Markets and Midterms
Investors are anxiously awaiting the results of the mid-term elections in November, for very different reasons and with a wide range of expectations. Some are hoping that a decisive change in the congressional status quo will reignite enthusiasm for the stock market in the coming year. There are others that are counting on a relatively strong showing by the Democrats, which would revalidate the current economic strategy and boost investor confidence. Elections influence markets (and the other way around,) and some elections more than others. It may be very timely now to look at the numbers, to see if past perspective illuminates this intersection of markets and politics in ways we can perceive and profit from.
Looking first at the overall average returns of the market during the election cycle since 1940, the Dow has gained 5.6% in the second year of presidential terms, 16.5% in the third year, and 3.7% in the fourth year. Statistically meaningful conclusions, especially in the case of tightly contested midterm votes, can be hard to come by; over the last 80 years, control over Congress has only shifted five times. In the quarters following these five elections, the only year stocks lost ground was 1994, when the Republicans took control of both the house and the Senate, (and then the loss was less than 1%.) However, the market went on to gain 18% in the first half of the following year, 1995.
According to a recent study by the Bessemer Trust Co., a combination of a Democratic President and a Republican Congress has, more often than not, proven to be a positive environment for investors, based upon data going back to 1900. The report also notes that in the quarter immediately following mid term elections, the stock market has an 85% chance of a gain. Losses are rare in this time period, and have occurred only three times since 1929. In fact, according to adherents of the stock market election cycle theory, the fourth quarter of the midterm election year has the highest average return, about 6.3%, of all quarters in the cycle. Over the last 20 election cycles since 1929, the average cumulative gain over the subsequent 3-quarters, beginning in October, has been more than 18%.
It’s the months leading up to the elections that can seem most treacherous. Using the examples of first term Presidents between 1930-2006, in the three months prior to elections, the market has fallen 5.9% on average for Democratic Congresses, and a little more than 1% for Republican Congresses.
While these statistics can help bring some perspective to investor thinking, it’s important not to confuse correlation with causality. Economic fundamentals, company earning power, and investor expectations make all the difference in the long term. Still, this election in particular may have a great deal of influence in terms of charting our economic course…and rarely has broad economic policy seemed so crucial, for both Main Street and Wall Street.