rebalancing. Usually equity income is pretty correlated with the market so it doesn't help you that much on that but fixed true fixed income would. >> What what are your sources of income? >> So on the on the um fixed income side it's preferred stocks and high yield bonds. The great thing about both of those asset classes is they're higher risk fixed income. So [clears throat] unlike so unlike like our biggest or high not biggest but our high yield fund is BNDS. There's a fund B&D that's just investment grade bonds and we're high yield bonds. So their fund yields four are fund yields eight. So in the long run, you'll get a lot higher returns from these higher risk bonds. And our preferred fund yields nine same um situation where you get higher income. And what's great about that is it's really almost like a hybrid security. So it's much lower risk than equities, but has equity like returns because eight or nine is pretty close to equities or 10 or 11. And so we think that's a attractive addition to almost all portfolios is BNDS or PFFA [clears throat] or similar funds where you get really good income. You have some correlation stock market um but low much lower volatility and really good income. >> Uh what about on the equity side? Sorry JT. >> That's okay. >> Oh on the equity side. So we have three equity income funds. ICAP is a large cap dividend fund. SAP's are small cap dividend fund and AMCA's are pipeline dividend fund. With all those funds, we do add income by writing cover calls. But importantly, there's two things that are different than our fund from our funds relative to others, which is we write very short-term calls, which is to do that yourself, I'd recommend shorter term, like one, two, three weeks, four max. [clears throat] And we get a lot of the dividends. So the those funds yield 8, nine, 10. We get a lot of the income from actual dividends from highpaying dividend paying stocks. shouldn't try to generate too much of your income from writing calls because like 10 11 12 what ends up happening is that in up markets your returns get capped because you're writing too many calls and particularly if you're writing them farther out. So the ideal strategy is to write very short-term calls on just a portion of your portfolio. And we can do that because we are investing in real dividend stocks that pay substantial dividends. So we don't need to write the whole portfolio to generate, you know, high singledigit um income flows. I was going to ask I've read a lot about um the perhaps loosening of you know covenants in a lot of debt these days. Have you noticed that or how's that uh factor into the underwriting and when you're looking at the you know how how confident you can feel about the cash flow coming in? Well, one thing that it's great about the securities that we invest in versus private credit or a lot of high yield bonds that are in the indices is that we're dealing with public companies and they typically have pretty high target credit ratings. So, [clears throat] they're not looking to take money out and distribute it to their uh private equity holders or investors rather. And so the covenants become a little bit less critical. We also have higher quality credits that also don't really need those covenants as much. And so that's the way we deal with that problem is focus on large public companies and then they're less likely to uh have this big incentive to take cash out of the business and distribute it to their LPs. How do you uh define good income versus bad income? What what I mean like what's sustainable yield versus a yield trap in the dividend companies? >> Well, first of all, it's important for all ETFs disclose something called SEC yield. And so that's the cash flow coming into the fund. And so with our fixed income funds, the cash flow yield is essentially the distribution yield. So we're not returning [clears throat] capital. We might from a tax perspective return some capital but that's good because you don't want to pay tax but the cash coming in is very close to the cash going out and you can that's published every month and it's very strict set of guidelines published by the SEC hence 30-day SEC yield being the name and then but you can also look that up for our equity income funds and then [clears throat] the reason that's valuable is you can see like the distribution yield the SEC yields usually like six or seven or eight. So that means we're only getting two or 3% from ball writing. So having a substantial amount of real income is critical. The other um issue some people we have a European ETF and that I'm told that Europeans get really really suspicious about any dividend yields much above three or four and that's a reasonable concern for common stock but not preferred. Preferred get paid first. That's why it's called preferred and the yields are usually seven eight nine sometimes six. So that's not a sign of distress. That's just an indication that it's more like debt and less like common uh dividends. But so if like a a common stock has a dividend that starts approaching 10, a lot of time the management team will say, "Well, we're not getting credit for the dividend and just cut it." So I would be concerned about trying to get super high yields from just common equities, but it's [clears throat] perfectly reasonable to get, you know, close to double digit yields from bonds and preferred because that's kind of their inherent return or or yield rather. And it does it's not a sign of necessarily distress. And also [clears throat] management teams of course with bonds they would they have to pay them or else go bankrupt. And then with preferreds they're loathed to not pay them and particularly what all the ones that we invest in are public companies. So public companies want to have good credit. This is why they don't need covenants as much because their shareholders want them to have good credit. Their um board wants them to have good credit but most importantly their counterparties. of their their um the companies they do business with. You know, pipelines being a good example, if you're transporting oil or natural gas, you know, there's credit risk on both sides. So, it's important for these companies to have good credit. So [clears throat] um with with better credits um you don't have to worry as much about defaults and um the sustainability of the dividend is quite high because the companies don't want to suspend the dividends because then they're the rating agencies will downgrade them. their counterparties will get concerned about their credit. So, well, why are your dividends suspended on your mo most of the time it's cumulative, so you owe the dividends back if you start paying common dividends again. So, um I would say [clears throat] that's a distinction to draw. Common stocks that pay super high dividends should be concerned about that preferred certain high yield bonds generally not. Do you use leverage or how do you think about leverage as a tool? >> Um with some of our funds we use um really the lowest leverage you'll find in the market. So closing funds use 40 to 45 in PFA [clears throat] we use 20. BNDS we don't use any leverage. Um and then IP SAP and um AMCA we run 15 to 20. So super low leverage, just a little bit of enhancement of income. Typically, we have preferred stocks, so they're not very volatile, just to add a little bit of income. And we do mon constantly monitor the risk of the portfolio. So like if the market becomes more risky, like during the pandemic or during the tariff tantrum, we'll take that leverage down so we don't just sit around with leverage without looking at the market. So, we think that's one technique to add a little bit of alpha. Um, as long as you actively management, we think that's a great strategy and keep it very low. You know, there's obviously, so leverage has kind of gotten a bad name because there's triple levered funds and, you know, nonsense like that and high yield, I'm sorry, um, closing funds use what we think is too much leverage, like 40 45% leverage. So we keep it really really low and monitor it depending on market conditions. >> So ever any concern about um you know with an ETF structure you have liquidity of coming in and out but if the underlying securities are not as liquid um you know you can run into market dislocations then on the ETF wrapper versus what's under inside of it. How do you think about that? Well, we only um trade in securities that are listed. So, there's more liquidity on the listed securities. >> Sure. >> Um, of course, with the equity funds, they're kind of infinitely liquid. So, they could be liquidated intra hour really, [clears throat] you know, particularly well really all the equity funds. And on the preferred side, we keep um well, first of all, we have inline redemptions and which we barely have, but let's say there was a market dislocation, we're getting redemptions, we only we just deliver the securities. So, we don't have to go sell any of our our securities to meet redemptions. So it's the only issue is just if we wanted to take leverage down and we have um hyperlquid securities that are intraday type liquidation securities like intra hour even. So we can get our leverage intraday down below uh one or you know to zero and start raising cash in extremely short order. The real key to understand is that if we [clears throat] did have a lot of redemptions, we would just deliver all of our underlying securities to them. So we don't, it's not like we'd have to, you know, find $20 million. We deliver. So in kind um creations and redemptions also lowers trading costs with PFA. It's a $2.2 billion fund. So we really only have inflows. It's a has great returns, but that lowers our trading cost because we don't get a whole whole bunch of cash and then have to deploy it and pay the bid as spread. We just get it. So that's actually great structure is to have these um inind creation redemptions. >> Jay, across your front, this is like a double uh two sides of the same coin, but where do you take risk? How do you generate the alpha? Is it security selection, structure, leverage, volatility, harvesting? How do you think about the way that you're generating risk and return? >> Well, we do well on the fixed income side, it's pretty straightforward. It's like um playing basketball or soccer with no opposing team because you have [clears throat] to manage the um risks inherent in fixed income that don't exist with equity. So that's in short call risk, credit risk, interest rate risk. And there's also opportunities on the new issue side and arbitrageing the index funds particularly preferred because they're pretty illquid. So that's pretty straightforward and that's why we've doubled the returns of the index with