The midterm elections will play a key role in stock market returns — and investors counting on a rebound in the market in the last quarter are hoping to be rewarded.
“Most of the stock gains seen during a midterm year happen late in the year,” says Ryan Detrick, senior market strategist at LPL Financial, a Boston-based broker dealer.
Stock market returns are also higher when control of Washington is split among the Democrats and Republicans. Since 1950, the average S&P 500 performance was nearly the same when neither party has control over Congress. The S&P 500 generated a return of 15.9 percent under a Democratic president and split Congress from 1950-2017, and 15.7 percent under a Republican president and split Congress, according to LPL Financial.
Pre-election jitters in the market occur before every midterm since Wall Street despises uncertainty, he says.
“Pre-election jitters make sense to us,” Detrick says. “When you look at four-year presidential cycles, the year of the midterm election have the most volatility and see the largest percentage pullbacks out of the four years. These years are frustrating.”
The volatility in October was not surprising because market corrections are part of the game, Detrick says. “The market was wound really right, but in the entire third quarter, the S&P 500 did not lose or gain 1 percent.”
After the election, investors should expect both November and December to be bullish since they tend to be the strongest ones historically during midterm years, he says.
“The solid fundamentals of a strong economy will once again take over and will eventually lead to a nice year-end rally,” Detrick says. “If you look at the S&P 500 one day after a midterm election going back to World War II in 1946, one year later it has always been higher in 18 out of the 18 elections.”
The market has experienced a large amount of uncertainty recently not only with the elections, but also the impact of the tariffs on the economy, the slowdown in the housing market and how the decisions made by the Federal Reserve will impact both the stock and bond markets, says Mark Hamrick, senior economic analyst and Washington bureau chief of Bankrate, a New York-based financial content and data company.
“This particular midterm election is coming at an interesting time when the Fed has been removing accommodation and the stock market has become somewhat dependent on low interest rates,” he says. “Add to that, the House of Representatives could potentially be controlled by the Democrats after the election. All of that introduces more uncertainty and it has been taken to a higher level by the Trump administration with his strategies on international trade.”
While the market is still riding the momentum of the last decade, the housing sector has started to “really show a deterioration in the economy and the market is also struggling as we approach midterms,” says Patrick Morris, CEO of New York-based Hagin Investment Management.
The interest rate hikes by the Fed are necessary for the long-term health of the economy, but combined with a lot of uncertainty around taxes and a slow housing market will be the drivers for the market for the remainder of the year. A decline in the market before the end of the year remains a possibility.
“Obviously, the status quo always seems to propel the market higher, so a Republican House and Senate would logically give us a continuation rally or at least a substantial dead cat bounce,” he says.
A Democratic takeover of the House could precipitate a correction or even a full on bear market.
“I think we are headed that way now,” Morris says. “Companies are trading at stratospherically high valuations in many industries while the Chinese economy is rapidly slowing while there is uncertainty from the impact of far, far right-wing dictatorship in Brazil, a major power shift in Germany and God only knows what here in the US.”
Investors who are expecting a bullish outcome for the end of the year will be disappointed, says Owen Williams, a portfolio manager for Interactive Brokers Asset Management, the Boston-based online investing company, and founder of Williams Markets Analytics.
“Investors should not expect November/December returns above the historical norms just because we are in a midterm election year,” he says. “The 2018 paths of equities and bonds are not following the historical trends. We see no reason to buy equities in hopes of an outsized post-election bounce.”
Instead of focusing on returns, investors should be concerned about liquidity.
“In our opinion, if we are going to see a year-end rally, it will have to be driven by corporate buybacks as investor sentiment has soured significantly,” Williams says.
Federal Reserve officials are “almost certainly reluctant to make any market-moving statements” about monetary policy ahead of the election, says Marc Werres, a managing partner for the Hinde Group, a San Francisco-based Registered Investment Advisor and a portfolio manager for Interactive Brokers Asset Management. The recent market sell-off was primarily sparked by a communication blunder by Chairman Jerome Powell who stated “we’re a long way from neutral on interest rates” and prompted an abrupt upward shift in interest rates.
The Fed has not been able to sooth the market’s nerves since the central bankers have been criticized by President Donald Trump, he says.
“It has made it difficult for the Fed to talk dovish without it appearing to bow to Trump,” Werres says.
Companies run into roadblocks if they cannot anticipate the prevailing political environment, specifically how pro-business the policies are likely to be, says Robert Johnson, a finance professor at the Heider College of Business at Creighton University in Omaha, Nebraska.
“The stakes for these midterm elections are particularly high, given the uncertainty that exists with the Robert Mueller investigation,” he says. “Outcomes are potentially dramatically different if the Democrats regain control of the House.”
More from U.S. News