Welcome to Trader Talk. I'm Kenny

Polcari, your host, and thanks for

joining us. And today, we're talking to

Jan Salaj, who is Reflexivity CEO and

co-founder, and Jay Hatfield, who's the

CEO and CIO of Infrastructure Capital

Advisors. Gentlemen, thank you for

joining us, and welcome to the

conversation. There's so much to talk

about, but we're going to start right

away with what's happening to the price

of oil now that we've got this at least

a 60-day ceasefire deal. We've seen oil

come down 27% in the last 2 weeks,

trading now at about 70 bucks. So, talk

to me in terms of, you know, where you

see the next opportunity with oil coming

down. Where you see the geopolitical

situation? What do you see as happening

in the markets? Talk to me a little bit.

>> Well, for us, I think the probably the

purest expression of this oil premium

coming out of the market have been

airlines. That's been probably the main

one because they go straight to the

bottom line.

>> Right.

>> So, that's been, I would say, what we've

emphasized the longest. Um

I think what you're going to see second

will probably be Currently, the way

markets are trading the Fed is primarily

to what's happening with energy prices.

Right, you can see that the leadership

is very reluctant to really hike.

But, they have been put in a very

uncomfortable position. We've gone from

in March two cuts being priced in to now

hike being priced in.

>> That's right. And actually, I think one

of the banks, I think it's Bank of

America, has got two hikes priced in.

>> Mhm.

>> Yes. But, the market is pricing in one.

>> Yes.

>> So, I think that's going to be another

thing will be very interesting to

follow. Obviously, we got the dot plot

that was pretty clear about there being

potentially hikes coming.

>> Right.

>> Um with the Fed chair notably abstaining

from submitting his own

>> Right.

>> view on that and being very careful

during

>> But, I think also, if you if you think

back in history, a Fed chair when it

they're first appointed almost always

gets challenged over something.

>> Right.

>> So, you try to just not make any obvious

blunders.

>> Right. Well, he's going to get

challenged because I don't see how he's

going to I don't see how he can justify

cutting rates in this environment.

Someone in the White House in DC is not

going to be very happy with that, but

that's a whole 'nother conversation.

[laughter]

>> We've been [clears throat] bearish about

oil for the last $15

for a specific reason. We expect OPEC to

go to maximum production,

>> Yeah.

>> which is about 32 million barrels. We'll

have a 4 million barrel surplus, and

that'll quickly run down the surplus.

So, we're actually think we could go

below 60.

>> Really?

>> [clears throat]

>> And for that reason,

we think that the chances of the Fed

increasing rates is absolutely zero.

>> Right.

>> And we're going to have two huge

negative headline prints in CPI over the

next 2 months,

>> cuz it takes 2 months for it to roll

over.

>> And we're also bullish about core.

Airline fares is in core.

There's other bleed through to core, and

then [clears throat] tariffs are rolling

off, and shelter

eventually, even if the Fed doesn't

correct the way they calculate shelter,

which is fraudulent.

>> Right.

>> except every 6 months.

>> Right.

>> So, it's like we were talking about the

markets here 6 months ago, which nobody

wants to hear.

>> Right.

>> And so, even if they don't fix that,

it's going to roll down. So, we have

three cuts in our forecast. We're

optimistic about rates, and we have a

9,000

target on the S&P, which does require

lower rates.

>> Wait, 9,000 this year?

>> This year, end of this year.

>> Really? [clears throat]

>> Mhm.

>> That's very aggressive. But yes, that

would require a couple of rate cuts.

>> Mhm.

>> I just don't see rate cuts at the

moment.

>> Mhm.

>> Unless you see this sudden CPI and PPI

and the PC start to really collapse as

>> oil

>> Well, that's our forecast. We're not

saying that Worsh is going to jam it.

>> Right.

>> He's going to lose that vote. He's 9-3

>> Right.

>> doves [clears throat]

versus um hawks. So, we're not That's

never been our call,

>> Right.

>> because he We were surprised Trump

nominated him. He's obviously a hawk,

has been a hawk his whole career.