PFFA and BMDs has be not buying as much but it's not as inefficient. On the equity side to your point it can be more challenging to generate alpha with equities because for two reasons. Uh passive funds are cap weighted which can be a phenomenal strategy because in effect you're a momentum trader and by the way that's a terrible thing to to do with fixed income because it's callable. So the higher it goes the more you should sell it but they index funds do that. So that counts for why we're [clears throat] so confident about beating on the um fixed income side. on the equity side, you know, the other there's two dynamics that give an advantage to index funds. The momentum and also sometimes the dumbest securities go up the most. So, you know, meme stocks or I don't believe that Tesla should trade at 220 times earnings, but maybe everybody else does. And so, my analysis doesn't really help. it may hurt even like it's better just to be like oh silver it's at 80 it's probably going to go to 180 and just play the momentum but [clears throat] what's in our favor is exactly what you mentioned so we are uh I would argue really great at macro you can access to our macro slides are highly proprietary data that you won't get anywhere else like the global monetary base etc and so we have a macro view and based on that view that drives our stock selection. So for instance [clears throat] about a year and a half ago we're in Midtown Manhattan so that helps a little bit and I used to be an investment banker. This is an investment banker tie. Um so [snorts] it became obvious when the Trump administration came in that there was this huge pentup demand for M&A. Rates are coming down huge issuance on fixed income side likely to be AI related IPOs. So we got really long all the investment banks and [clears throat] that worked spectacularly well. But it was driven by the macro like rates are coming down a little bit by analyzing the political situation. So you can use your macro skills to pick stocks. We use a GARP uh model. So growth at a reasonable price. So that's why we hate Tesla because it's really not growing and it trades at >> unreasonable price. Yes. And [clears throat] which like I said can outsmart yourself. Like I wouldn't recommend shorting it, but we're okay missing out on the sort of Tesla opportunities. Well, what you don't want is to be like it hasn't happened yet, but it mean at like eight a peg of eight. So the P to growth ratio is like seven or eight times and then if they miss it goes down 60%. So we want to avoid the down 60s. we'll give up a few GameStops or I mean actually Tesla's underperformed over the last five years but in the earlier years we might have given that up. Um there might have been times where it was trading at reasonable pegs, but I don't I would have to go back and look. But so [clears throat] we do think that being disciplined on the valuation side can add alpha. But more importantly, writing very short-term covered calls on individual stocks where you have a gain and where it's close to your target based on on GARP or PEG type valuation metrics can be a phenomenal approach particularly if diversified portfolio because what you also capture is overvaluation in certain sectors like over the last couple weeks for instance I would argue that consumer Staples got pretty fully valued. So like we're in Coke and IAP and some of that was getting called away but then they reported and it's not like getting crushed but it's off a couple bucks. So what it does is it forces you to rotate out of fully valued sectors like utilities. We've sold Southern Company is a 91 but we've sold calls at 98 and 100 and have some of that called away. So when you do it on individual stocks, you're [clears throat] not taking losses, you're taking gains, and you're forcing yourself to recycle into better valuations. And you don't do stupid things. Like during the tariff tantrum, we didn't write any calls because we didn't have gains and it wasn't near our target. [clears throat] And so whereas if you look at most of the call writing funds, they're just mechanical. like they always have calls written out two or three months and they redo them regardless of fundamentals. So they'll redo them when there's a tear tantrum or the market goes down irrationally like it kind of did over the last three or four days. [clears throat] And so then and if it's an index call and it goes in the money, they're just taking a loss. It's not like selling southern at at you know in the high 90s when you have like a 20% gain. So that's the we think tremendous value added for alpha and then you know opportunistically running a little bit of leverage when the market's good can get you a little bit better returns. So, uh, short answer is if all we could do was pick stocks, we still could probably beat, but it would be harder. If we can write bespoke short-term covered calls, little, I would argue, heavily stack the deck in our favor. And then a little bit of extra income from little bit of leverage on preferred in most markets, we'll add alpha. So, we're kind of stacked. Not super easy, just pure equities, but we stacked the deck in our favor by having these kind of hedge fund light strategies, running a little leverage and writing covered calls. >> What What makes that covered call market inefficient? Like where there is kind of a sounds like a free lunch. >> Well, a lot of times my kids ask me like, who the heck is buying these call options? >> That's a good way that's a better way of asking the question perhaps. And to some degree it is what I would argue somewhat irrational retail investors. So [clears throat] like in our hedge fund, we don't do this in our ETFs, but we'll write micro naked 10,000 micro strategy calls. And I would argue that's just pure irrationality on the part of retail investors. But to some degree it's also just and even when it's a mechanically just being done by market makers, the volatility of micro strategy might be driven by retail investors even though it may not be be the ones making markets like that. But where I would argue it the alpha is coming from is not us analyzing oh well the volatility is you know 3% above or below where it should be but overlaying fundamentals on what's mostly a technical market. Um and having a bias towards selling options. Like there are services that tell you, oh, we should, you know, it's much more lucrative to buy options and you get a higher return, but they failed to recognize that the decay of options makes [clears throat] it like you're going to casino and the casino's raking off 10%. [clears throat] And so what we're doing is the opposite of that. We're selling risk to the street and sometimes directly to investors, but um the fact that that risk we're selling decays over time stacks it odds in our favor. And since we layer them one week at a time out, even when it looks like we take a loss, [clears throat] it the stock gets called away and we replace it with other stocks. So we maintain our exposure to the market. So, it's not so much that there's just a bunch of idiots out there buying call options. It's more that we're just taking advantage of the fact that it's the probabilities are stacked in your favor by um having theta or decay in your portfolio and then managing your exposure. This is really what the street does on the other side of the trades. managing your exposure to the market because they're short a bunch of calls and they have to be long other securities. [clears throat] So if you constantly monitor your exposure to market, you're really not taking that much risk. So like if you love like right now, I guess trying to pick on a good example. So we love KKR think that everybody's freaked out for no reason. We might write a call. We're actually not writing a lot of calls on that, but let's say we did a 120 and it's at it's at like 210 right now. I mean 2 220 and said 210. Um [clears throat] then if it ran at 220 we might just buy some stock and then let that get called away over the next week or two. So if you actively manage that selling of calls then it can produce alpha. If you just sit around and go play golf during the day then half the time you would be capped out on big returns and you would have a lower return on your overall portfolio. So you do it requires you to um be a bad golfer. So you have to be looking at your screens all day or else kind of as you're implying the fact the times when you get capped out on some stock would offset all the decay of the portfolio. So you have to manage your exposure to the market and your exposure to your ideas to make sure they don't get carried, you know, get called away and then you lose all the upside. >> Jay, I'm just going to give a quick shout out to the folks at home. And Jake's got some vegetables which is a little lesson for us and we'll come back and talk about some of your macro views. Uh London, UK, what's up? Boyisey, Idaho, Philly, London, Toronto, Aras, Sa Saudi Arabia, what's up? Valareereeso, Tombble, Texas, Yorkshire, Pedatikva, Israel, Utah, Snomish, Tallahassee, Kingwood, Texas, Tmacula, what's up? Wingong, New South Wales, early stuff for you. Rochester, New York, Jared's Cross on the main streets, Lousan, Switzerland, Vienna, Austria, Tan, Iran. Really amazing. Good to see you got your internet back. Uh JT, hit us with some veggies. Market folks, it's uh 15 minutes past the hour. You can come back and find these later. >> All right. So, today we're going to have to be talking about resolutions. And I'm curious, Toby, did you make any New Year's resolutions? >> Same one I make every year. a lot of value to just a little bit of value for performance. Let's go. [laughter] >> All right. Well, actually, uh, we're not going to be talking about that type of resolution. It's going to be a little bit different. Uh, so first of all, shout out to friend of the show, Luke Delana, for inspiring today's veggies. Uh, and this comes from a book of his that's this hidden little gem. When I asked him privately like, "What's your best book you ever wrote?" And he said this one. Um, and it's called The Control Heristic. Uh, it's it's uh it's it's quite good. So, pick that up if you you have a chance. Anyway, on with [clears throat] the show. Imagine that you're looking at a photo on your phone like one does. And at normal size, everything looks crisp and normal and clear. Uh, and but if you zoom in far enough, it starts to turn into little squares like pixels and compressed artifacts, weird jagged edges. And the photo didn't change. We know that. But the amount of detail that you demanded did. And you're looking at the same thing just at different resolutions. So that's the kind of resolution we're talking about today. And and in