A potentially ugly U.S. election combined with a series of geopolitical conflicts have created the highest confluence of market risk factors that Federated Hermes chief equity strategist Phil Orlando has seen in his 43 years in the investment business. Speaking at BNY Mellon Pershing’s INSITE conference yesterday, Orlando maintained his firm is sticking with its soft-landing scenario for the economy, but he acknowledges that the dynamics could change.
Toward the end of his presentation, Orlando told attendees that the stock market’s near-term performance in the run-up to an election had “an eerily accurate ability” to predict the outcome. Specifically, over the last 100 years if stock prices rose during the three months from August through October, the incumbent won 83% of the time.
Orlando added that Federated expects a 5% to 10% correction during the second or third quarter, though he shrewdly did not give a precise, month-by-month time frame. “The stock market has done really well; we’re expecting consolidation,” followed by an end-of-year relief rally after the election, he said.
Orlando also noted that, if the economy does not enter a recession in the two years before a presidential election, the incumbent has high odds of winning. If it does enter a recession, the president usually loses, as former president Donald Trump, George H.W. Bush and Jimmy Carter discovered.
Federated does not expect a recession this year. Orlando said the investment firm’s view is that the 1.3% growth rate of GDP in the first quarter will be the low point of the year. “We think growth will settle in at 1.5% or 2.0%” for the remainder of 2024.
Why does he see a soft landing? Two of the most critical factors are the pace at which inflation continues to decline and how the Federal Reserve response to that plays out, he said. All of the negative forecasts for a recession in 2024 are “off the table,” he said, which has prompted the central back to delay its timetable for cutting interest rates. Still, Federated expects the economy to slow for the rest of the year.
America has emerged from the pandemic as the world’s strongest economy, but its federal debt of $35 trillion, at 125% of GDP, is growing at an unsustainable rate, Orlando said. He noted that at the turn of the century federal debt stood at nearly $10 trillion and it had tripled in the last two decades.
How did inflation, as measured by the Consumer Price Index, soar from 1.4% in January 2021 to 9.1% in June 2022? It’s worth remembering that the nominal CPI averaged a “benign” 2.8% over the last 40 years.
Orlando pointed to the Fed’s own analysis, which attributed 60% of the cause to excessive federal stimulus policy, 20% to kinks in the supply chain and 20% to the Fed’s own easy monetary policy. The central bank didn’t raise interest rates until March 2022 and later admitted it should have done so one year earlier, Orlando said.
The attempt to expunge inflation has been tricky in the final mile. The Fed’s favorite measure of inflation, PCE (Personal Consumption Expenditures) peaked at 5.6% in February 2022 and is now down to 2.8%. But the central bank has indicated it doesn’t expect this measure to reach 2.0% until the end of 2026—two and a half years from now. “Where does this leave us?” Orlando asked rhetorically. “With a debt hangover.”
That’s why the Fed hasn’t cut rates, despite the market’s expectations back in January that it would do so three times this spring. Orlando says Federated thinks there may be only two rate cuts later this year, probably after the election.
Federal debt serving costs are now $1 trillion, more than the U.S. defense budget, at a time when there are conflicts in Ukraine, in Israel and off the coast of Yemen. Orlando said Federated disagreed with those who believe that China will invade Taiwan later this year, but said the possibility can’t be completely dismissed.