>> He's made it very clear he is.

>> Yeah, right. He's very politically

powerful though, so Trump capitulated to

that.

>> Right.

>> But that we believe the data, we're

forecasting the data will justify two

cuts. Not this year, but over the next

year.

>> Okay, so 12 So within the next 12

months, not in the next six.

>> at least one cut this year.

>> Yeah. Look, I just want to say one thing

cuz you brought about airline fares,

which I thought was interesting because

the price of oil had skyrocketed.

[clears throat]

Is that I just I was on vacation, I had

gone to Europe. I got to tell you

something.

First of all, the plane was completely

sold out. I got I was in I was in

France. Americans everywhere. People are

traveling. Everywhere you went, it was

crowded, there was tourists, plenty of

Americans everywhere I went. Um and so

it's kind of interesting because I

thought there would have been maybe a

little bit of a a little bit of a

pullback, but I didn't see any pullback

at all in terms of, you know, in terms

of traveling, people spending the summer

going abroad.

>> I mean, I think that's the other premium

that

currently or the risk premium, if you

call it, which is that when there's

geopolitical uncertainty, people are

more reluctant to travel. If that comes

off,

>> Right. Right, that comes off. But that

just came off, right? I mean, these

people that bought these tickets had to

buy them three, four months ago.

>> Yeah, so I'm saying it's going to get

more crowded.

>> Right, it's going to get more crowded.

And it's And if the price of oil comes

down and ticket prices actually come

down,

that'll only fuel that that whole

conversation.

Um

All right, so let's talk about Warsh's

reforming the 2% rule versus these rate

cut headwinds, right? New new Fed chair

Kevin Warsh just held rates steady at

last week's meeting at 3 and 1/2 375,

which I think is, by the way, kind of

well within the normal range, right?

Um but he's stripping out the forward

guidance, which I actually think is kind

of interesting, right? I think it's a

complete rethink of how the Fed is

communicating to the markets. Um and I

remember back, you know, when I first

came into this business 1980, Greenspan

was the Fed chair, and Greenspan didn't

say anything. He came out, here's what

we decided, he went back in. He didn't

hold your hand, he didn't give you a

Xanax, he didn't say to me ask me any

question you want, come lie down on the

couch, none of that.

And if that's what we're going back to,

I would actually think that that's a

good idea.

I think it's less chaotic for the

markets.

>> Absolutely. The only issue we have with

it is the dot plot is a fantastic

contraindicator.

>> Yeah.

>> So, if they think there's increases,

there's almost certainly going to be

decreases.

>> Right.

>> But, [clears throat] it is ridiculous

cuz you have like 19 now, 18

different views. The Fed should come up

with one view

>> Right.

>> with a better economic model.

>> Yeah.

>> Don't use Keynesian models, they don't

work. Look at the money supply, look at

oil prices, forecast inflation.

And then it's okay, like it would be

reasonable to cut now after the oil

comes through because PC is absolutely

going to go below two. It's easy to

forecast. It's already below two if you

correctly calculate it.

>> Well, okay, it's going to be interesting

cuz I tomorrow is expected to be hotter

than last month, but then

there are some people that think it's

going to be even hotter than the

expectation tomorrow on both top line in

the core. And so, I wonder if that means

people are going to sit back and say,

"Okay, let's wait a minute because oil

now is down 27% in the last 2 weeks."

So, the CPI next month and the PPI next

month and next month's PC should really

reflect that cuz this one it's too soon

for it to be reflected in this report.

So, I'm curious how the market's going

to react.

>> It should be

relatively irrelevant. You can calculate

PC from CPI and PPI.

>> So, [clears throat] any there might be

some rounding difference where it's 0.4,

but it's really 0.35, but it should be a

muted reaction because it's irrelevant

given the 30% drop in oil prices.

>> Well, you know, it might be a muted

reaction as a human being, but you know,

the problem is you have all these

algorithms, all these smart logic

algorithms that do nothing but scrape

the headlines and they look for positive

or negative words and then they react as

a result, right? Um and that's the part

you can't control.

