Lead-Lag Live

Jay Hatfield on Deregulation Effects, Strategic Bond Alternatives, and Inflation Risk Management Strategies

• Michael A. Gayed, CFA

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Join us for an enlightening conversation with Jay Hatfield, a Wall Street veteran, where he dissects the intricate world of financial markets with a focus on deregulation and its potential ripple effects on inflation. We'll guide you through the complexities of the fixed income market and the unique benefits of active management. Jay provides invaluable insights into how biases in rating agencies might actually offer hidden investment opportunities, especially in niche sectors like pipelines and REITs. If you're curious about the strategic maneuvers that can lead to identifying mispriced securities, this discussion is tailored for you.

We then pivot to the fast-paced domain of utility investment banking, where the stakes are high and adaptability is key. Jay and I evaluate the strategic differences between smaller, nimble firms and their larger counterparts, like Goldman Sachs, in responding to market shifts. We delve into the distinctions between bond alternatives and traditional income investments, introducing the BNDS fund designed for those seeking unlevered fixed income products. This nuanced discussion will equip retail investors, particularly retirees, with the knowledge to navigate these investment waters confidently.

To wrap it up, we explore the intricate relationship between money supply and inflation, assessing factors like tariffs, corporate tax rate adjustments, and global economic influences, including China's activity. We also engage in a thought-provoking debate on whether AI could prove to be a deflationary force, bolstered by the U.S.'s access to abundant energy resources. Jay offers strategic advice on managing inflation risk, with vigilant credit monitoring at the forefront. This episode promises a comprehensive exploration of contemporary financial themes, ensuring you're well-prepared to safeguard your capital in an ever-evolving landscape.

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

 Sign up to The Lead-Lag Report on Substack and get 30% off the annual subscription today by visiting http://theleadlag.report/leadlaglive.


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Speaker 1:

deregulations in news quite a bit. I'm curious does that impact anything going forward when it comes to financials and various bonds there?

Speaker 2:

Not in the short run, because they're just great credits anyway. They're overcapitalizing great credits. I mean you could make some argument well, if there's looser regulation they'll do something nutty and they'll blow up. I'm not as sympathetic to that as others might be, and if that happens, that'll be like five to 10 years from now.

Speaker 1:

What would change the dovish view on inflation, meaning, let's say, oil somehow sustainably rises? I mean, we saw a spike with the Russia sanctions, right? Could that just throw the thesis off, at least for a moment in time?

Speaker 2:

That's a negative, no doubt, because what's not appreciated even by the Fed, it seems, is that there's a 5% bleed through of oil prices to core, energy prices to core. So, in other words, if energy price is up 10, which they are over a short period of time then core would go up 0.5.

Speaker 1:

My name is Michael Guy, a publisher of the Lead Lag Report. Joining me here is Mr Jay Hatfield. Jay, I know a lot of people have seen you doing the media runs, especially on CNBC. Congrats on all the exposure there. But for those who are not familiar with your background, who are you? What have you done throughout your career? What are you doing now?

Speaker 2:

Thanks, michael, it's great to be on. So I've been on Wall Street for 35 years. I'm a CPA MBA from Wharton, with distinction. I have my career as an investment banker doing utilities work for two large hedge funds, most notably 72 Point, which is run by Steve Cullen, and launched my own firm, created an MLP, took it public and then we launched our now six funds over the last 10 years AMZA, pffr, pffa, icap, scap and now BNDS. We launched today.

Speaker 1:

So you've been busy, clearly, which was the first of the funds that you launched?

Speaker 2:

AMCA is our pipeline fund because we had or I had founded an MLP and I was an MLP investment banker. That was a natural fund to launch. Timing wasn't great, but it's been great since the pandemic, so that was our initial flagship fund.

Speaker 1:

And then the subsequent fund launches. What different areas are covered there?

Speaker 2:

So we're really 70% fixed income. Now Our flagship fund's PFFA. It's $1.4 billion. It's a top-performing fund. Pffr is just an unlevered index version kind of a PFFA. So we really focus on PFFA. And then ICAP's a large-cap dividend fund. So great household names. So great household names.

Speaker 1:

NSCAP is also a dividend fund, obviously with smaller cap companies, but we try to have the highest quality of the small cap companies you mentioned. You're now like 70% fixed income Hard last several years. Talk to me about the journey of being an active fixed income manager in this cycle.