the brain, we might be able to say that resolution refers to the number of statements that are available to describe a concept. So for instance, let's compare two statements here. And we're going to try not to get political with this, but okay. Statement number one, vaccines are safe. Statement number two, most vaccines are safe and nearly all are safer than unvaccinated exposure, but a few of them are dangerous and have extreme side effects for some people. Okay, obviously like a big mouthful. Uh, and we talk about truth in general like that it's this binary switch like right or wrong, true or false, but that that conflict is is maybe not always what's actually what we're worried about. It's actually more like what resolution are we allowed to speak in. So, you know, as you saw with that example, like low resolution, vaccines are safe, uh, is fast, portable, clear, easy to explain. High resolution is much higher fidelity but a lot more conditional, heavier to carry and transmit. Uh and that that pressure of what's available at a resolution also happens in political discourse. And it even has a name. So care to give a guess uh as to what the name is of that. >> No, >> you'll you'll know the answer when I say it. >> That's the Overton window. This is the the envelope of ideas that a public figure can say without getting treated as an out outside the mainstream. And I think part of what people miss with that is that this window is also filtering resolution as much as it's filtering ideology. So too compressed feels like this slogan for idiots. Basically too detailed can feel like you're overexplaining the story even when you're just being more accurate. So, this explains, I think, why politicians can often sound dumb and still be quite effective. It's they're not they're not broadcasting the full model all the time. They're they're shipping this low resolution packet that's optimized for broad reach. Less conditions, less exceptions, less ways to mishar what you're saying. Um, and in mass coordination, what they're aiming for that that kind of bandwidth beats high fidelity. So a message that's 60% accurate and repeatable can dominate a message that's 95% accurate but kind of too heavy to carry around and share. So quick sidebar on Joseph Overton uh was not a pundit. Uh he was actually an electrical engineer and project manager at DAO. Uh he later became a senior executive at the the Meno Center for Public Policy in Michigan. And in the 90s he developed what he called a window of political possibility to describe this constraint that we've been talking about. Uh and [clears throat] sadly he died it at 43 in in 2003 in an ultralight airplane crash just a few months after his wedding. But after his death his colleagues popularized this model and it became known as the Overton window. So the the window that of public discourse isn't it's not just selecting for truth, it's also selecting for transmittable truth. Uh and so outside you know nuance feels like you're kind of this like mealymouth waffler. uh you know you're overexlaining everything. Uh and in public arguments they collapse often into slogans not because everyone loves slogans but because slogans fit through the Overton window. So simple true or false misses something important. A statement can be correct at one resolution and then feel misleading at another and no one's actually being dishonest here. Uh so I think an example from finance might also drive this home. Uh, lowresolution statement. Index funds are the best default higher resolution statement. For most long-term no nothing investors, diversified low fee indexing beats most active options after tax and fees. The exceptions are real but narrow and hard to identify in advance. All right, the first isn't a lie. It's a simple compression of the truth. The second is probably much closer to kind of the full map, but like who the hell has time to to say all of that in a sound bite, right? So, uh, and we don't get unlimited bandwidth when we're talking with each other. There's time limits, there's attention limits, character limits, audience limits. Uh, if you're speaking to a specialist, you can probably stay zoomed in and give the full picture, but if you're speaking to millions of strangers, you usually can't. Uh, and my my hunch is that this explains a lot of the the divisions that we feel. Uh, one person is speaking high resolution, the other is here, you know, and the other person then hears the actually guy on the internet. uh one person's speaking in low resolution and the other person hears this like irresponsible simplicity and they just aren't sharing the same the same zoom level. So different domains, different error rates of this, you know, engineering and medicine you like precision is super important. Mass politics, public coordination, the job's really more about alignment. Uh and a perfectly nuanced message that nobody can carry around in their head is functionally useless. So, it's kind of silly of us to expect political slogans to meet some academic standards or to expect scientific caveats to function as rallying cries. Like they're calling each other dishonest on both sides of this when when these messengers are just clashing. So, [clears throat] um so maturity I think is not picking one zoom level to live in forever. It's having an adequate focus, knowing when a simple model is good enough, and knowing when the edge cases are worth the effort of that more granularity. So, next time you're tempted to say, you know, this guy's a lying idiot, uh, maybe first ask yourself, what zoom level are they speaking at right now, most likely, and half the time, maybe it's not dishonesty, it's it's just a different resolution. >> Good stuff, JT. I wasn't lying. I was compressing the truth, your honor. [laughter] >> There you go. I when I wrote Choir is Multiple, I wrote that to a fifth grade reading level and it's it's like 10 times the sales of any of my other books which were I I wasn't aware that there were reading levels before that. So that [snorts] certainly works. Very interesting stuff from Luca, too. >> Hemingway was uh wrote a fifth grade level, didn't he? >> It's hard to read though. >> Is it? You think so? >> I just think it's boring. I just think it's like getting rabbit punched all the time. Getting jabbed. >> Oh, >> no. No, it doesn't mix it up enough. Jay, uh, let's talk about macro a little bit. What are the, uh, what are the risks that people can't see right now that you think are going to have the most influence over the next one, three, five years? Easy one to start off. >> Yeah. Layup. >> Great. [clears throat] And that was a great dissertation because I'm constantly dealing with that problem. When you go on national television, they ask you these complicated questions. You got to answer it in one sentence. >> So, you're just as likely to mislead people as give them any insights. So, we I would argue have very unique um macro research on our website. So, this might so we're not really going to say things you've heard all the time. Our biggest concern probably is this ongoing problem with the BLS reporting inflation data. specifically the shelter component is by uh designed six months delayed. So, it's sort of like we were doing this podcast and then you just wait six months to issue it, which not a good policy obviously, but then they use renewing rents and they also which are, you know, if you've ever either rented or been a a um a lessor [clears throat] typically hold back on all the increases so you don't create turnover. So that delays it further. And then they use terrible '7s style data data collection. They call people and do little panels. And so for that reason, you can see this on our website. Uh [clears throat] inflation has been overstated. PC core, if you use modern data collection like the internet, [clears throat] it's developed since the 1970s. uh Zillow and Apartment List, you'll see the the target inflation's already at two. And so our fear is that BLS keeps blowing the reporting of of inflation and we don't get the three rate cuts we need. And that's important. Nobody seems to focus on it, but we have a recession going on in residential housing and construction and that's causing the um labor markets slow and people [clears throat] are confusing that with a whole bunch of other things, tariffs and other things that needs to get fixed to have good economic growth this year. And so that's our big concern is that the data doesn't [clears throat] reflect what's already happened which is inflation's well-contained and rates are way too high. Um and you can see that by the way the money splice shrinking which is very dangerous. Typically you have a recession when the money splice shrinking. So it's really all around the Fed. We're kind of okay with worsh this year even though he's an ultra hawk because he must have promised the president he was going to cut rates and maybe he understands this issue with the BLS longer term we're concerned about war but it's probably not today's or this year's business >> one thing I I noticed I I saw a chart that showed the uh health care expenses and premiums and apparently it was derived from some like tautology of profit within healthcare company insurers and not from like actually what the premiums I pay for my employees which were definitely not down 20% over the last 5 years if anything like doubled so what what's going on there >> well that's a good example it goes the other direction but there is a lot of complete nonsense that's put out by the BLS and I agreed that like I our company pays like pays in had a 20% increase in healthcare premiums. So there are these strange methodologies that are used. I mentioned shelter for financial services. So our business if the stock market goes up that's treated as inflation because people are paying higher fees on because the aum goes up. Health care is the opposite. And maybe we're fortunate at least if you want lower rates that that doesn't get properly reported. But I'll also give that an example as an example of why I fear Worsh because he [clears throat] is probably the biggest proponent of this completely madeup 2% inflation target. So for instance, we could have pretty modest real inflation which comes from the expansion of the money supply but maybe a little tick up because uh Medicare or med medical inflation is surging. And so he overreacts to that and raises rates, you know, dramatically like he did in the mid 2000s which precipitated great financial crisis when if you really think about it, you know, raising rates is not going to lower our insurance premiums. Yeah. Like it's a true supply shock or it's just it's it's maybe not even a supply shock. It's just that in the US we have the