>> Definitely. Just the probability of

being in line is very high because it's

easy to calculate.

>> Yeah. And were you were you on that?

>> Well, I want to go back to a point you

were making before, which is that okay,

are we going back to the Greenspan era

where we don't telegraph so many things

in advance. And I think in an

environment like this where there's

uncertainty over energy prices, right?

Because also, yes, currently we seem

like we have a deal.

We've also been dealing with a situation

administration that could renege on that

overnight. Right. But you could wake up

tomorrow and there's no deal.

>> Right.

>> So, the Strait of Hormuz is open today,

closed tomorrow.

>> Right.

>> It's like always somewhere in between.

>> Right.

>> The

>> Although right now it's open.

>> At the moment it's open. Seems like it.

>> And there's 19 million barrels of oil

that that flowed through the other day.

>> Right. So, then you have the waiver,

exactly. Now, the other thing to then

think about also is that I think there

is genuine uncertainty in terms of over

the medium term what the impact from AI

is going to be. Not just as it affects

jobs and productivity, but also there's

a huge capex cycle that's currently

going on that is actually powering the

economy. That is actual money going in.

>> Right.

>> So, being

I the issue that I think the Fed has

faced before with forward guidance is

that they felt locked into it. Yeah.

It's like if I don't do what I guided,

right? I was wrong.

>> 100%.

>> And so, removing that I think is giving

them that degree of flexibility that you

had in the '90s that they probably

would

>> should return to it from.

>> And that's exactly what Greenspan did.

Greenspan never guided forward, right?

He just got and said, "Here's what we

did. Now the market's going to figure it

out."

>> And they didn't have this completely

arbitrary 2% target.

>> Right.

>> He would cut rates over the weekend if

the stock market was weak. And that was

a real Fed chair. He did a fantastic

job. We need to go back to that where

the Fed uses judgment, they look at

markets. This Fed would never Like if

them market crashed 30%, They wouldn't

do anything. They would say, "Oh, well,

inflation's above target." They have no

ability to forecast. They don't read the

markets. Greenspan was a consultant. He

wasn't a Fed.

>> The JJ Fed or the Kevin Warsh Fed?

>> [clears throat]

>> Well, I don't I think Kevin Warsh is

stuck with the old Fed basically because

there's nine members that are the old

school Keynesians. Right. And they

believe in in the inflation expectations

being a critical driver of inflation. We

totally doubt. So, when you're stuck

with that inflate the expectations

theory, then you have no flexibility.

Oh, we're going to lose credibility. We

can't cut rates even though the market's

down 30%. And they just do nothing and

just look at the market and sometimes

the the economy melt down like they did

in the end of 2018

when they were raised rates way too many

times. So, we need a more market

responsive, less rules-based.

Unfortunately, Greenspan kind of ushered

in this rules-based and it's been a

disaster ever since we had 2% target.

>> Yeah. Well, then I think the the great

financial crisis happened. You had Ben

Bernanke come out and then everything

was that's this whole generation of

that's this whole generation of

investors and people in this business

out there that have grown up with that

hand-holding, right? Where the Fed came

out, sit down, let's talk about it, ask

me all these questions, let me give you

I think and I think I understand during

the crisis maybe that was okay, but then

they just kept it going, which I think

created a lot of chaos

at times.

Right? All right, so let's talk about

S&P 9,000 because that's your call,

which I think is which I think is great.

I'd love to see S&P 9,000. Um but we've

got this eight this AI cliff, right?

Market valuations are being entirely

propped up by this AI boom.

Uh

uh but the sustainability of that growth

is kind of where there's some question,

right? Are we ahead of ourselves? Is the

trade too stretched? Look at how quick

the market, you know, sold off yesterday

as a result of what happened in yes,

South Korea and oh, that market's up 95%

year to date, which is unsustainable

anyway. I'm surprised the market only

corrected by 10%. Why it didn't Why it

didn't correct more.

>> Mhm.

>> But, talk to me about how we get the S&P

9000

when we have this this this mismatch

between AI and and the rest of the

market.

