Inflation needs to come down ‘to get that bond market rally’: Strategist

Infrastructure Capital Advisors Founder, CEO and Portfolio Manager Jay Hatfield joins Yahoo Finance Live to discuss the latest moves by the Fed, inflation, and bond yields.

Video transcript

SEANA SMITH: Jay, it's great to see you. So I guess, just your reaction to what we're seeing play out today, what we have seen play out so far this quarter, and what that signals is ahead in 2023.

JAY HATFIELD: Thanks, Seana, for having me on again. What I think is really dominating the market right now is not a Santa Claus rally, but really a global bond selloff, which started, really, with the ECB, but was exacerbated by the Bank of Japan. So we're hoping that that rise in rates stalls out somewhere in the 4% level. And then that could set us up for a better price action into the end of the year and the beginning of next week.

PRAS SUBRAMANIAN: Hey, Jay, Pras here. So you think that we hit that bond market low here? You think that's what's happening right now-- we're bottoming out right now, and then possibly 2023, you kind of see a little bit of a liftoff there?

JAY HATFIELD: Yes, Pras, that's our thesis, is that you had mentioned, by the way, housing prices yesterday. That's really why we're very optimistic about inflation being below what the Fed is forecasting because housing prices predict the change in shelter in CPI with a 6 to 12-month lag. And those have rolled over. We have our own index. It went negative.

Our own CPI real-time index, it went negative three months ago. So we think you need to have inflation coming down to get that bond market rally. And bond prices are not just important to fixed income, but also equities. And that's really why tech stocks are weak today and really why stocks have done so terribly this year.

SEANA SMITH: So, Jay, what does all this mean, then, just in terms of Fed policy, how restrictive the Fed is likely going to be next year, and what this all means just in terms of the odds of a recession? Is there still a chance that the US could avoid a recession?

JAY HATFIELD: We think so, Seana. The-- we're more optimistic than most because we've studied the last 11 recessions, except for the pandemic. They're all caused by tight monetary policy, raising mortgage rates, and then crushing the housing market. You know, particularly in '07, '08, obviously, we were building 4.5 million homes a year. Now we're building about 1.4.

The reason we're optimistic that we might have a technical recession would be very mild. So we don't think we're going to get mass layoffs in these interest sensitive sectors really because of the pandemic and also post-financial crisis. So but that's a sector to watch, but just last week, the new homes sold was 10% above expected.

So it doesn't seem like the housing sector is crashing, but that's what we should watch, particularly in the first six months, because that's normally a weak time for economic growth anyway, as measured by the Commerce Department. So we think there's going to be a slowdown for six months, but then we could get a big rally towards the end of the year, even in the riskier tech stocks.

PRAS SUBRAMANIAN: Hey, Jay. So looking ahead for 2023, based on what you just said right now and the Fed's sort of tightening cycle, what do you like next year? And is there even a play even in, like, real estate, for instance?

JAY HATFIELD: Well, we think so. We would be still be defensive, particularly in the first six months. Preferred stocks is really our number one pick. Those are particularly of the ones that are $25 preferred. So they're traded on the stock exchange, so they're easy for individual investors to access. They're issued by public companies.

And if you look at their 30-year default rates, they're about 0.3%, which is higher than investment grade bonds, but high yield bonds are 4%, so just 10% less than 10% of high yield bond default rates. So good credits and that are very depressed, they're down about 20-- over 20% this year. So that's our number one pick.

REITs, we think are-- if we're correct about inflation and REITs coming down, REITs will also do well, particularly the pandemic recovery type REITs, retail REITs, even some high quality offices. So that's what we think, particularly for the six months, could work. And then if we do have a major rally, then the higher beta stocks could be appropriate in the second half.