best health care in the world, worst way of paying for it, but the best actual healthare and [clears throat] so um and it keeps expanding. So we're probably not picking up the quality factors either. >> But certainly doesn't >> lots of hydonic adjustments, right? But there who knows what the hell >> directly. But so that's a example one where it goes the wrong way. like it. I agree with you. When I look at medical inflation and it's like 0.1 or something, I'm like, I don't know how you're calculating that. But most of the other ones overstated. But my real issue with Wars is in we've had very strong prosperity since [clears throat] World War II. So outside the 70s and 80s which were damaged by oil price increases when inflation so outside that period inflation averaged 2.7%. So not two but 2.7. So why don't we care? Why don't we have a targets 2 to 3%. The push back is that oh inflationary expectations will become unanchored. That's the most ridiculous theory of inflation ever created. Yet gets repeated constantly. So it's an urban myth. In our models, inflationary expectations are deflationary because the only real place it gets reflected is in bond prices. So so yields rise, bond prices drop, and that tightens up the mortgage market, which tightens up the housing market. The notion that individuals can have high expectations and get higher wages is ridiculous. If you look back over the last couple years for Democrats, you know, the Michigan survey, they thought inflation was going to expand at 10 and Republicans at 1%. Sort of like asking whether you liked Bad Bunny or not. It's like, oh, 90% of Democrats do and 90% of Republicans don't. But believe me, so the notion is, oh, if you have high expectations, you're going to get high wage increases. The Democrats didn't get 10% increases, and the Republicans won. Nobody got any increases. There's no market power left in the US economy. So this whole expectation series is completely bogus. And therefore, it would not be an issue if we loosened up that target. and then we could have certain sectors like medical care rise but not try to precipitate a recession to deal with that. So that's my fear would war longer term think he's going to be okay in the short run but this notion that we can precisely calculate inflation is ridiculous. So that's why we need a band so we don't have the volatility that we had. So keep in mind that inflation was barely above two, like basically two, and the Fed raised rates 17 meetings in a row. Like we cannot have that. We should all be on the war path to try to educate Congress, the Senate, and eventually the Fed that that is a horrible, horrible target and needs to go away. Joe, what do you think about the idea that the 2-year the yield on the 2-year is a pretty good proxy for the federal funds effective rate and and we should be guiding towards that because I I track those two and I think it's been a pretty good uh I think it's like led the federal funds effective rate pretty effectively for you know as far back as I can go on the data. That's an idea from Tom Mlen Mlullen oscillator. I don't think I've seen it from anybody else. Well, you know, I think, you know, I always use interviews and questions and comments to learn. So, I should look at the tier more, but I'll give you the real key to trading bonds, is look at the Fed funds terminal rate, which right now, I just looked it up on Bloomberg, it's 3.17. So, you can be a perfect 10-year bond trader. If you just know that number, then you add 110 basis points, then you'll know exactly where the 10ear is going to trade. So, I think the two-year obsession is a little bit probably misleading, but to be honest with you, you need to track it a little bit more carefully, but [clears throat] we have a chart on our website, and like I said, you can get tremendous data you won't get anywhere else in the world. And so, right now, my rule would turn you into a perfect bond trader. And by the way, you know, when the yield curve is not inverted and the Fed's not tight, it's not the terminal rate of Fed funds. It's the actual rate of Fed funds. I mean, they're the same, but you can see both of those calculations that normally the the 10-year trades 100 over Fed funds. Fed funds trades 75 over the inflation rate. So, it's normally right around 275. So, um, I'll study a little bit more, but I would say you're going to be far have far more clarity if you just focus on those two elements. And like we even trade Fed fund futures like we're actually making pretty good money. Well, sort of irrelevant amount of money, but we're long the um December contract and we because people just got way too bearish about cuts. So, um, right now going back to that same screen, like now we're up to 55 basis points of cut this year cuts this year. We think we're going to get to 75, um, by the end of the year when Wars was nominated was at 45. But that's really what's driving the tenure. So, I wouldn't focus much on the two-year, but I'll go and look at those correlations. But I always find like when I go on TV or radio and everybody's like, "Oh, well, the yield curve's deepened." And I go like, "No, it hasn't. is still 100 over the Fed funds rate. So, it hasn't steepened. Like I guess the 30-year steepen, but who the 30-year is really irrelevant. Nobody prices anything off the 30-year like mortgage. I I focus the one financial condition that matters is the 30-year mortgage because that drives housing. Housing usually causes recessions. We have that data also on our website. Didn't this time because it was offset by AI building boom. Not just the technology but also the chip plants and and other infrastructure although investment zero. It's actually not the two are netting to zero. Uh so it's not helping growth but it's not causing recession. But if you watch the money supply housing you'll call at almost every um market turn. [clears throat] And so if you watch Fed funds in the 10-year, 30-year mortgage priced off the 10-year, you got 90% of the battle. And I think people are just confusing themselves by looking to the 2-year. It's not what the Fed controls, and it's not the the most critical element, which is Fed funds. >> What do you think about the inversion? You touched on it very briefly, but we've been inverted. We had been inverted for since 22 was the longest and deepest in the limited data that we have and now we've been uninverted very kind of chopping around for 6 months there and now we're at like 53 basis points of two to three to three months. That's the old Cam Harvey version. Do you have any views on whether >> well you know inversion is simply an indicator that the Fed is way too tight. [clears throat] you know, to to invert the yield curve, they need to severely restrict the growth of the money supply or even right now it's negative. So, it's an indicator that the Fed is is has its boot on the throat of the economy and is likely to cause a recession. And I'm sorry to be repetitive. You can also get this data on our website. You can see that there are two sectors of investment that I already mentioned. that are clearly in recession. Like they have negative year-over-year growth almost 1%. So the Fed is choking the economy. It just they got lucky for two reasons. One, we already mentioned tech boom is more physical than it normally is. Like the internet just had software engineers and some laptops. So much more physical. But also the great financial crisis made the housing sector less cyclical. So like when I was a kid in the late 70s, we were building 2.5 million homes, uh there was a big housing speculation boom and in the latest cycle since the great financial crisis, we've never gotten over 1.7 million homes. The normal is like 1.5. So when there's no no boom, there's less of a bust. So even though we have something that would sort of tongue and cheek we call the Hatfield rule. So when housing starts glo go below 1.1 million you have a recession. Well you might not get one in this case because we never have the boom. So you're sort of out of the bust. But the Fed is completely out to lunch, completely incompetent and should have cut rates like over a year ago when you know real time inflation went pretty close to their target of 2%. And you can see that we calculate CPI-R and PC-R but it showed on our website. You can replicate it. Just look at Zillow apartment list. So really it's an indicator of a terrible Fed. That's ECB is actually great central bank. So that's Europe's only advantage over the US. >> Um Jay, we're we're coming up on time. If uh folks want to follow along with what you're doing or get in contact with you, what's the best way of doing that? >> Um our website's inforapuns.com and we do have a monthly webinar where we take questions just like we are now about our ETFs. But I really love macros. We do talk a lot about macro, but it is relevant. Like I mentioned in the beginning of the program, if you don't get the macro right, you're not going to get the stock picking right. You're not going to get the asset allocation right. And [clears throat] so it is worthy of of obsession. And even if you don't agree with us, we give you the data so you can come to your own conclusions. But I would argue our data is highly proprietary, unique, and should stimulate um you know more insights even if you don't fully agree with our views. >> JT, any final words? >> No, we're good. >> Check out Janalytic folks. Uh Jay Hatfield Infra, thank you so much for spending time with us. We'll uh we'll look forward to seeing you again sometime. Uh >> great questions and great education. You can send me a bill. [laughter] >> We'll be back next week.
Jay D. Hatfield, Portfolio Manager InfraCap Small Cap, Income, MLPs and REIT Preferreds | S08 E05
Summary
Transcript