>> Well, this is not a target like the

internet targets in the end of the '90s.

So, it's not just AOL's 3000 or 5000 or

10,000 because they have more eyeballs.

So, simply

we start the year 23 times

uh 27 earnings. That's the year-end

target for this year.

>> Yeah.

>> Which is Which is a little bit

aggressive though, isn't

>> bit. 23 requires low rates.

>> Right. Okay.

>> But, I would point out a lot of people

use 18 as a historical multiple. That's

before the corporate tax cut.

So, the corporate tax We dropped it 35%

to 35 to 21. Huge drop. That raises the

sustainable multiple in our models by

four.

>> So,

>> So, 23 is only one point above normal.

>> you think is is really the kind of

>> sustainable sustainable rate. And that's

where we kind of been trading since that

corporate tax cut.

>> Okay. That's interesting. I didn't

realize that.

>> And then the move from eight to nine is

simply marking to market

the 27 earned consensus S&P earnings

estimates. So, it's simply just using

our same methodology,

not some bullish move. You just have to

reflect it. And by the way, if it comes

down, we would lower it. But, it's been

moving up almost every day. Yeah, you

can see a chart of it. If you have a

Bloomberg terminal, you can look that

up.

And so, actually, I'd say the risk is

more to the upside cuz those earnings

are going to continue to rise when we

report earnings in July.

>> So, so S&P 9000 is almost a 20% climb

from here. Were we at 7400 right now?

>> Right.

>> Well, think about what we've gone

through. First of all, June's a terrible

month, normally.

>> Right.

>> We're not even off significantly.

Getting a lot of rotation. Yeah. Then we

had a war.

>> Yep.

>> So, I would argue

if you had told me beginning of the year

okay we're going to have a major war

oil's going to go over 100

and we're in June where is the S&P? Um

now 6,500 7,000 something like that. So

get the mar- if you're a market

whisperer you'd say wow if we're 7,400

with all this brain damage just imagine

when we get into July we normally have a

power rally should get up to 8,000.

>> midterm election yes so then you're

going to have kind of that or maybe not

maybe you don't think the midterm

elections is going to be an issue for

the market.

>> And I think it's a fait accompli I mean

the Democrats are going to wipe out the

Republicans but

>> In both houses?

>> Uh if the Senate's going to be kind of

50 like literally 50/50 right 50 maybe

51 most likely but [clears throat] so

but that's not going to change policy.

What we really don't want is a sweep of

the Democratic socialists and an

increase in the corporate tax rate.

Corporate tax rates drive global

economic growth and stock prices that's

an unmitigated disaster. That's a 28

issue.

So I don't know why the market would

sell off now just because the Senate

maybe goes Democratic.

>> Well I guess the problem is if the

Senate

if it remains split

then the market likes kind of gridlock.

>> Mhm.

>> But if they take both houses

you know although the president can

still veto anything that comes to his

desk but um

I think it sets it up for some anxiety

in the market.

>> I think so long as and I think this is

what Trey was saying before as well as

so long as you don't have the Fed

aggressively

beginning a hiking cycle I don't think

the market just collapses on its own

weight. It just doesn't seem to

we've run at Preff Equity we've run a

ton of analysis on this and you always

find that it's withdrawal of liquidity

that ultimately gets people to you can

talk about valuations and I think

valuations are important cuz it tells

you how much the market can go up and

down but it tells you how far you are

from some kind of norm. But ultimately,

directionally, it's definitely impacted

by whether or not liquidity is coming in

or going out.

If we haven't reached a point where they

start withdrawing liquidity, and this is

I think the critical moment now where

they're making that decision, energy

plays into it. You

fall back exactly on the point that Jay

had made, which is if you told me at the

beginning of the year that you have to

go through all of this period, where the

S&P would be, it's done better than

that.

>> Yeah. No, definitely. I

I'm I'm I'm pleased with what the market

has done this year considering

everything we've thrown at it. Right.

>> And I would just emphasize what John

said. If you want to call the market

nearly perfectly,

>> Yeah.

>> follow the money supply.

>> Yeah.

