Jay Hatfield, InfraCap Founder, CEO and Portfolio Manager, joins Yahoo Finance Live to discuss the outlook on inflation and expectations of the Fed.

Video Transcript

ALEXIS CHRISTOFOUROS: I want to continue our markets conversation though, and bring in Jay Hatfield, who is founder, CEO, and portfolio manager at InfraCap. Jay, glad to have you join us today. I want to start with what's happening on the geopolitical stage right now because we have the collapse of the Afghan government and the takeover of the country by the Taliban. To what extent is this a market-moving event, Jay?

JAY HATFIELD: I don't think it's the dominant factor right now in the market. It clearly was disturbing. And if you look on Twitter last night, there was kind of a Twitter storm. So I think that maybe caused a little bit of weakening, about maybe 10 handles in the S&P. But the dominant risk right now we see is really stagflation in '22 and that the Fed has lost control of inflation.

So not only did you see the images from Afghanistan, you also had reporting that not just Bullard and Kaplan, which tend to be the thought leaders on the Fed, but other members are realizing that inflation is out of control and are likely to accelerate the taper. And we believe they're going to have to raise rates at least twice in '22 because of the fact that the sectors that they expect the most, which is housing and consumer durables, that's where the most inflation is coming from.

So it's clear that Powell is holding the smoking gun on inflation. And the Fed is starting to figure that out.

ALEXIS CHRISTOFOUROS: So do you believe that inflation is transitory, which the Fed has kept telling us it is, or do you think it's going to stick around for longer?

JAY HATFIELD: Transitory isn't really an economic theory. That's more of a political talking point. We think it's really accelerating. If you mark CPI to market, so in other words, specifically look at housing. And instead of using the BLS methodology of asking homeowners every six months whether they think rents have gone up, you just look at the market, which if you just look on the internet, which maybe the BLS should learn how to use, then the CPI would be really running 8% year over year.

PPI is running 8%. And in fact, if you look at a chart of steel, finished steel that is, it looks more like a hyper-inflation. It's up 200%. And that hasn't fed through the value chain. So we see inflation potentially going double digits. And even if the Fed didn't taper, which is a trivial case, but if they kept increasing the monetary base of 25% in the long run, you're getting 25% inflation. So that's a trip. But that's not going to happen. They're going to taper it, probably in September.

But we have a monetary inflation going on. And the Fed has lost control of it. And tapering, by the way, is not going to slow down inflation. That's just going to pour less gasoline on an already out of control fire.

ALEXIS CHRISTOFOUROS: So ideally, if you do believe that, and from what I'm hearing, I think you believe the Fed is really behind the curve on inflation, what can they do to make up for lost time, if anything? How aggressive should they get?

JAY HATFIELD: Well, they obviously, they should follow-- Kaplan was the first that I'm aware of to go public but this as a September taper announcement, October taper, and then start raising rates possibly before the taper's over, because keep in mind that mortgage rates are at all time lows. Housing prices are up 18%. Rents are up 10%.

The only thing that's going to slow the housing market down is higher rates. Just not buying as much securities is not going to slow down because there is a momentum to these situations as well, as we know from the boom during the 200s. Once housing prices start going higher, people buy on a speculative basis.

So just putting less gasoline on the fire is not going to slow down the housing market, nor the consumer durable market. And I would also just note that a lot of these increases, like that steel 200%, that hasn't been reflected fully in the value chain. And if you talk to real people-- I was talking to some people on Long Island at a Marina. And they said that, first of all, they can't get any boats, even next year. And these steel price increases are starting to reflect into actual charges they have to make, so even installing docks, price is up to 200% because of the steel that goes into it. So there's real inflation that's accelerating and not decelerating.

ALEXIS CHRISTOFOUROS: So Jay, if you are forecasting stagflation in the next year or so, what are you recommending clients do to beef up their portfolio and to protect against, defend against this stagflation?

JAY HATFIELD: Well, we think that clients should always have a lot of income. And so we would recommend the defensive dividend stocks. That includes preferred stocks, by the way, which are probably the most defensive because they're senior to common. But also, the stocks are actually working in today's market, consumer staples, utilities, REITs, telecom, real telecom, not the news services companies, but the service providers, wireless companies.

So be defensive at the margin. Stagflation sounds horrible, but it's not the worst thing in the world. There's a small chance of recession. Keep in mind that the Congress is potentially going to raise corporate taxes, which is terrible for growth. We're estimating that could take 1% out of growth.

And also there's about a $2 trillion fiscal headwind. But nevertheless, if we have stagflation, defensive sectors should do well. Dividends should do well. We think the Treasury bond market is going to be quiet because normally, when the Fed is raising rates, the Treasury yield curve tends to flatten. I don't think it'll invert. But in extreme situations, invert.

So defensive dividend stocks are where we think at the margin. There's no panic. Like I said, stagflation is not the end of the world. And you can even see from today's market, you have tons of bad news about the Fed and Afghanistan. And right now, we're down all of 9 S&P handles.

And so it's not like we're really saying that there's a panic. But it is more dicey than it's been for the last year and a half now with the Fed not on our side, whereas it was on our side since mid-March of 2020.

ALEXIS CHRISTOFOUROS: Jay, companies are sitting on a record amount of cash right now because all of the uncertainty with this delta variant. Has that changed your expectations for earnings going forward? Because a lot of us were thinking they were going to use that cash and build out and bring on more workers. And now they may just be running scared and holding onto that cash until they have a better feel for what's going on with the virus.

JAY HATFIELD: We don't think the virus is the dominant influence right now. I mean, it's more of a problem in China where they're likely to have shutdowns. In the US, it's extremely unlikely because the worst situation with the virus is in the southern states, which are typically Republican and extremely unlikely to shut down. So we don't think it's a huge economic problem.

It obviously is a very, very significant public health problem. But because we're approaching herd immunity or at least getting closer, both through vaccines and, unfortunately, by people getting it, we think that will resolve itself in the next month or two. But you did raise a tremendous point that I don't think a lot of politicians understand, is it corporations don't just build things.

When they retain earnings because they have lower taxes, they hire people. Most businesses are like our businesses, are service business. So if we're expanding, we don't go build a factory. We hire more employees. And corporations are 50% of US employment. So if there is a corporate tax increase, we think that is going to make stagflation worse or could even put us into a recession next year.

ALEXIS CHRISTOFOUROS: All right, Jay Hatfield, more to talk about for sure in the short term. We'll have you back on. Jay Hatfield of InfraCap, thanks so much for being with us.