And we're live. We're running a little bit late. Sorry folks. This is Value After Hours. I'm Tobias Carile joined as always by my co-host Jake Taylor. Our special guest today is Jay Hatfield from Infraap. He's going to tell us a little bit about How are you, Jay? >> I'm doing well. Thanks for having me on, Tobias and Jake. >> Pleasure. Tell us a little bit about Infra. >> We are a $3.5 billion money management company. We have six ETFs all focused on monthly income, three on the fixed income side, three on the equity income side. We also have a hedge fund and so uh we are um committed to providing great total return but also good income for investors who want to sleep at night and know that they have good stable income coming from their portfolios. What's the um attraction to income oriented strategies? Well, it's primarily helpful for people who I would recommend having it even when you're young, having some, but for older individuals who are looking forward to retirement in retirement. It can give you a good base load for your portfolio whereby you know a good percentage of your expenses are being covered by the income coming from your portfolio. And then [clears throat] you could have more growthy and risk growthier or riskier investments in the remainder of your portfolio because what you don't want is like during we haven't had one since 22 but during major drawdowns you don't want to have to be selling securities and taking losses and so nor do you want to be worried about that even if it doesn't happen [clears throat] and so it can provide a lot of solace um if you have fixed income that can be a lot less volatile than the rest of your portfolio. So you can also use it for rebalancing. This is what major pension funds do. So every quarter they say, "Oh, well my fixed income, you know, because the equities are down a lot, it rose from 40 to 45. So we'll sell 5% fixed income and buy 5% equities." So it can be a great way to buy at the bottom and sell at the top. force yourself to do that by um setting an allocation of fixed income and then rebalancing. Usually equity income is pretty correlated with the market so it doesn't help you that much on that but fixed true fixed income would. >> What what are your sources of income? >> So on the on the um fixed income side it's preferred stocks and high yield bonds. The great thing about both of those asset classes is they're higher risk fixed income. So [clears throat] unlike so unlike like our biggest or high not biggest but our high yield fund is BNDS. There's a fund B&D that's just investment grade bonds and we're high yield bonds. So their fund yields four are fund yields eight. So in the long run, you'll get a lot higher returns from these higher risk bonds. And our preferred fund yields nine same um situation where you get higher income. And what's great about that is it's really almost like a hybrid security. So it's much lower risk than equities, but has equity like returns because eight or nine is pretty close to equities or 10 or 11. And so we think that's a attractive addition to almost all portfolios is BNDS or PFFA [clears throat] or similar funds where you get really good income. You have some correlation stock market um but low much lower volatility and really good income. >> Uh what about on the equity side? Sorry JT. >> That's okay. >> Oh on the equity side. So we have three equity income funds. ICAP is a large cap dividend fund. SAP's are small cap dividend fund and AMCA's are pipeline dividend fund. With all those funds, we do add income by writing cover calls. But importantly, there's two things that are different than our fund from our funds relative to others, which is we write very short-term calls, which is to do that yourself, I'd recommend shorter term, like one, two, three weeks, four max. [clears throat] And we get a lot of the dividends. So the those funds yield 8, nine, 10. We get a lot of the income from actual dividends from highpaying dividend paying stocks. shouldn't try to generate too much of your income from writing calls because like 10 11 12 what ends up happening is that in up markets your returns get capped because you're writing too many calls and particularly if you're writing them farther out. So the ideal strategy is to write very short-term calls on just a portion of your portfolio. And we can do that because we are investing in real dividend stocks that pay substantial dividends. So we don't need to write the whole portfolio to generate, you know, high singledigit um income flows. I was going to ask I've read a lot about um the perhaps loosening of you know covenants in a lot of debt these days. Have you noticed that or how's that uh factor into the underwriting and when you're looking at the you know how how confident you can feel about the cash flow coming in? Well, one thing that it's great about the securities that we invest in versus private credit or a lot of high yield bonds that are in the indices is that we're dealing with public companies and they typically have pretty high target credit ratings. So, [clears throat] they're not looking to take money out and distribute it to their uh private equity holders or investors rather. And so the covenants become a little bit less critical. We also have higher quality credits that also don't really need those covenants as much. And so that's the way we deal with that problem is focus on large public companies and then they're less likely to uh have this big incentive to take cash out of the business and distribute it to their LPs. How do you uh define good income versus bad income? What what I mean like what's sustainable yield versus a yield trap in the dividend companies? >> Well, first of all, it's important for all ETFs disclose something called SEC yield. And so that's the cash flow coming into the fund. And so with our fixed income funds, the cash flow yield is essentially the distribution yield. So we're not returning [clears throat] capital. We might from a tax perspective return some capital but that's good because you don't want to pay tax but the cash coming in is very close to the cash going out and you can that's published every month and it's very strict set of guidelines published by the SEC hence 30-day SEC yield being the name and then but you can also look that up for our equity income funds and then [clears throat] the reason that's valuable is you can see like the distribution yield the SEC yields usually like six or seven or eight. So that means we're only getting two or 3% from ball writing. So having a substantial amount of real income is critical. The other um issue some people we have a European ETF and that I'm told that Europeans get really really suspicious about any dividend yields much above three or four and that's a reasonable concern for common stock but not preferred. Preferred get paid first. That's why it's called preferred and the yields are usually seven eight nine sometimes six. So that's not a sign of distress. That's just an indication that it's more like debt and less like common uh dividends. But so if like a a common stock has a dividend that starts approaching 10, a lot of time the management team will say, "Well, we're not getting credit for the dividend and just cut it." So I would be concerned about trying to get super high yields from just common equities, but it's [clears throat] perfectly reasonable to get, you know, close to double digit yields from bonds and preferred because that's kind of their inherent return or or yield rather. And it does it's not a sign of necessarily distress. And also [clears throat] management teams of course with bonds they would they have to pay them or else go bankrupt. And then with preferreds they're loathed to not pay them and particularly what all the ones that we invest in are public companies. So public companies want to have good credit. This is why they don't need covenants as much because their shareholders want them to have good credit. Their um board wants them to have good credit but most importantly their counterparties. of their their um the companies they do business with. You know, pipelines being a good example, if you're transporting oil or natural gas, you know, there's credit risk on both sides. So, it's important for these companies to have good credit. So [clears throat] um with with better credits um you don't have to worry as much about defaults and um the sustainability of the dividend is quite high because the companies don't want to suspend the dividends because then they're the rating agencies will downgrade them. their counterparties will get concerned about their credit. So, well, why are your dividends suspended on your mo most of the time it's cumulative, so you owe the dividends back if you start paying common dividends again. So, um I would say [clears throat] that's a distinction to draw. Common stocks that pay super high dividends should be concerned about that preferred certain high yield bonds generally not. Do you use leverage or how do you think about leverage as a tool? >> Um with some of our funds we use um really the lowest leverage you'll find in the market. So closing funds use 40 to 45 in PFA [clears throat] we use 20. BNDS we don't use any leverage. Um and then IP SAP and um AMCA we run 15 to 20. So super low leverage, just a little bit of enhancement of income. Typically, we have preferred stocks, so they're not very volatile, just to add a little bit of income. And we do mon constantly monitor the risk of the portfolio. So like if the market becomes more risky, like during the pandemic or during the tariff tantrum, we'll take that leverage down so we don't just sit around with leverage without looking at the market. So, we think that's one technique to add a little bit of alpha. Um, as long as you actively management, we think that's a great strategy and keep it very low. You know, there's obviously, so leverage has kind of gotten a bad name because there's triple levered funds and, you know, nonsense like that and high yield, I'm sorry, um, closing funds use what we think is too much leverage, like 40 45% leverage. So we keep it really really low and monitor it depending on market conditions. >> So ever any concern about um you know with an ETF structure you have liquidity of coming in and out but if the underlying securities are not as liquid um you know you can run into market dislocations then on the ETF wrapper versus what's under inside of it. How do you think about that? Well, we only um trade in securities that are listed. So, there's more liquidity on the listed securities. >> Sure. >> Um, of course, with the equity funds, they're kind of infinitely liquid. So, they could be liquidated intra hour really, [clears throat] you know, particularly well really all the equity funds. And on the preferred side, we keep um well, first of all, we have inline redemptions and which we barely have, but let's say there was a market dislocation, we're getting redemptions, we only we just deliver the securities. So, we don't have to go sell any of our our securities to meet redemptions. So it's the only issue is just if we wanted to take leverage down and we have um hyperlquid securities that are intraday type liquidation securities like intra hour even. So we can get our leverage intraday down below uh one or you know to zero and start raising cash in extremely short order. The real key to understand is that if we [clears throat] did have a lot of redemptions, we would just deliver all of our underlying securities to them. So we don't, it's not like we'd have to, you know, find $20 million. We deliver. So in kind um creations and redemptions also lowers trading costs with PFA. It's a $2.2 billion fund. So we really only