>> M0 is what we recommend. The Fed,

housing,

then as [clears throat] long as you get

the Fed cycle right, you'll get every

cycle right. So, we got bullish when the

Fed intervened in 20 after the pandemic

started.

>> Right.

>> We got bearish when they overheated the

economy. Money supply is growing 70,

means there's inflation's too high,

they're going to tighten.

And then we got bullish after this the

cutting cycle.

>> Well, so do you think that Kevin Warsh

is going to shrink the balance sheet,

take some liquidity out of the system? I

mean, he certainly wants to.

>> That's an issue almost no one

understands.

>> Right.

>> First of all, the balance sheet

is large only because the Fed's paying

interest on reserves.

>> Right.

>> They used to [clears throat] be 8

billion of reserves, it is now 3.2

billion.

So, the balance sheet is fine given that

because assets equal liabilities. Like,

they haven't done anything crazy. They

did during the pandemic, they haven't

done anything crazy, they shrank it back

down. So, if Warsh wants to shrink it,

there's only two ways to do it.

Radically

increase interest rates, which he's not

going to do.

>> to do.

>> [clears throat]

>> Or stop paying interest on reserves,

which we're not in favor of, but that's

the only way to shrink the balance.

>> But could he do that?

>> He could, it would be extremely

politically unpopular. It would also be

less profitable cuz if the Fed cuts

rates, then they can make a spread on

the reserves versus owning treasuries.

>> Right.

>> So, I don't know why he's so focused on

that. They're not doing anything nutty.

They were during the pandemic, but then

they shrank it down. So, most people

don't understand that you can't to to

reduce rates, you have to increase the

size of the you have to increase the

size of the balance sheet. You have to

increase the monetary base.

>> Right.

>> I don't know why people don't understand

it. It just it's just pure accounting.

I've studied it. I always studied

uh monetary economics when I was in

college. So, I've been looking at it for

47 years. So, it's pretty easy to

interpret. But for some reason, even

people who should understand it don't.

And so, it's they're not independent

variables. The Fed wants to shrink the

balance sheet, they've got to tighten

policy or get rid of interest on

reserve, which is going to be extremely

unpopular with the banking system.

>> I would just add one point to this,

which is that when you're not ready to

do something, you set up a task force.

>> Right. Right.

>> So, I don't think that we're

anywhere near starting that process.

>> Well, I thought I thought part of the

conversation was in order for him to cut

rates, he had to shrink the balance

sheet at the same time cuz one would

offset the other. Is that right?

>> Yeah, but you just can't do that. That's

not the way it works. You to to lower

rates,

>> Right.

>> you have [clears throat] to increase the

size of the monetary base, which means

you have to buy more assets and increase

it. That's And by the way, during the

pandemic, if you don't believe that,

they actually had to keep rates below

above zero. Yeah. They had to go in and

do reverse repo of 3.5 trillion. So, a

lot of even people who should know this,

the Fed has to constantly intervene to

keep rates where they are. And so,

they're going to lower it, they have to

intervene by injecting more liquidity,

increasing the size of balance sheet.

>> Right.

>> So, you can't do they're not independent

variables. Everybody treats them as

such. They're like, "Oh, well, they're

actually they're lowering rates, but

it's offset by the balance sheet." It's

not true. You The balance sheet is 100%

correlated with the Fed funds. And

sometimes they do short-term borrowings

to offset it, but the net balance

sheet's 100% correlated.

>> So, where do you think

uh the 10-year Where do you think the

10-year goes by the end of the year?

>> 3.75 or below 4.

>> Really? It's 3.5 right now.

>> A 100 over

the terminal Fed funds rate.

So,

to get there,

we would have to be pricing in three

cuts. Right. Not have to actually do

them,

but everybody would have to completely

reverse in the Fed funds market. But, I

would point out Fed funds is not a very

liquid market. Like, we trade it, but

there's pretty There's not very many

people trade it. The 10-year is a liquid

market.

>> Yeah.

>> It's barely budged during the war.

>> Right. I know. It's been It's stayed

right there.