Speaker 2:

Well, it's actually worked out quite well and the reason for that is within fixed income and that's why we launched BNDES as well. You really have sort of three classes. They're pretty similar. So obviously you have treasuries and mortgages and then you have well, treasuries is one, then you have low spread product like mortgages, investigated bonds, municipal bonds, but then the high yield sector, both bonds and then preferreds, which tend to have credit ratings similar to high yield bonds. They're a war of an all-weather security. They yield six of those bonds and preferreds yield six, seven, eight, eight and a half nine.

Speaker 2:

So then, sort of regardless of the volatility and the change in interest rates, there's still value in those securities. Volatility and the change in interest rates, there's still value in those securities. So if you look at the returns of PFFA, they've been pretty strong, like pretty close to the coupon, around or a little bit below the coupon, I guess, around 8%, about double the index. So it's been a pretty good all-weather security. But to your point, that's in basically the worst possible, like six years you could own fixed income in because of the pandemic inflation caused by the Fed, too rapid tightening by the Fed. But those securities good public companies are, like I said all weather, so the returns have been good. So we favor those quote. Riskier securities but usually a better long-term returns. Less interest rate risk If you pick the credits rate. Low default rates.

Speaker 1:

Okay, that's a good direction to go. That term pick the credits right. There is an argument, which I think is valid, that active management tends to work much better in fixed income than equities Right. There is an argument which I think is valid, that active management tends to work much better in fixed income than equities Right, because mispricings are different, liquidities are different, dynamics are different. Talk to me about the process you employ when it comes to trying to identify mispriced opportunities.

Speaker 2:

So we first cover the companies that are relevant to fixed income, just like we were investing in the equity, and then, based on the models we build, talking to the company, looking at their financial statements, we assess their probability default and give it our own proprietary credit rating. And what we found and this is how we've added value value is the rating agencies have certain biases that we think are incorrect. They don't like preferreds in general. They over-penalize them for being junior securities, even if the corporate credit's really good. They still do three notches, like energy transfers are great, mlp, bbb plus credit Preferreds still BBB plus, even though default rate of the entity is very low. And they also don't like pass-through entities, like pipelines, utilities and REITs, because they don't de-lever as fast as other companies and those companies have great assets and can always cut the common dividend. So we've done really well with those securities so we're able to in effect arbitrage the rating agency's bureaucratic approach to rating issuances issues.

Speaker 1:

That sounds pretty time intensive. Do you have a team with you that's doing that with you? I mean, how do you even go about doing this?

Speaker 2:

Yeah, so we have a research team of six people, yeah, and we always say we're bad golfers. So we do it all day long and part of the weekends as well. So we like doing it. So maybe you shouldn't invite us to your next cocktail party. But um, that's just what we do, we enjoy it and we like it particularly too, because I think the point that should be made about active management of equities versus fixed income sometimes with equities the worst company becomes the best. Most extreme example might be a GameStop where we would all agree oh, that's way overvalued, but it goes up 300%. But that doesn't happen with bonds and preferreds because they're callable at bar. So the upside's limited but the downside's unlimited. So the worst can't become the best because it's capped out. So that's why doing the analysis is more important. One of the reasons why it's more important to do the analysis with fixed income, whereas with equities you might want the lower quality company because maybe there's a short covering rally where they literally cure cancer. Have some other event that you take it over.

Speaker 1:

It really doesn't happen with fixed income. Space is specific to the issue, to the debt, versus specific to sector movement across the debt market, right. So I used to read a lot of these old school books Market Wizards by Schwager and I remember some trader that Schwager was interviewing was describing the markets in terms of following like that school of fish, right. So that's the sector and industry movement is more important identifying that than which fish might be at the top of the or front of the pack.

Speaker 2:

You know, in certain, definitely in certain markets, like, obviously like in 2015, all you needed to do to outperform was not be an energy Cause. It just crashed and everybody's in complete panic. That was kind of the beginning of the green movement somewhat irrational green movement, I'd argue but nevertheless that was the play, I would say, particularly on the preferred side. Now it's much more issue by issue, so we'll find particular opportunities like Southern California. Edison is obviously a utility in Southern California Fires. Out there, Everybody panics and sells the bonds, not recognizing it's a regulated utility that has no credit defective credit risk and, by the way, fire liability is capped in California and only state in the country. And so there's these one-off inefficiencies driven by either news or these big index funds will dump certain securities because they have to rebalance at the end of the month. So I think a lot of the new issue is more not sector-based but more obviously just the one company, the one public. So we're finding most of our alpha in security selection versus sectors, Although I'd say, particularly during the last two years, we were initially underweight financials, which helped a lot.

