Midterm Election Jitters

by: Richard A. Anderson

Midterm elections occur every four years at the midpoint of the four-year presidential term. With about one month until Election Day on November 6th, midterm elections are at the forefront of many individual’s thoughts for both the political and investment implications.

From a political perspective, control of Congress and influence over future policies are at stake. As it currently stands, the House of Representatives, the Senate, and the White House are all controlled by Republicans in what is often referred to as a unified government. But, with all 435 House of Representatives seats and 35 of the 100 Senate seats up for voting, there is the potential for the Democratic Party to win control of one or both chambers of Congress and create a divided government.

Historically, midterm elections have not been kind to the president’s party. Since the Civil War, the president’s party has lost an average of thirty-two seats in the House of Representatives and two seats in the Senate in every midterm election.1 The reason behind the president’s party losing seats in Congress is that there is greater motivation for the supporters of the political party not in power to vote in order to seek change.

Historical patterns suggest November’s midterm elections will result in a divided government, which has many Americans asking what does this mean for policy? But it also has global investors asking how the markets might react to the midterm election results.

Research conducted by Capital Group found that in midterm election years, markets tend to be more volatile and returns are more muted as compared to all other years. In the first ten or so months of midterm election years, there is more uncertainty about the election’s outcome and its policy impact. However, in the weeks leading up to the election markets tend to rally when outcomes are easier to predict. This lends credence to the old adage that markets don’t like uncertainty.

The good news for investors is that markets usually reward investors for withstanding the uncertainty. Since 1950, the average one-year price return for the S&P 500 following a midterm election is 15%, which is more than double that of all other years during a similar period. Also, the S&P 500 has been higher one-year after midterm election day every time since 1950.2

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In addition, research conducted by LPL Research supports the notion that midterm elections can provide a tailwind for markets. LPL Research examined the past 120 years of the Dow Jones Industrial Average and found the period from the fourth quarter of the president’s second year in office through the second quarter of the president’s third year in office has historically been the best nine-month period of the entire four-year presidential cycle.3 This is extremely timely information given we have just entered the fourth quarter of President Trump’s second year in office. These next three quarters have historically been the most favorable part of the four-year presidential cycle because of presidents’ efforts to boost the economy with pro-growth policies ahead of the election in year four.

The midterm elections will be closely monitored, and rightfully so, for its potential policy implications. For those who are concerned about how markets will react to potential policy changes, history suggests the political calendar will provide a boost for stocks over the coming months. Politics in general, and midterm elections in particular, generate a lot of uncertainty and impassioned opinions that can lead to short-term market volatility. Yet, the long-term drivers of stock returns are expectations of future cash flows of individual companies. Therefore, we believe it is prudent for investors to look past the short-term volatility and overcome any political leanings to focus on the long-term wealth creation of investing in the capital markets.

1“US mid-term elections: What is at stake?,” BBC News. https://www.bbc.com/news/world-us-canada-29412354. May 7, 2018. 2“Can midterm elections move markets? 5 charts to watch,” Capital Ideas. https://www.thecapitalideas.com/articles/midterm-elections-markets-5-charts. September 12, 2018. 3John Lynch & Jeffrey Buchbinder, “Midterm Mayhem?,” LPL Research. https://lpl-research.com/~rss/LPL_RSS_Feeds_Publications/WMC/Weekly_Market_Commentary_09182018.pdf. September 18, 2018.