Easy Income Portfolio: June 2025 Update

Welcome to the Easy Income update for June. The markets remain volatile, though perhaps not as volatile as they were in April during the announcement of Liberation Day tariffs. The market has recovered 1.6 percent, a solid comeback. Over the last week, we have been essentially flat.

Bonds have not kept pace with stocks. We have attempted to generate movement in the bond market, but every time it tries to rally, economic news knocks it back down. We are up about a percent for the week in bonds, which represents all of the stock returns for the last month since May 15th. Much of that return was driven by the consumer price index and producer price index reports that emerged earlier this week.

Interest Rates and Geopolitical Developments
Interest rates remain steady, but the big curveball this week was Iran and Israel. Israel attacked Iran, Iran fired back, yet this has not led to a dramatic rally in Treasury prices or the US dollar as it might have just last year. The high degree of uncertainty around trade and commerce continues to weigh on markets.

The president has announced that we will levy tariffs. I believe it is July 9th when he will send letters over the next couple of weeks (hopefully by the end of next week) to nations around the world, informing them of their new tariff rates. No more discussion. This is simply what it will be.

Federal Reserve Outlook
We have a Fed decision coming this month, though there probably will not be any action in June. The Fed has essentially telegraphed they will not act. Had we seen a truly bad jobs reading, unemployment claims report, or other economic indicator giving them reason to think the economy was slowing rapidly and required lower rates, they might have acted. We did not get that. CPI and PPI came in lower than expected but remained above the Fed’s two percent target.

More importantly, when examining CPI prices, everything increased to varying degrees: rent, shelter, car insurance, except energy and energy-related commodities. Gas prices provided a significant boost, falling considerably during the month. Add energy back in, and inflation rates would have had the Fed seriously considering raising interest rates in the coming weeks, not lowering them as the president desperately wants.

I believe (trying to recall what he called Powell this time, whether it was “moron,” “stupid,” or “idiot,” something along those lines) he demanded one hundred basis points, roughly four months of rate cuts at once, to spur economic growth. Powell correctly sat on his hands because the primary fear must be reigniting inflation by cutting rates prematurely.

Economic Fundamentals
The economy is actually in decent shape. Unemployment numbers remain solid, though we must monitor continuing claims hitting cycle highs, meaning people stay unemployed longer. The Challenger Gray Report shows impending layoffs. All federal government employees with expiring employment agreements will hit the market later this month, followed by deferred retirees entering the rolls in September and October.

Current hard numbers look good, but looking ahead several months, unemployment claims could easily jump. Another serious concern for the US economy: we witnessed over 300,000 quits and removals from the workforce by foreign workers through legal means. These workers are critical to meeting job demand across several industries. If they continue departing due to fears about current US immigration policy, it will create labor shortages that drive inflation higher.

Powell made the right call. He did nothing. The president does not like it. He is a real estate guy who will never like anything that does not involve lowering rates at every Fed meeting forever. Obviously, that will not happen anytime soon.

Portfolio Changes
In our Easy Income portfolio, yield has remained high while volatility stays relatively low. We are raising the yield this month with one portfolio change. We rarely make changes, but I want to move away from XBB, the completely unmanaged BB index, and swap it for InfraCap Capital’s bond ETF corporate bond BNDS: also high quality, high yield with an average rating around triple B.

I see minimal triple C paper or junk in the portfolio holdings. They hold some high-quality preferred stocks, but this is essentially high-quality, high-yield where Jay Hatfield and his team have done the credit work. He approaches credit analysis almost exactly as I do. I have tremendous faith in his portfolio management approach.

Portfolio Holdings Analysis
The top holdings are bonds I know well, having completed credit analysis on many that I own and have recommended:

• Plains All-American PAA The pipeline company
• Crescent Energy Finance CRGY The oil and gas partnership between John Goff and Kohlberg Kravis Roberts
• Charter Communications CHTR A company we paid substantial monthly fees to until leaving Florida (we own the stock in another portfolio, have completed credit work, understand the outlook and impending spinoff, all positive for the debt)
• Organon OGN A Merck spinoff from several years ago focused on female healthcare products (excellent company with strong cash flow)
• Lincoln National LNC One of the country’s finest insurance companies (their headquarters sits ten minutes from here in light traffic, convenient for any necessary discussions)
• Flagstar Financial FLG The renamed New York Community Bank, which I like, have recommended, and own (we hold shares of that particular preferred stock)
• Land O’Lakes: The butter company

This combination delivers monthly dividends with experienced management that understands credit and economics. We are getting slightly over eight percent yield, replacing a 5.8 percent yield with over eight percent.

Management Perspective
I spoke with Jay Hatfield recently. He expects Fed rate cuts in the second half of 2025, probably correct unless we see higher inflation, higher energy prices from prolonged Iran-Israel conflict, or tariff war expansion.

The bond market has stabilized following the Liberation Day sell-off, though it is not rallying. Hatfield believes Treasury yields will remain between 4.25 and 4.5 percent over the coming months. He doubts the ten-year will stay above 4.5 percent long because that means seven percent mortgage rates, which would damage housing demand and force earlier Fed action.

Like me, he believes credit fundamentals for high-quality, high-yield remain very strong even under mild recession scenarios when excluding obvious junk. Most BNDS portfolio companies are asset-sensitive, old-economy businesses: oil and gas pipelines, real estate, industrials, and banks with stable cash flows. The key: extremely low default risk.

Risk Management Strategy

Default risk represents the major challenge with high-yield bonds. If we can underwrite most of that risk away, we deliver solid total returns—exactly what Hatfield accomplishes. The market prices in more risk than Hatfield believes exists, and he anticipates potential rate cuts providing additional tailwinds by lowering treasury base rates.