Speaker 2:

That was just because they didn't have very good yields. And we are negative on balance, more negative than rating agencies on financials because they're good credits until they're not good credits. So First Republic was rated A, which is a very strong rating, about two weeks before they filed for bankruptcy, so it's hard to tell what's exactly going on with financials. They were overall good credits but typically overrated and yields are too low. So we did, to your point, benefit from being underweight financials. I think that would be worth calling out versus just pure security selection.

Speaker 1:

Is that typically sort of a structural underweight, just because, to your point, it's something that can become a bad credit?

Speaker 2:

I think so and also just because we do like to produce above index income as well and we don't like taking a lot of interest rate risk. So even if there's no default risk, you don't get great returns holding. You know, goldman sachs preferred like a five yield. Um, if gets dislocated or there's new issue, we'll add that we actually are much closer to the benchmark. Now on financials, a lot of financials came public, like bank, bank of Hawaii and CFG Citizen Financial at very attractive rates. So we added it because they were undervalued. But if they're just like normal value trading, really tight to treasuries, a lot of interest rate risk, even though there's no credit risk, we typically would be underweight those securities.

Speaker 1:

Deregulations in news quite a bit. I'm curious does that impact anything going forward when it comes to the financials and various bonds there?

Speaker 2:

Not in the short run, because they're just, they're great credits anyway. They're overcapitalizing great credits. I mean you could make some argument, well, that there's looser regulation, they'll do something nutty and they'll blow up. I'm not as sympathetic to that as others might be and if that happens that'll be like five to 10 years from now. So we'd have time to monitor that. But overall, it's true of actually a lot of just like what I mentioned, sce.

Speaker 2:

You can come up, you could go through our portfolio and come up with oh well, I don't like that company for this reason, that reason and most of the time we're going to respond that much. But the preferreds or the bonds are very attractively priced and very safe because they have all the equity as cushion to support the credit. So there's many situations where might not be the greatest equity investment but it's a good fixed income investment. Or in the case of banks, we're super bowled up about goldman sats and mortis talion investment banks, but that doesn't mean that their credits they're, you're going to make much money in their fixed income because it's so tight anyway, you can't really tighten that much more I said, I think that's actually another good direction to go, which is that, um, arguably it's easier to be a fixed income uh manager when you're in a credit spread, widening, blowout type of environment, because you know things get overpriced and over discounted, right.

Speaker 1:

So when you're in these kind of environments where things are very tight, um, broadly speaking and I understand there's degrees of variability in that obviously um, how do you, how do you eke out alpha? I mean, it seems like it's hard to really sort of identify real overreactions on the downside, given the way spread.

Speaker 2:

We would think that it would be harder. But there's kind of three dynamics. There's always these, the news events like the C Corp, Southern California Edison, so misinterpreted news or over-interpreted news. There's always, well, in good markets, where we're near par, there's new issue. We can do new issue because we're active. The index funds can't. We buy it at par. We usually sell it to them well above par, so we're able to take gains in even very short time periods. So that's also an opportunity. And we get to recycle our portfolio more often because if things are trading near par, we might buy them slightly discounted. They trade above we sell.

Speaker 2:

Then the final point is that it's fairly complicated, but these 70% of the preferred ETFs are passive. They rebalance every month. So, particularly if there's a lot of new issue, they dump a lot of their securities at the end of the month somewhat unceremoniously and cause them to drop by two or three bucks, and so we're able to step in because we're active. We don't have to rebalance and buy those. So even in stable markets the big index funds disrupt the preferred market. It happened at the end of the year. There's a lot of big new issue of preferreds got added and then they dumped all the everything else and created buying opportunities. So that doesn't go away, even if we're close to par.