have inflows. It's a has great returns, but that lowers our trading cost because we don't get a whole whole bunch of cash and then have to deploy it and pay the bid as spread. We just get it. So that's actually great structure is to have these um inind creation redemptions. >> Jay, across your front, this is like a double uh two sides of the same coin, but where do you take risk? How do you generate the alpha? Is it security selection, structure, leverage, volatility, harvesting? How do you think about the way that you're generating risk and return? >> Well, we do well on the fixed income side, it's pretty straightforward. It's like um playing basketball or soccer with no opposing team because you have [clears throat] to manage the um risks inherent in fixed income that don't exist with equity. So that's in short call risk, credit risk, interest rate risk. And there's also opportunities on the new issue side and arbitrageing the index funds particularly preferred because they're pretty illquid. So that's pretty straightforward and that's why we've doubled the returns of the index with PFFA and BMDs has be not buying as much but it's not as inefficient. On the equity side to your point it can be more challenging to generate alpha with equities because for two reasons. Uh passive funds are cap weighted which can be a phenomenal strategy because in effect you're a momentum trader and by the way that's a terrible thing to to do with fixed income because it's callable. So the higher it goes the more you should sell it but they index funds do that. So that counts for why we're [clears throat] so confident about beating on the um fixed income side. on the equity side, you know, the other there's two dynamics that give an advantage to index funds. The momentum and also sometimes the dumbest securities go up the most. So, you know, meme stocks or I don't believe that Tesla should trade at 220 times earnings, but maybe everybody else does. And so, my analysis doesn't really help. it may hurt even like it's better just to be like oh silver it's at 80 it's probably going to go to 180 and just play the momentum but [clears throat] what's in our favor is exactly what you mentioned so we are uh I would argue really great at macro you can access to our macro slides are highly proprietary data that you won't get anywhere else like the global monetary base etc and so we have a macro view and based on that view that drives our stock selection. So for instance [clears throat] about a year and a half ago we're in Midtown Manhattan so that helps a little bit and I used to be an investment banker. This is an investment banker tie. Um so [snorts] it became obvious when the Trump administration came in that there was this huge pentup demand for M&A. Rates are coming down huge issuance on fixed income side likely to be AI related IPOs. So we got really long all the investment banks and [clears throat] that worked spectacularly well. But it was driven by the macro like rates are coming down a little bit by analyzing the political situation. So you can use your macro skills to pick stocks. We use a GARP uh model. So growth at a reasonable price. So that's why we hate Tesla because it's really not growing and it trades at >> unreasonable price. Yes. And [clears throat] which like I said can outsmart yourself. Like I wouldn't recommend shorting it, but we're okay missing out on the sort of Tesla opportunities. Well, what you don't want is to be like it hasn't happened yet, but it mean at like eight a peg of eight. So the P to growth ratio is like seven or eight times and then if they miss it goes down 60%. So we want to avoid the down 60s. we'll give up a few GameStops or I mean actually Tesla's underperformed over the last five years but in the earlier years we might have given that up. Um there might have been times where it was trading at reasonable pegs, but I don't I would have to go back and look. But so [clears throat] we do think that being disciplined on the valuation side can add alpha. But more importantly, writing very short-term covered calls on individual stocks where you have a gain and where it's close to your target based on on GARP or PEG type valuation metrics can be a phenomenal approach particularly if diversified portfolio because what you also capture is overvaluation in certain sectors like over the last couple weeks for instance I would argue that consumer Staples got pretty fully valued. So like we're in Coke and IAP and some of that was getting called away but then they reported and it's not like getting crushed but it's off a couple bucks. So what it does is it forces you to rotate out of fully valued sectors like utilities. We've sold Southern Company is a 91 but we've sold calls at 98 and 100 and have some of that called away. So when you do it on individual stocks, you're [clears throat] not taking losses, you're taking gains, and you're forcing yourself to recycle into better valuations. And you don't do stupid things. Like during the tariff tantrum, we didn't write any calls because we didn't have gains and it wasn't near our target. [clears throat] And so whereas if you look at most of the call writing funds, they're just mechanical. like they always have calls written out two or three months and they redo them regardless of fundamentals. So they'll redo them when there's a tear tantrum or the market goes down irrationally like it kind of did over the last three or four days. [clears throat] And so then and if it's an index call and it goes in the money, they're just taking a loss. It's not like selling southern at at you know in the high 90s when you have like a 20% gain. So that's the we think tremendous value added for alpha and then you know opportunistically running a little bit of leverage when the market's good can get you a little bit better returns. So, uh, short answer is if all we could do was pick stocks, we still could probably beat, but it would be harder. If we can write bespoke short-term covered calls, little, I would argue, heavily stack the deck in our favor. And then a little bit of extra income from little bit of leverage on preferred in most markets, we'll add alpha. So, we're kind of stacked. Not super easy, just pure equities, but we stacked the deck in our favor by having these kind of hedge fund light strategies, running a little leverage and writing covered calls. >> What What makes that covered call market inefficient? Like where there is kind of a sounds like a free lunch. >> Well, a lot of times my kids ask me like, who the heck is buying these call options? >> That's a good way that's a better way of asking the question perhaps. And to some degree it is what I would argue somewhat irrational retail investors. So [clears throat] like in our hedge fund, we don't do this in our ETFs, but we'll write micro naked 10,000 micro strategy calls. And I would argue that's just pure irrationality on the part of retail investors. But to some degree it's also just and even when it's a mechanically just being done by market makers, the volatility of micro strategy might be driven by retail investors even though it may not be be the ones making markets like that. But where I would argue it the alpha is coming from is not us analyzing oh well the volatility is you know 3% above or below where it should be but overlaying fundamentals on what's mostly a technical market. Um and having a bias towards selling options. Like there are services that tell you, oh, we should, you know, it's much more lucrative to buy options and you get a higher return, but they failed to recognize that the decay of options makes [clears throat] it like you're going to casino and the casino's raking off 10%. [clears throat] And so what we're doing is the opposite of that. We're selling risk to the street and sometimes directly to investors, but um the fact that that risk we're selling decays over time stacks it odds in our favor. And since we layer them one week at a time out, even when it looks like we take a loss, [clears throat] it the stock gets called away and we replace it with other stocks. So we maintain our exposure to the market. So, it's not so much that there's just a bunch of idiots out there buying call options. It's more that we're just taking advantage of the fact that it's the probabilities are stacked in your favor by um having theta or decay in your portfolio and then managing your exposure. This is really what the street does on the other side of the trades. managing your exposure to the market because they're short a bunch of calls and they have to be long other securities. [clears throat] So if you constantly monitor your exposure to market, you're really not taking that much risk. So like if you love like right now, I guess trying to pick on a good example. So we love KKR think that everybody's freaked out for no reason. We might write a call. We're actually not writing a lot of calls on that, but let's say we did a 120 and it's at it's at like 210 right now. I mean 2 220 and said 210. Um [clears throat] then if it ran at 220 we might just buy some stock and then let that get called away over the next week or two. So if you actively manage that selling of calls then it can produce alpha. If you just sit around and go play golf during the day then half the time you would be capped out on big returns and you would have a lower return on your overall portfolio. So you do it requires you to um be a bad golfer. So you have to be looking at your screens all day or else kind of as you're implying the fact the times when you get capped out on some stock would offset all the decay of the portfolio. So you have to manage your exposure to the market and your exposure to your ideas to make sure they don't get carried, you know, get called away and then you lose all the upside. >> Jay, I'm just going to give a quick shout out to the folks at home. And Jake's got some vegetables which is a little lesson for us and we'll come back and talk about some of your macro views. Uh London, UK, what's up? Boyisey, Idaho, Philly, London, Toronto, Aras, Sa Saudi Arabia, what's up? Valareereeso, Tombble, Texas, Yorkshire, Pedatikva, Israel, Utah, Snomish, Tallahassee, Kingwood, Texas, Tmacula, what's up? Wingong, New South Wales, early stuff for you. Rochester, New York, Jared's Cross on the main streets, Lousan, Switzerland, Vienna, Austria, Tan, Iran. Really amazing. Good to see you got your internet back. Uh JT, hit us with some veggies. Market folks, it's uh 15 minutes past the hour. You can come back and find these later. >> All right. So, today we're going to have to be talking about resolutions. And I'm curious, Toby, did you make any New Year's resolutions? >> Same one I make every year. a lot of value to just a little bit of value