>> It's trading at 50 over. Normally trades

100 over Fed funds. So, I would look

to that as an indicator of whether we

have

have rate cuts or not, if you don't

believe our forecasts. The 10-year is

saying, "We don't need rate cuts." It's

down today. The The yield is down today.

But, to get it much below four, we'd

have to take out those two increases

they're priced in and get three cuts

priced in, and then it would should

drift below four.

>> I mean, it has been interesting that

since you had the Fed meeting, the

you've seen airlines going higher, which

was driven also by the oil price. And

then, too, home builders have been doing

well.

>> Mhm.

>> Home builders have been doing well.

>> And so, that is going to be directly a

function of where the rates are.

>> But, it's interesting that home builders

are doing well when mortgage rates are

now back at 6.6 and 1/2%, aren't they?

30-year mortgage rates.

>> But, I think to the point that we were

just discussing, I think the expectation

is that if

the 10-year is here or lower,

right, and the economy stays in pretty

good shape, which it will unless you

start hiking rates, then that's

>> Mortgage rates will come down.

>> Yes.

>> Yeah, I agree 100%. It's all

anticipatory. The actual earnings are

pretty bad. We're long home builders.

It's a great trade today.

>> Yeah.

>> It has been a good, but it's all

anticipating lower rates.

>> Yeah. would

>> to that those type of indicators versus

this illiquid fed funds market.

>> sector the real estate was up 1 and 1/2%

yesterday.

>> Mhm.

>> You know, I mean there were there were

there were seven sectors that ended

yesterday in the green versus four that,

you know, I mean it was all the tech

names are getting taken to the woodshed,

but the the the rest of the market was

actually

did fairly well considering, you know,

everyone was screaming and yelling and

lighting their hair on fire. I'm like,

"Oh, let's slow down a little bit."

>> And that's also generally a good thing

you want to see if you believe that

market goes higher, you want the breadth

to increase.

>> 100% you want the breadth to increase.

>> There's no way we're getting 9,000 just

on tech. It's not

>> No, no, it can't No, no, it absolutely

can't happen, but that being said, would

you still

at these levels, would you still be

adding to tech or would you be adding to

some of the other sectors?

>> Well, definitely to the other sectors. I

think that this is what currently the

bet is, right? If you think that this

was up until this point uncertainty

about the direction of rates and then

uncertainty about the direction of oil

and we're resolving both or we'll be

resolving both, it the opportunity is

outside of tech cuz there's nothing

about this

that has brought any new information

about where the AI is going or where

tech is going.

>> So, where's the opportunity you know,

and like what sectors would you look at?

>> Well, I would just again, broadly things

that are related to immediate

developments are and I'm just repeating

myself, home builders, airlines and so

on because you're now compressing the

premium, you're also bringing rates down

and so on. So, that's

where you want to be now. I think in the

sort of 3 to 6-month horizon, you're

going to start wanting to look at some

of the small caps and mid caps and so on

because again, if the economy is doing

well and rates are generally headed

lower,

>> Right.

>> that's typically the sectors that do

well.

>> Right, but small caps are already doing

well.

>> Yeah, I think everything is doing well

generally, right? Like there's you're

starting to see it's not as we were just

saying, despite the fact that we've had

all a geopolitical conflict, the fact

that we've had energy prices

extremely extremely high, things have

held in incredibly well.

And if now the market can convince

itself that actually the hikes are

probably an overreaction and that at a

minimum we're going to be staying where

we are and possibly going lower

then you will see that next leg up.

>> Right, so there has to be a change of

there has to be a broader change of

heart because like I said the market at

the moment is pricing in a hike before

the end of the year. So there's going to

have to be and maybe that comes when we

see

next month's CPI and PPI and PCE if we

start to see you know the price of oil

has really impacted that then maybe that

narrative will change. In any event

gentlemen we've run out of time but I

want to revisit this in four or five

months to see where we are. I'd love to

get you by the end of the year to see if

we're in fact at as the P9000 which

would be tremendous if we were.

Gentlemen thank you very much for

joining us until the next time take good

care.