Speaker 1:

You mentioned sort of the newsroom aspect of it. So price reacts and that's the opportunity. When that happens, just take me through sort of mechanically as a firm. Are all the analysts talking to each other saying, ok, let's start paying attention to this. How quickly are you moving on actually executing the buy? Because I have to assume these dislocations don't tend to last that long, right, so you need to get it. We don't know.

Speaker 2:

We're all over it. I mean, we started talking about the fire like the second it broke out. I, fortunately, am a utility investment banker. I cover Southern California Edison. I'm from California and investment banker I used to cover Southern California Edison, I'm from California and so we were looking at maps, looking at the liability.

Speaker 2:

We refocused on the fact that there's this 10% cap on the losses, which is the most important thing, because it seems like actually SCE is responsible for one of the fires we don't know yet but there's some evidence that leads one to believe that. But we put that into our models. They'd taken a $3 billion hit in rate base. We lowered our earnings, came up with an equity price target, but of course I was like 55. That indicates that the preferreds are money good. But we so we did that analysis quickly and then we as people panicked. We were buying the preferreds and now they stabilized and so we made some good purchases of those bonds.

Speaker 2:

But it does take a lot of quick work, but we have the advantage of the sell side. We don't have to publish things, you don't have to get them approved. So some of your viewers might see like, oh, there's a piece out of Goldman about the SCE situation, but it took them like three days to publish it. That's because they work at these gigantic firms have to get it approved, Whereas we're getting a really good idea like, literally, you know, five or six days before that.

Speaker 1:

There's this term. I hear more and more bond alternatives and to me that's just code for a covered call strategy on equities which is not really a bond alternative. Is there such a thing as a bond alternative? Is it still an asset class which is distinctive, because we know the FINRA does not like to use the word unique?

Speaker 2:

well, I mean, I guess you could call that I would. I prefer not to call it bond alternatives because, like one of the things when we go to retail, our conferences, that we try to hammer home is this distinction between equities and bonds and preferreds, and and the benefits of being senior to common and having lower risk not necessarily lower mark to market risk, but lower risk that you have a drop in income. And so I'd prefer not to confuse retail investors and say, for instance, that our equity funds, so we have three fixed income funds and three equity funds. So you know we have three fixed income funds and three equity funds. The equity funds are riskier than the bond, the bonds and preferred stock funds. They get the income we get mostly gets paid after, I mean would get paid after the preferreds we generate.

Speaker 2:

Usually about 20% of our income comes from options. But you know that should be pretty stable. But if the market crashes we're not going to write a lot of options because that's a horrible strategy. So it's less sustainable. It's going to be probably twice as volatile as even risky fixed income. So I'd rather just call it equity income. So I'd rather just call it equity income. But if you're an income investor. You can have bonds and equity income and maybe cover a pretty good percentage of your nut if you're retired. And that gives you some comfort because then you don't have to go sell, because that's disconcerting when you have to sell securities to pay your bills and maybe the market's down. But if you just take the cash that comes in every month pay your bills, then you can sleep better at night.

Speaker 1:

You had alluded to a little bit earlier, but as we're chatting today, on January 15, 2025, you have a new fund BNDS. Talk to me about the objective there and why launch it Well we, of course, have had great response to PFFA.

Speaker 2:

I think we had 500 million of inflows last year. Our processes have proven to be good at avoiding problems with credit good credit selection, appreciating securities, and so that same process can be done with bonds and a lot of our clients wanted that. It's also an unlevered fund. Some people push back on PFFA as low leverage, but still some leverage, and so we really had sort of pre-client demand for it because a lot of our clients are older, thinking about retirement or wanting to come for whatever reason. I've always liked income if we're not as younger. So BNDES is a different asset class so you can look at it differently from preferreds better recoveries if there are bankruptcies, so we continue to get a lot of interest on our fixed income products. So we launched BNDES.

Speaker 1:

Let's zoom out for a bit and talk about where we are in fixed income in general, where we are on the cycle. I'm sure you have a macro view on bonds and equities as well. What are you thinking in terms of the way this year is going to play out?

Speaker 2:

Well, we've been shocked at how fast the bond market sold off when the prospects of a Trump administration became obvious. They had like 120 base points of sell-off in the long end, which is all driven by pessimism about Fed rate cuts. But we have a differentiated view on inflation, which, by the way, helped us see the double-digit inflation that was coming when the Fed was calling it transitory. So we believe the money supply matters. You can't inflate the money supply without creating inflation. If you could, we wouldn't need income taxes or any taxes. Just print money. But we know now from the pandemic when you do that you have inflation. The money supply shrunk 3% Inflation is actually already at the Fed's target.