for performance. Let's go. [laughter] >> All right. Well, actually, uh, we're not going to be talking about that type of resolution. It's going to be a little bit different. Uh, so first of all, shout out to friend of the show, Luke Delana, for inspiring today's veggies. Uh, and this comes from a book of his that's this hidden little gem. When I asked him privately like, "What's your best book you ever wrote?" And he said this one. Um, and it's called The Control Heristic. Uh, it's it's uh it's it's quite good. So, pick that up if you you have a chance. Anyway, on with [clears throat] the show. Imagine that you're looking at a photo on your phone like one does. And at normal size, everything looks crisp and normal and clear. Uh, and but if you zoom in far enough, it starts to turn into little squares like pixels and compressed artifacts, weird jagged edges. And the photo didn't change. We know that. But the amount of detail that you demanded did. And you're looking at the same thing just at different resolutions. So that's the kind of resolution we're talking about today. And and in the brain, we might be able to say that resolution refers to the number of statements that are available to describe a concept. So for instance, let's compare two statements here. And we're going to try not to get political with this, but okay. Statement number one, vaccines are safe. Statement number two, most vaccines are safe and nearly all are safer than unvaccinated exposure, but a few of them are dangerous and have extreme side effects for some people. Okay, obviously like a big mouthful. Uh, and we talk about truth in general like that it's this binary switch like right or wrong, true or false, but that that conflict is is maybe not always what's actually what we're worried about. It's actually more like what resolution are we allowed to speak in. So, you know, as you saw with that example, like low resolution, vaccines are safe, uh, is fast, portable, clear, easy to explain. High resolution is much higher fidelity but a lot more conditional, heavier to carry and transmit. Uh and that that pressure of what's available at a resolution also happens in political discourse. And it even has a name. So care to give a guess uh as to what the name is of that. >> No, >> you'll you'll know the answer when I say it. >> That's the Overton window. This is the the envelope of ideas that a public figure can say without getting treated as an out outside the mainstream. And I think part of what people miss with that is that this window is also filtering resolution as much as it's filtering ideology. So too compressed feels like this slogan for idiots. Basically too detailed can feel like you're overexplaining the story even when you're just being more accurate. So, this explains, I think, why politicians can often sound dumb and still be quite effective. It's they're not they're not broadcasting the full model all the time. They're they're shipping this low resolution packet that's optimized for broad reach. Less conditions, less exceptions, less ways to mishar what you're saying. Um, and in mass coordination, what they're aiming for that that kind of bandwidth beats high fidelity. So a message that's 60% accurate and repeatable can dominate a message that's 95% accurate but kind of too heavy to carry around and share. So quick sidebar on Joseph Overton uh was not a pundit. Uh he was actually an electrical engineer and project manager at DAO. Uh he later became a senior executive at the the Meno Center for Public Policy in Michigan. And in the 90s he developed what he called a window of political possibility to describe this constraint that we've been talking about. Uh and [clears throat] sadly he died it at 43 in in 2003 in an ultralight airplane crash just a few months after his wedding. But after his death his colleagues popularized this model and it became known as the Overton window. So the the window that of public discourse isn't it's not just selecting for truth, it's also selecting for transmittable truth. Uh and so outside you know nuance feels like you're kind of this like mealymouth waffler. uh you know you're overexlaining everything. Uh and in public arguments they collapse often into slogans not because everyone loves slogans but because slogans fit through the Overton window. So simple true or false misses something important. A statement can be correct at one resolution and then feel misleading at another and no one's actually being dishonest here. Uh so I think an example from finance might also drive this home. Uh, lowresolution statement. Index funds are the best default higher resolution statement. For most long-term no nothing investors, diversified low fee indexing beats most active options after tax and fees. The exceptions are real but narrow and hard to identify in advance. All right, the first isn't a lie. It's a simple compression of the truth. The second is probably much closer to kind of the full map, but like who the hell has time to to say all of that in a sound bite, right? So, uh, and we don't get unlimited bandwidth when we're talking with each other. There's time limits, there's attention limits, character limits, audience limits. Uh, if you're speaking to a specialist, you can probably stay zoomed in and give the full picture, but if you're speaking to millions of strangers, you usually can't. Uh, and my my hunch is that this explains a lot of the the divisions that we feel. Uh, one person is speaking high resolution, the other is here, you know, and the other person then hears the actually guy on the internet. uh one person's speaking in low resolution and the other person hears this like irresponsible simplicity and they just aren't sharing the same the same zoom level. So different domains, different error rates of this, you know, engineering and medicine you like precision is super important. Mass politics, public coordination, the job's really more about alignment. Uh and a perfectly nuanced message that nobody can carry around in their head is functionally useless. So, it's kind of silly of us to expect political slogans to meet some academic standards or to expect scientific caveats to function as rallying cries. Like they're calling each other dishonest on both sides of this when when these messengers are just clashing. So, [clears throat] um so maturity I think is not picking one zoom level to live in forever. It's having an adequate focus, knowing when a simple model is good enough, and knowing when the edge cases are worth the effort of that more granularity. So, next time you're tempted to say, you know, this guy's a lying idiot, uh, maybe first ask yourself, what zoom level are they speaking at right now, most likely, and half the time, maybe it's not dishonesty, it's it's just a different resolution. >> Good stuff, JT. I wasn't lying. I was compressing the truth, your honor. [laughter] >> There you go. I when I wrote Choir is Multiple, I wrote that to a fifth grade reading level and it's it's like 10 times the sales of any of my other books which were I I wasn't aware that there were reading levels before that. So that [snorts] certainly works. Very interesting stuff from Luca, too. >> Hemingway was uh wrote a fifth grade level, didn't he? >> It's hard to read though. >> Is it? You think so? >> I just think it's boring. I just think it's like getting rabbit punched all the time. Getting jabbed. >> Oh, >> no. No, it doesn't mix it up enough. Jay, uh, let's talk about macro a little bit. What are the, uh, what are the risks that people can't see right now that you think are going to have the most influence over the next one, three, five years? Easy one to start off. >> Yeah. Layup. >> Great. [clears throat] And that was a great dissertation because I'm constantly dealing with that problem. When you go on national television, they ask you these complicated questions. You got to answer it in one sentence. >> So, you're just as likely to mislead people as give them any insights. So, we I would argue have very unique um macro research on our website. So, this might so we're not really going to say things you've heard all the time. Our biggest concern probably is this ongoing problem with the BLS reporting inflation data. specifically the shelter component is by uh designed six months delayed. So, it's sort of like we were doing this podcast and then you just wait six months to issue it, which not a good policy obviously, but then they use renewing rents and they also which are, you know, if you've ever either rented or been a a um a lessor [clears throat] typically hold back on all the increases so you don't create turnover. So that delays it further. And then they use terrible '7s style data data collection. They call people and do little panels. And so for that reason, you can see this on our website. Uh [clears throat] inflation has been overstated. PC core, if you use modern data collection like the internet, [clears throat] it's developed since the 1970s. uh Zillow and Apartment List, you'll see the the target inflation's already at two. And so our fear is that BLS keeps blowing the reporting of of inflation and we don't get the three rate cuts we need. And that's important. Nobody seems to focus on it, but we have a recession going on in residential housing and construction and that's causing the um labor markets slow and people [clears throat] are confusing that with a whole bunch of other things, tariffs and other things that needs to get fixed to have good economic growth this year. And so that's our big concern is that the data doesn't [clears throat] reflect what's already happened which is inflation's well-contained and rates are way too high. Um and you can see that by the way the money splice shrinking which is very dangerous. Typically you have a recession when the money splice shrinking. So it's really all around the Fed. We're kind of okay with worsh this year even though he's an ultra hawk because he must have promised the president he was going to cut rates and maybe he understands this issue with the BLS longer term we're concerned about war but it's probably not today's or this year's business >> one thing I I noticed I I saw a chart that showed the uh health care expenses and premiums and apparently it was derived from some like tautology of profit within healthcare company insurers and not from like actually what the premiums I pay for my employees which were definitely not down 20% over the last 5 years if anything like doubled so what what's going on there >> well that's a good example it goes the other direction but there is a lot of complete nonsense that's put out by the BLS and I agreed that like I our company pays like pays in had a 20% increase in healthcare premiums. So there are