Midterms and the Stock Market - Another brief history

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A brief history on midterms and the stock marketflag

You might be asking, will the midterm election affect my portfolio? Will the midterms affect the market or the economy? Is it better for stocks if Republicans win or if Democrats win? How will the election affect inflation and interest rates?

Remember, the market loves certainty. It hates uncertainty. Political gridlock (via a divided government) leads to certainty that nothing will get done (no extreme legislation passed). A unified government (one party controlling the presidency and Congress) increases chances of bills getting passed and therefore changes being implemented. And change equates to uncertainty. Therefore, the market loves gridlock and a divided government.

A little over five months from now, we will know if the Republicans have flipped Congress or not.

They only need one seat in the Senate to win a majority. They need five seats to win a majority in the House. Pennsylvania, Wisconsin, Arizona, Georgia and Florida all have key elections that could determine whether or not Congress flips.

While we don’t know what will happen this time, we can look to the past to see what has happened. Election outcomes and expectations of outcomes affect the stock market in the short term.

As for this election cycle, according to Jeremy Siegel, Finance Professor at Wharton:

The most favorable outcome for markets would be a Republican win in both the House and the Senate. If Republicans take the House and not the Senate, that would also be a relatively favorable outcome.” This goes back to the market loving gridlock and certainty.

The best returns have come under Democratic presidents kept in check by a split or Republican Congress – a 13% and 13.6% average gain for the S&P 500 respectively. The S&P 500 average return in years where Democrats have simultaneously held the Oval Office and both houses of Congress is 10.5%.

But also note that over the long term, midterm elections have no bearing on investment portfolios.(1) 


Now, for a quick history on midterm elections and the stock market: 

wall street

Stocks tend to sell off ahead of midterm elections.

Market volatility increases immediately before and after midterm elections.

Stock markets tend to bounce higher in the two quarters after midterm elections.

Midterm election years tend to have weaker stock market returns.

Corrections are normal during the second year of a presidential term, which we are in.

Markets often bounce back strongly after U.S. elections are over.


So, who typically wins midterms?

The U.S. President’s party typically loses seats in Congress.

One thing to consider if Democrats lose: Less government spending. President Joe Biden and Democrats will be significantly less likely to pass big legislation if Republicans gain control of either the House or Senate. Markets often like big government spending. (2) But at the same time, markets typically do not like high inflation. And big government spending adds fuel to the higher inflation fire. If Democrats win, another thing to consider is potentially higher taxes, which could help fight inflation. (1)


Presidents and Markets

In short, Democratic presidents have an edge. From 1945 through the end of 2021, the compound annual growth rate for the S&P 500 has been 9.4% under Democratic presidents compared with 6.6% for Republican commanders-in-chief. But, presidential policy could have lagging effects.

The second years of presidential terms produce the lowest average S&P 500 return—just 4.9%.

The best market returns come during a president’s third year in office when there’s a push to stimulate the economy ahead of the next election.

Remember, history doesn’t guarantee future results, and over the long term, midterm elections have no bearing on investment portfolios.(1)

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(1) https://www.forbes.com/advisor/investing/midterm-elections-stock-market/

(2) https://www.forbes.com/sites/sergeiklebnikov/2022/01/19/we-looked-at-how...

(3) https://www.capitalgroup.com/advisor/ca/en/insights/content/articles/us-...

(4) https://seekingalpha.com/article/4482443-a-midterm-correction-is-par-for...