Speaker 2:

It's overstated because the shelters calculated on a delayed basis. So we've remained bullish about inflation. It seemed like a terrible call 24 hours ago but it's not really an anomaly. Cpi printed cool. We had a cool PPI. We had a cool PCE the month before. So there's all these fears about inflation, but no data is supported and we continue to believe as that data comes out, people will calm down about this fallacious notion that inflation magically reappears. Inflation is not caused by economic growth. The budget deficit is bad, but it's been bad since, you know, for the last 25 years, most of us who are older have given up on it going away. So our target on the 10-year is 375. So and the launch of BNDS was nearly perfectly timed because we, you know, launched it the day before the CPI print came out.

Speaker 1:

Your crystal ball is phenomenal. Give me that. If that's the case, it sounds like you're, I guess, more bullish on duration.

Speaker 2:

We are. We don't understand this like, oh, let's be in the five here, and also it's better to be in a higher spread product, like high yield bonds and preferreds. If you're bullish about the stock market, we have a 7,000 target on the S&P. We're assuming there's an effective corporate tax rate cut. That's wildly beneficial to stocks, I guess. I think obviously, but some people don't focus on it. You have higher earnings, more growth, because there's higher return on invested capital, higher multiples, higher stock prices. We've already seen the movie in 2017. Powell spoiled it in 2018 by overtightening monetary policy, but 2017 saw the movie. That's likely to be what happens this year. But our view again is corporate tax reductions increase economic growth, which is actually anti-inflationary because the ratio of GDP to money improves. That means the price level is probably not going to go down, but it's going to be stabilized by that. So we're quite bullish this year. But we do need to be more right than wrong about bonds. If bonds go to 5%, then it's going to be tough to get to our 7,000 target.

Speaker 1:

It doesn't sound like you think Trump policies will alter that dynamic that dramatically. I mean all the concerns around tariffs being inflationary, you know. Do you think those overblog?

Speaker 2:

Absolutely. I think that's just a miss. It's more of a hangover from the election no-transcript why those talking points continue to be reiterated. But if you really think about what a tariff is, it's a one-time increase in price level. Inflation is ongoing. There's revenue that comes from. That can pay down the budget deficit, which ultimately will be invested in private capital, or you can directly cut taxes on capital, so you get more growth, less demand. A one-time increase in the price level, a long-term decrease in the price level.

Speaker 2:

And then I think the most ludicrous thing is that deporting criminals could increase the inflation rate. And if you really it's important to be more neutral when you analyze policy. If you're trying to make money, like we believe more in the party that's called greed is good versus Democrats or Republicans, party that's called Greed is Good versus Democrats or Republicans, so it's important to actually listen to Trump administration officials. They're talking about deporting criminals, not raiding chicken plants or raiding the fields, and deporting people who are working, so that's not inflationary. In fact, the minimum wage is rising half the country, so we have a surplus of low wage labor. Ai is automating a lot of lower skilled jobs, so we think that's particularly ludicrous that you could increase inflation by deporting some small percentage of the population to Syria legally.

Speaker 1:

Got to love the narratives that are out there that people just gravitate towards. What would change the dovish view on inflation Meaning? Let's say oil somehow sustainably rises? I mean, we saw a spike with Russia. Sanctions right. Could that just throw the thesis off at least for a moment in time?

Speaker 2:

That's a negative, no doubt, because what's not appreciated even by the Fed, it seems, is that there's a 5% bleed through of oil prices to core, energy prices to core. So in other words, if energy prices are up 10, which they are over a short period of time then core would go up 0.5. And so that is a risk to the outlook. We're not confident that it will necessarily hold at this level of oil prices. We think that the Trump administration is going to put pressure on the Saudis to pop more oil, and right now it's very, very cold in the United States and Europe. We'll see how the weather unfolds, but that's definitely supporting oil prices and we'll also see how effective.