these strange methodologies that are used. I mentioned shelter for financial services. So our business if the stock market goes up that's treated as inflation because people are paying higher fees on because the aum goes up. Health care is the opposite. And maybe we're fortunate at least if you want lower rates that that doesn't get properly reported. But I'll also give that an example as an example of why I fear Worsh because he [clears throat] is probably the biggest proponent of this completely madeup 2% inflation target. So for instance, we could have pretty modest real inflation which comes from the expansion of the money supply but maybe a little tick up because uh Medicare or med medical inflation is surging. And so he overreacts to that and raises rates, you know, dramatically like he did in the mid 2000s which precipitated great financial crisis when if you really think about it, you know, raising rates is not going to lower our insurance premiums. Yeah. Like it's a true supply shock or it's just it's it's maybe not even a supply shock. It's just that in the US we have the best health care in the world, worst way of paying for it, but the best actual healthare and [clears throat] so um and it keeps expanding. So we're probably not picking up the quality factors either. >> But certainly doesn't >> lots of hydonic adjustments, right? But there who knows what the hell >> directly. But so that's a example one where it goes the wrong way. like it. I agree with you. When I look at medical inflation and it's like 0.1 or something, I'm like, I don't know how you're calculating that. But most of the other ones overstated. But my real issue with Wars is in we've had very strong prosperity since [clears throat] World War II. So outside the 70s and 80s which were damaged by oil price increases when inflation so outside that period inflation averaged 2.7%. So not two but 2.7. So why don't we care? Why don't we have a targets 2 to 3%. The push back is that oh inflationary expectations will become unanchored. That's the most ridiculous theory of inflation ever created. Yet gets repeated constantly. So it's an urban myth. In our models, inflationary expectations are deflationary because the only real place it gets reflected is in bond prices. So so yields rise, bond prices drop, and that tightens up the mortgage market, which tightens up the housing market. The notion that individuals can have high expectations and get higher wages is ridiculous. If you look back over the last couple years for Democrats, you know, the Michigan survey, they thought inflation was going to expand at 10 and Republicans at 1%. Sort of like asking whether you liked Bad Bunny or not. It's like, oh, 90% of Democrats do and 90% of Republicans don't. But believe me, so the notion is, oh, if you have high expectations, you're going to get high wage increases. The Democrats didn't get 10% increases, and the Republicans won. Nobody got any increases. There's no market power left in the US economy. So this whole expectation series is completely bogus. And therefore, it would not be an issue if we loosened up that target. and then we could have certain sectors like medical care rise but not try to precipitate a recession to deal with that. So that's my fear would war longer term think he's going to be okay in the short run but this notion that we can precisely calculate inflation is ridiculous. So that's why we need a band so we don't have the volatility that we had. So keep in mind that inflation was barely above two, like basically two, and the Fed raised rates 17 meetings in a row. Like we cannot have that. We should all be on the war path to try to educate Congress, the Senate, and eventually the Fed that that is a horrible, horrible target and needs to go away. Joe, what do you think about the idea that the 2-year the yield on the 2-year is a pretty good proxy for the federal funds effective rate and and we should be guiding towards that because I I track those two and I think it's been a pretty good uh I think it's like led the federal funds effective rate pretty effectively for you know as far back as I can go on the data. That's an idea from Tom Mlen Mlullen oscillator. I don't think I've seen it from anybody else. Well, you know, I think, you know, I always use interviews and questions and comments to learn. So, I should look at the tier more, but I'll give you the real key to trading bonds, is look at the Fed funds terminal rate, which right now, I just looked it up on Bloomberg, it's 3.17. So, you can be a perfect 10-year bond trader. If you just know that number, then you add 110 basis points, then you'll know exactly where the 10ear is going to trade. So, I think the two-year obsession is a little bit probably misleading, but to be honest with you, you need to track it a little bit more carefully, but [clears throat] we have a chart on our website, and like I said, you can get tremendous data you won't get anywhere else in the world. And so, right now, my rule would turn you into a perfect bond trader. And by the way, you know, when the yield curve is not inverted and the Fed's not tight, it's not the terminal rate of Fed funds. It's the actual rate of Fed funds. I mean, they're the same, but you can see both of those calculations that normally the the 10-year trades 100 over Fed funds. Fed funds trades 75 over the inflation rate. So, it's normally right around 275. So, um, I'll study a little bit more, but I would say you're going to be far have far more clarity if you just focus on those two elements. And like we even trade Fed fund futures like we're actually making pretty good money. Well, sort of irrelevant amount of money, but we're long the um December contract and we because people just got way too bearish about cuts. So, um, right now going back to that same screen, like now we're up to 55 basis points of cut this year cuts this year. We think we're going to get to 75, um, by the end of the year when Wars was nominated was at 45. But that's really what's driving the tenure. So, I wouldn't focus much on the two-year, but I'll go and look at those correlations. But I always find like when I go on TV or radio and everybody's like, "Oh, well, the yield curve's deepened." And I go like, "No, it hasn't. is still 100 over the Fed funds rate. So, it hasn't steepened. Like I guess the 30-year steepen, but who the 30-year is really irrelevant. Nobody prices anything off the 30-year like mortgage. I I focus the one financial condition that matters is the 30-year mortgage because that drives housing. Housing usually causes recessions. We have that data also on our website. Didn't this time because it was offset by AI building boom. Not just the technology but also the chip plants and and other infrastructure although investment zero. It's actually not the two are netting to zero. Uh so it's not helping growth but it's not causing recession. But if you watch the money supply housing you'll call at almost every um market turn. [clears throat] And so if you watch Fed funds in the 10-year, 30-year mortgage priced off the 10-year, you got 90% of the battle. And I think people are just confusing themselves by looking to the 2-year. It's not what the Fed controls, and it's not the the most critical element, which is Fed funds. >> What do you think about the inversion? You touched on it very briefly, but we've been inverted. We had been inverted for since 22 was the longest and deepest in the limited data that we have and now we've been uninverted very kind of chopping around for 6 months there and now we're at like 53 basis points of two to three to three months. That's the old Cam Harvey version. Do you have any views on whether >> well you know inversion is simply an indicator that the Fed is way too tight. [clears throat] you know, to to invert the yield curve, they need to severely restrict the growth of the money supply or even right now it's negative. So, it's an indicator that the Fed is is has its boot on the throat of the economy and is likely to cause a recession. And I'm sorry to be repetitive. You can also get this data on our website. You can see that there are two sectors of investment that I already mentioned. that are clearly in recession. Like they have negative year-over-year growth almost 1%. So the Fed is choking the economy. It just they got lucky for two reasons. One, we already mentioned tech boom is more physical than it normally is. Like the internet just had software engineers and some laptops. So much more physical. But also the great financial crisis made the housing sector less cyclical. So like when I was a kid in the late 70s, we were building 2.5 million homes, uh there was a big housing speculation boom and in the latest cycle since the great financial crisis, we've never gotten over 1.7 million homes. The normal is like 1.5. So when there's no no boom, there's less of a bust. So even though we have something that would sort of tongue and cheek we call the Hatfield rule. So when housing starts glo go below 1.1 million you have a recession. Well you might not get one in this case because we never have the boom. So you're sort of out of the bust. But the Fed is completely out to lunch, completely incompetent and should have cut rates like over a year ago when you know real time inflation went pretty close to their target of 2%. And you can see that we calculate CPI-R and PC-R but it showed on our website. You can replicate it. Just look at Zillow apartment list. So really it's an indicator of a terrible Fed. That's ECB is actually great central bank. So that's Europe's only advantage over the US. >> Um Jay, we're we're coming up on time. If uh folks want to follow along with what you're doing or get in contact with you, what's the best way of doing that? >> Um our website's inforapuns.com and we do have a monthly webinar where we take questions just like we are now about our ETFs. But I really love macros. We do talk a lot about macro, but it is relevant. Like I mentioned in the beginning of the program, if you don't get the macro right, you're not going to get the stock picking right. You're not going to get the asset allocation right. And [clears throat] so it is worthy of of obsession. And even if you don't agree with us, we give you the data so you can come to your own conclusions. But I would argue our data is highly proprietary, unique, and should stimulate um you know more insights even if you don't fully agree with our views. >> JT, any final words? >> No, we're good. >> Check out Janalytic folks. Uh Jay Hatfield Infra, thank you so much for spending time with us. We'll uh we'll look forward to seeing you again sometime. Uh >> great questions and great education. You can send me a bill. [laughter] >> We'll be back next week.