The fund targets mispriced high-yield bonds and preferred stocks where rating agencies are overly pessimistic, just as I have done for thirty-five to forty years. Rating agencies make static assumptions and poorly understand real estate, banking, or oil and gas pipeline industries, consistent with my three decades of findings. Hatfield excellently exploits these inefficiencies in ETF format.

By focusing on underappreciated credits, the portfolio generates yields modestly higher than the general high-yield market without additional risk. That is where we capture the extra 220 basis points: through credit underwriting. He also includes some preferred stocks (under twenty percent of the portfolio) that provide a nice yield boost.

We are excited about this swap. Hatfield employs one additional strategy I appreciate: they own positions in high-yield indexes and, when appropriate, sell covered calls against them for extra income. They are not doing much of this currently but are permitted to do so and have succeeded with it in other funds.

Trade Recommendation: Sell XBB not because it is a poor product, but because we can capture 220 basis points without reaching or stretching by adding modest leverage and superior underwriting to high-quality, high-yield bond selection. Sell XBB, buy BNDS first thing Monday morning.

Economic Outlook
The economy is fundamentally sound, though we will probably see a summer slowdown. Too much uncertainty exists to avoid this. Businesses do not know how tariffs will affect their operations or raw material sourcing. They are postponing hiring, delaying, or eliminating capital expenditures, and avoiding expansion: essentially treading water.

The uncertainty index from the National Federation of Independent Businesses shows the highest reading ever since tracking began in 1975. Considering everything that has negatively impacted the world and economy since 1975 that would frighten, unnerve, and paralyze small business owners, this highest-ever reading demonstrates how much tariff and trade war possibilities concern American small business owners.

This will likely trigger a late-year slowdown. If tariffs are implemented at White House-suggested levels, we will almost certainly see inflation. Expect mild to moderate stagflation sometime over the summer, possibly into fall, with interest rate cuts becoming more likely once we have trade clarity toward year-end or early next year.

Sector Exposures
Our biggest exposures are well-distributed (we are not overcommitted anywhere) but include oil and gas exposure through pipeline companies, pipeline closed-end funds, and oil and gas royalty trusts. Obviously, the war sparked a huge Friday crude oil rally. Continued conflict will drive prices higher.

Long-term, remember that even if Chinese demand remains weak and OPEC increases production, oil and gas demand will keep rising. As long as demand exists, product will flow through infrastructure: pipelines, gathering centers, shipping terminals, the assets we own in closed-end funds. We will collect those fees and that money will keep flowing.

We will continue extracting from the ground, though US oil and gas production probably will not change significantly over the next year or two: no economic incentive exists to fully open the throttles. But as long as production continues, we collect royalties. Natural gas demand in particular will remain very strong from electrification initiatives with an AI component that we expect to continue growing.

We are not concerned about recent weakness in oil and gas-related assets. We consider this complete market mispricing, largely offset by gains in other fund assets.

Real Estate Markets
Examining the Mortgage Bankers Association data (we maintain mortgage exposure), no major changes are coming in residential mortgages. Default rates are not rising. According to the Mortgage Brokers Association, we probably will not see mortgage rates fall meaningfully below six percent for several years. Rates will generally stay around current levels with some political and other volatility, but barring serious economic problems spurring refinancing waves, we will not see dramatic mortgage rate declines.

Current coupon mortgages being purchased now are solid, unlikely to change significantly, and will continue producing high income levels, making our residential mortgage assets more attractive.

Regarding commercial real estate, KKR reported last week: “This is perfect. We love being real estate debt investors here. Prices across all real estate classifications are showing improvement signs. This is when we want to aggressively be the lender of last resort with solid underwriting and loan-to-value ratios because we are still collecting nice premiums to older rates—we get paid to take the risk.”

Asset class collateral is stabilizing across all sectors, including office. Last month, conversions from offices to condos, laboratories, and medical facilities, plus demolitions, exceeded total new office buildings coming online in the United States. We are destroying supply. Class A buildings we lend on through our assets will see steady demand at eighty to ninety percent occupancy rates that will continue rising, at the expense of lower-end properties. Our mortgage assets primarily handle new and transaction financing, not the assets facing elimination.

Even commercial real estate’s most troubled segment is improving, making our commercial real estate mortgage investments increasingly attractive.

Risk Factors
The biggest potential disruptions are war: obviously, continued conflict will spike interest rates and inflation, though our oil and gas assets will largely offset this within the portfolio. Tariffs and related political noise will remain problematic.

If we can reach deals or compromises that allow the administration to feel comfortable backing away from aggressive tariff implementation, and achieve some resolution and certainty, everything will stabilize at levels that do not negatively impact financial markets.

Portfolio Diversification
This portfolio structure includes US bank subordinated debt that trades differently than our oil and gas infrastructure. Business development companies operate under completely different conditions than Indonesian and Australian government bonds. Closed-end fund arbitrage funds (we own several) do their own thing and generate monthly cash. Risk transfer securities on European and US banks behave completely differently than oil and gas royalty markets.

We own numerous uncorrelated assets. Some zig, others zag, smoothing volatility. They share one trait: consistent high cash flow streams, much of it monthly. Cash constantly flows through our accounts, further dampening volatility, filling our pockets, and creating reinvestment opportunities.

Conclusion
That covers the June Easy Income portfolio update. This portfolio performs exactly as intended. It is easy.

 We are performing at a very high level with most performance paid in cash, and volatility remains at sleep-well-at-night levels.

Thanks, folks. We will return next month with the July update.