Economic data showing resiliency ahead of summer inflation, hawkish Fed

Infrastructure Capital Advisors CEO Jay Hatfield joins Yahoo Finance Live to discuss the expectations on inflation after the latest economic data reported resiliency amid recession fears.

Video transcript

AKIKO FUJITA: Let's bring in Jay Hatfield, Infrastructure Capital Advisors CEO. Jay, you know, we were talking about the numbers that we got out this morning on PCE. Certainly puts the Fed in a bit of a difficult position, although increasingly it feels like the expectation is swung towards another rate hike. How do you think the Central Bank processes the data we got today?

JAY HATFIELD: Thanks for having me on, Akiko. Well, this Central Bank as you're pointing out, does focus on PCE core, which we think is very misleading. It's overstated by about 1 and 1/2 per cent because it use a very, very lagged component for shelter. But it is entirely reasonable the Fed will raise rates because they're normally a year behind.

And if you look at the data carefully, inflation absolutely peaked in June and then started declining in July. In fact, our own index, CPI does show our real time inflation has declined since July by over 1%. So we really think we're in a deflation. And this Fed just like they were with transitory is completely off. But that means they because they're so lagged will probably could very well raise rates in June even though they shouldn't.

SEANA SMITH: Jay, we are seeing inflation maybe declining more rapidly than some of the data is suggesting. How quickly then could we potentially get back to that 2% level?

JAY HATFIELD: Thanks, Seana. Well, we think that we could get there maybe not the reported numbers, but any reasonable adjustment of the numbers by the end of the year. In fact, if you do-- we've done a forecasted headline CPI year over year as of June, reported in July will be only 3.5%.

So everyone will be able to figure out except perhaps the Fed that inflation's rapidly declining. But that process will continue because a lot of wringing inflation out of the system is simply anniversarying the height of the inflation. So July and August and September will be after those peaks of the data should start to support what we see as what the leading indicators are telling us, both PPI and CPI/R.

AKIKO FUJITA: I mean, with that said, there are concerns about where the economy is headed. You could argue today's data certainly points to the resilience of the consumer and demand is still strong. And yet, I wonder if you think there's always a lag factor with data, but you think the Fed is especially behind. I mean, what does that trajectory look like going into year end?

JAY HATFIELD: Well, that sort of gets to them. It's a great question because it gets to the core of the problem with the Fed's forecasting framework. They use the Phillips curve, which hypothesizes that all inflation comes from the labor market. So they would naturally be concerned, probably raise rates because we have a strong labor market. But really, if you look at the data, inflation is almost always caused by rapid inflation in housing and commodity shocks.

In fact, in the '70s, very little people know this data, oil prices rose by an unimaginable 1200%. So that's like our oil going from now going from 100 to 1,200, which would just cause massive inflation. So that was the key driver, not wages. Wages typically are lagging indicator. Real wages will actually decline as they have recently.

So that's why we think this is a fundamentally flawed Fed. They will raise rates and they probably won't cut them till March. They should have cut them in March when we had the banking crisis. So they'll probably cut them a year late, next year in March.

SEANA SMITH: Jay, what does all this then mean for a recession, just given the fact that, yes, inflation is high. But when you take a look at a lot of the economic data coming out, specifically what we're seeing from the consumer, what we're seeing in housing, it's remained very resilient. Do you think we're going to be able to avoid a recession even if the Fed hikes again next month?

JAY HATFIELD: Well, that's also the key question because it's very, very normal when you have an inversion and tight Fed policy to have a pretty significant recession. But if you think about the transmission mechanism of monetary policy, it's wholly on the housing sector. So that was terrible 1078 because we were building 4.5 million homes, had an excess of inventory.

Here, we have the reverse situation because of the pandemic. So that's why our call is no recession. It is nonconsensus because the data-- historical data doesn't support it. But keep in mind, we've never ever had a pandemic in post-World War II history, so we really don't know. But we know we have a shortage of housing and autos. So we're not getting the layoffs.

And if you look at construction spending, it's very resilient. We have the infrastructure bills out there supporting construction. So that's why our nonconsensus call is actually estimating 0 to 1% growth this year, so slowing but not a recession.

AKIKO FUJITA: Let's talk about strategy now and where investors should be putting their money. You say you like the tech sector. You're certainly not alone in that. We saw this week just how much exuberance there is around artificial intelligence. How are you looking at that space? Is the better bet here on the chips or the tools that will help build the technology or expand the technology or is it about the Microsofts and Alphabets who are really leading where this technology goes?

JAY HATFIELD: Well, our key insight that I really got being an investment banker, is that when you do have these new technologies, it's actually functional and what makes the US have a huge advantage over China and Russia, is that you get an overvaluation of the companies that are public. And then that drives innovation and investment in private companies. And eventually, they go public, and then that's when they come back to normal valuations.

So that's kind of the key insight. We've seen that with Tesla, where they were arguably overvalued, then get a lot of IPOs. So we think that's going to continue. So we would hesitate to get out of the trade. It's obviously, going to have downturns solely on valuation.

So we think that with regard to that, I would be-- since it's a fairly risky trade-- be with the more established companies with substantial earnings, so no startups. People tend to underestimate the difficulty in turning profitable.

In fact, when I was an investment banker, we didn't even have Morgan Stanley. We didn't even allow companies that weren't profitable to go public because they're too risky. So we'd stick with the big names-- Microsoft, Nvidia, AMD. And we'd rather be diversified rather than making a big call on chips versus software versus cloud. All of them are going to benefit. And it seems like it's the biggest trend since the internet.

SEANA SMITH: Jay when it comes to the more overall speaking, the narrow market breadth that we've really seen since the start of this year, does that worry you at all just about whether or not the fact that this could potentially not be sustainable?

JAY HATFIELD: Well, definitely. What you really saw the first half of the year was a pretty broad based rally, including all the stocks that we manage through ETFs like preferred stocks, utilities, and MLPs. But then when the banking crisis hit, you saw this massive rotation, where all those sectors were sold, financials as well, large cap dividend stocks, like we have in ICAP. So if you look at the returns on our funds, they're way up and then now flat to down. But yet tech is skyrocketing because it's viewed as a safe haven and then you have AI.

So it's been a bifurcated market. Today, tech is dragging the stocks up. Yesterday they were crashing. We wouldn't really rotate into the more, you know, the dividends and value until you get to July because then you have earnings. These companies are all doing really well. It's just that they're being shorted or sold by money managers who are underweighed tech and need to keep up with their benchmarks.

So short-term outlook for basic economy companies, I would say, dicey. But in July, we're going to get more build up on those like preferred stocks, for instance.

AKIKO FUJITA: OK. Jay Hatfield, good to have you on today. Appreciate your time.