Speaker 2:

We know the Trump administration is going to tighten sanctions on Iranian oil and Russian oil, but usually it's not very effective because oil is oil and so if you transship it it's very difficult to tell where it's from. So typically those sanctions haven't been as effective as people would have hoped. So we're waiting to see on that, but I do think that is the one thing that is inflationary about Trump policies is being tight on sanctions on Iran and Russia. So your question is a great question.

Speaker 1:

How does China factor into anything inflationary? When it comes to the US, I mean, you know the yields are very different as far as how China's yields have been versus the US. I mean, let's say China were to suddenly magically re-accelerate and I say magically purposely I've got to assume that's going to have all kinds of knock-on effects on inflation. And then the Fed has to then worry about China now being a driver of it.

Speaker 2:

Well, we do think the Chinese economy will recover, but it's important to note that when we say China is doing terribly, they're growing at four and a half percent. That's below five, but they say 45% of their GDP. So they are investing, increasing supply, maybe inefficiently relative to the US, so that's actually deflationary. So we don't really see any big moves in the economy in China. I guess that they started consuming a ton more oil, but what we've observed about Chinese oil demand is it's really mostly just sticky, so in other words, it just grows slowly, kind of no matter what. If they're growing at 6%, it grows slowly. If they're growing at 4%, it grows slowly. So we don't see any big inflation coming from there. And we do think that all this talk about tariffs is likely to be mostly focused on China. So that's a pretty narrow group of products can be sourced from other areas. So that's one reason we're bullish on the tariffs, even in the short run not being that inflationary.

Speaker 1:

What gets you most excited at this point in your career Meaning you've got these various funds, you're launching products, you're raising assets. Is there some part of the investment landscape that you'd like you really get excited for and say like this is gonna be the next major opportunity that you will hopefully launch another fund around?

Speaker 2:

Well, we do think that the way we write covered calls is superior to most funds. The way we write covered calls is superior to most funds. So with larger cap stocks at least, we only do it on individual stocks and very short-term calls, and that's proven to be a very lucrative strategy. We even have a hedge fund where we did had fantastic returns yesterday or last year rather doing that, and so we will probably look to do that with the NASDAQ. So NASDAQ has great volatilities. Everybody wants to play in the NASDAQ, so that's what would be our value add.

Speaker 2:

Instead of doing mechanical index calls, we would say right, you know, have a price target in NVIDIA and write part of that stock. So do it artesially, do it very short term, get a lot of expirations. You keep your data to the market so you don't get capped out in up markets, which most indexed call writing funds do. So that's our current focus. I won't say what it is, but we have a pretty good ticker reserve. Strangely, that does matter to us at least, Like BNDS, we think is a pretty great ticker for a bond fund, Assuming you don't use vowels, I guess. So that's kind of our latest thought on a new product, and I do think it's very labor intensive, so you have to be a financial professional to really write a lot of short term calls. But it's a great way to add value to your clients portfolios. And it's best done in a fund because then you don't incur all the capital gains, because it all gets put into the same mix and you can optimize the capital gains, whereas an individual portfolio that's very difficult to do.

Speaker 1:

I do wonder if the proliferation of these cover call strategies has suppressed volatility. Just selling options into the vol to generate that income, and you see, there's just a tremendous number of ETFs now that do this. I think so.

Speaker 2:

Yeah, but I think there's also a lot of day traders and momentum traders and they somewhat balanced that up and there's always kind of a new new volatility spike. So we've mentioned that the holding company of SCE Corp is EIX, so those volatilities have blown out to almost 100%. So there's usually opportunities, even when you know too many people are writing too many covered calls.

Speaker 1:

Yeah, no, that makes a lot of sense. Do you get a sense that there's any froth at all? I mean, I understand the bullish argument on the S&P, I understand that. But I see, like at the edge, you know trading volume and levered funds. I see at the edge, you know at the edge, money going to speculative meme coins all over again. So you're guessing maybe there's too much liquidity and that typically is where things start to turn around, anything like that. Just given your user experience, that give you maybe some pause as far as the sort of more bullish thesis.

Speaker 2:

Well, it certainly did in 21 because the Fed was being completely nutty, because they were contained to buy bonds inject this liquidity into a system where way too many people were gambling. We call that gambling versus investing. When you buy Bitcoin, particularly buy other coins besides Bitcoin, do momentum and name stocks. So that concerns us a lot. But when the Fed is shrinking the money supply by 3% but there's animal spirits because Trump is the new president, that's less concerning because it's not that complicated.

