The Election and the Markets

With the entire country following developments in the primaries as if this year’s presidential race was the latest season of the reality show “Survivor,” Federated’s Chief Equity Market Strategist Phil Orlando offers his take on how the fall elections might have an effect on financial markets. Control of the House and Senate may have more influence on markets than the presidential race.

What issues are most important for investors and businesses in this year’s elections?  To quote former President Clinton, "It's the economy, stupid," and I think that's what's going to be driving the thought process of investors and businesses this year. Some of the key metrics that I think they're going to be focused on is the pace of economic growth, corporate revenues and earnings, and the level and direction of interest rates and inflation.  Now, the problem, from our perspective, is that fiscal policy over the last couple of years has been suboptimal.  As a result, we had 1.7 percent GDP growth last year — we're projecting two and a half percent this year.  Those numbers are below trend line growth of about three percent.  And so corporate profits this year are probably going to be only up single digits or so. Now, interest rates and inflation are relatively benign, and when you put all that together, the stock market we think is going to have a pretty good year, up about 15 or 20 percent, getting the S&P to about the 1450 level by the end of the year.

As the economy, equity and labor markets have improved, so have Obama’s approval ratings.  What’s your take on his reelection prospects?  Oh, there's no question that the president has enjoyed a very nice approval bounce since the State of the Union. The reality is that the employment metrics, which I think are incredibly important, have improved. Non farm payroll, the weekly jobless claims, the household surveys, the ADP reports, all of those metrics are good and we think getting better. So if you're judging the presidency on the basis of the labor market strengthening or weakening, all of that is in the president's favor. On the other side of the coin, the Republicans are doing their best to give this election away. You've got all of the major candidates, to this date, still beating themselves up. Now, when you strip all of that away, there are still two key metrics that are important.  Looking back over the last 60 years no president has won reelection with the rate of unemployment above 7.3 percent.  Right now, we're at 8.3 percent.  Over the last 60 years, no president has won reelection with an approval rating below 48 percent. The president has gotten back right to that level. He's in pretty good shape right now in terms of the direction, but you've still got plenty of time. There's a huge monkey wrench that has gotten thrown into his reelection chances with regard to the turmoil in the Middle East and the price of energy. 

Which would the markets prefer: a unified or divided government?  At this stage, what do we think will be the likely outcome on that front in this fall’s elections?  Typically, the markets like divided government because they like an effective check and balance, with one party not giving away the candy store and the other party providing that effective check and balance.  I think, though, given the lack of efficacy in fiscal policy over the last couple of years, and the recognized need that we've got a lot of hard decisions to make in terms of entitlement reform and tax reform, and $15 trillion of federal debt, I think investors, businesses and voters are going to be looking for people who can be statesmen and can make the hard decisions to put the economy in the right direction.
 
Now the question is, what does that mean for the markets?  I refer back to a study that Deutsche Bank did recently in which they went back and looked at every permutation and combination from 1936 to the present.  A Democratic president or a Republican president, a split Congress, a Republican Congress, a Democratic Congress, their conclusion was that the best combination was a Congress, a House and a Senate that were controlled by the Republicans.  It didn't matter who the president was.  In those circumstances, where the House of Representatives and the Senate were controlled by the Republicans, the stock market was up by an average of 15 percent a year on average every year from 1936 to the present.  So from the perspective of the financial markets, the most important thing is hold onto the House, try to regain control of the Senate, and do the best that you can with regard to the presidency.