“So if history holds, that suggests the second half of this year could be rocky depending on how ugly the political situation gets,” Orlando said.
And that presents an interesting political dynamic.
“The stock market has an uncanny ability to predict the next president,” he said. “Since 1928, the S&P 500 has correctly predicted the next president 86 percent of the time.”
To see why, look at the stock market’s performance three months prior to the election.
Orlando explained that when the stock market is positive during the months of August, September and October the incumbent party wins. On the flip side, the challenging party tends to win when those months are negative.
This ties back to the Federal Reserve. “I think one of the conundrums that Dr. Yellen isn’t talking about is her concern that the Fed tightening policy may have a deleterious impact on investor psyche and financial market performance,” Orlando said. “I think the Fed is deathly concerned that if they tighten policy it might be perceived as a mistake, the market trades off, and if done at the wrong time it could impact the election.”
He wasn’t suggesting that Yellen will play politics with potential interest rate hikes (though other people surely will suggest that), but he does think there’s a good chance the Fed will hike rates sometime this year—most likely in December.
Getting back to the impact of politics on the markets, Orlando noted there have been 11 post-war recessions in the U.S., and seven of those occurred in the first year of a new president’s term. And that’s due to fiscal policy error when a new president and Congress come in and feel they have a mandate to change the agenda. Those politically induced recessions typically roll into the middle of the second year of the new presidential administration.
“The second half of this year could be choppy because it’s the eighth year of President Obama’s term. 2017 and perhaps part of 2018 could be choppy because our new leaders might drive us into a recession,” Orlando said.
“I’m giving you a roadmap for the next five years,” he continued. “I’m suggesting that we [Federated Investors] are cautious because of the politics and we’re playing defense. If our worst-case scenario is correct where the second half of this year is tough and we roll into recession next year, there’s money to be made on the other side of recession, and the buy-in typically comes in the middle of year two [of the next presidential administration, or mid-2018].