Speaker 2:

Again, I would just urge everybody to try to leave their politics at home. It's better to, even if you don't like the new president. It's better to have a pro-business president than an anti-business president. And it's important to note the Democrats and Biden were pursuing not a liberal agenda, a progressive anti-business, unambiguously anti-business agenda that even converted 50% of Silicon Valley to support Trump. Do you know how bad a policy you have to have to get? These people are liberals Musk used to be a liberal to support Trump. So that is unambiguously good for business and stocks to have somebody who's on your side, even if they don't execute it perfectly, maybe screw some things up with tariffs. So I'm not concerned about the animal spirits, but, to your point, if it's driven by excess liquidity, like in the late 90s, the Fed was increasing the money supply by 12% a year because of YTK. That was a huge sign. Excessive monetary growth, excessive speculation that's when you should get out.

Speaker 1:

I was laughing at that bit. It's like do you know how bad the Biden administration was to get the flipping? It really is true and it's funny. It's not like, with hindsight, was that long ago that that people didn't seem to understand that? Um, we, I feel like we should hit on ai a little bit. Um, in the context of duration, I hear two opposing arguments. One is that ai is disinflation, because most technological innovations ultimately end up being disinflationary, which is beneficial for duration. The other argument I hear is that these data centers and AI is going to require so much energy that you're going to get cost push inflation just to be able to support AI. Where do you land on that?

Speaker 2:

We're very much in the first camp. So any automation, new investment and, by the way, that investment in AI is what's going to keep the economy growing, because we're very concerned if rates stay as high as they are now. The 30-year mortgage is over seven. We're in a housing recession already, but the only reason we don't think we're going to go into an overall recession is tech spending. So AI is critical, and so we do think it'll be deflationary. And so we do think it'll be deflationary.

Speaker 2:

And then, with regard to the cost of energy and making the data centers, I'd make two points there. First of all, if you say something's inflationary, I'm going to say the only thing that causes inflation is excessive monetary growth. It's not quite true, because you have supply shocks. So I guess you can analyze the electricity situation as a supply shock. But what a lot of people don't appreciate I used to be a utility investment banker, so I know way too much about this just to fund power plants, you can produce as much electricity as you want in the United States because you can just build a natural gas plant near free natural gas A lot of times, like in the Permian, it's nearly free and produce unlimited amount of natural gas at reasonable prices.

Speaker 2:

So, particularly in the US, that's extremely unlikely, and particularly now that we have an administration that doesn't oppose natural gas generation. It's the cleanest, lowest cost, fastest generation to produce. Calpine just got bought up, used to be my client by Constellation Owns a ton of natural gas plants, so a free market will solve the problem. If we weren't able to build those natural gas plants then it could be inflationary, but we don't. Obviously now it's very likely it will be built.

Speaker 1:

Jay, for those who want to track more of your thoughts, your views, the research of the firm, and who want to learn more about the funds, in particular BNDES, where would you point them to and maybe just close off with sort of a pitch for BNDES, just given that you just launched it?

Speaker 2:

Well, so wwwinforcapfundscom you can probably get there by Googling my name. You might get like a car dealership in Ohio too, but you could easily figure out which one's which. But we do think that fixed income you mentioned equity income and it's tempting just to do like the tesla call writing etf and get like a 22 income, but you could have a huge capital loss in that uh because and also capped returns relative to owning tes. So we think it's important to have a lower risk portion of your portfolio in senior to common fixed income. We think within fixed income, a little bit more credit risk is a better place to be, less interest rate risk. So that's preferreds, pffa and BMDS.

Speaker 2:

And just know that we're on the job, watching the credits, looking for problems. We will sell if we think it's a bad situation. We bought in the case of SC, but they didn't have the cap on the fire. We probably would be selling on the fire liability, because those liabilities are going well over $100 billion. So we might have been a seller versus a buyer. So we're doing that work to protect your capital.

Speaker 1:

I maintain what I said at the start of the conversation. One of the smartest guys in the room here, with Jay Hatfield, appreciate those that watch this live and hopefully we'll do this again in the coming month or months. So appreciate it, jay.

Speaker 2:

Thanks, Mark.

Speaker 1:

Thank you.

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Michael A. Gayed, CFA

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