3 ways the midterm elections could impact the stock market – Forbes Advisor

KEY POINTS TO REMEMBER

  • Stocks tend to sell off ahead of the midterm elections.
  • Market volatility is pronounced immediately before and after the midterm elections.
  • Stock markets tend to rebound in the two quarters following the midterm elections.

When it comes to stock market performance, midterm election years are not like other years.

Take 2018, when Democrats regained control of the House of Representatives. The GOP had just pushed through a massive package of tax cuts, and the unemployment rate ended the year below 4%. Consumer confidence had peaked after the Great Recession as business investment surged.

You would think that this scenario would lead to a booming stock market, but that’s not what happened. Instead, stocks fell 6.2% in 2018 as the Federal Reserve raised interest rates four times and the United States entered a trade war with China.

History shows that market performance during the 2018 midterm election year is hardly an anomaly. In fact, the second year of a presidential term follows a predictable pattern: average stock returns tend to decline in the second and third quarters, with high market volatility, followed by a stock market rebound at the end of the year and in the first semester. of the following year.

“In the short term, the midterm elections are affecting client portfolios,” said Tyler Ozanne, financial adviser at Probity Advisors. Let’s take a closer look at how this plays out.

Stock markets trend lower ahead of midterm elections

“It’s been long, painful and depressing.” That’s how Joseph Liro, an economist at Stone & McCarthy Research Associates, described stock market performance to The New York Times after the third quarter of 2002, a midterm election year.

His grumpiness was justified: after barely budging in the first three months of 2002, the S&P 500’s total return fell 13% in the next three months, then another 17% thereafter.

Corporate earnings suffered, consumer spending was uninspired and international equities, particularly in Japan and Europe, further weighed on risk appetite. Meanwhile, there were worries about an impending war in Iraq, one of the world’s top producers of crude oil.

While market performance is rarely this spectacular during midterm election years, data shows you shouldn’t be surprised when stocks falter ahead of the election, according to data from Sam Stovall, chief market strategist. investments at the CFRA.

“I call the midterm election year the ‘sophomore crisis’ for the president,” Stovall told Forbes Advisor.

Midterm reviews are held during the third quarter of the second year of a presidential term. According to data from Stovall, in midterm elections between 1945 and 2021, stocks saw an average decline of 1.8% in the second quarter and another decline of 0.5% in the third quarter.

Interestingly, these are the only two quarters that have seen an average price decline over the past 76 years, according to Stovall.

A number of trends have already been set for history to repeat itself, not the least of which is Russia’s invasion of Ukraine and the impending Fed rate hikes.

Midterm election years tend to see increased market volatility

Investors should prepare for a bumpy ride in the quarters before and after the midterm elections.

The 2022 midterm election year got off to a rocky start for markets as potential Fed interest rate hikes weighed on demand for the big tech stocks that have dominated the post-lockdown recovery. of Covid. That has some investors worried about a general slowdown in the economy as the Fed tries to rein in high inflation.

With stocks entering the year trading at high valuations, it’s no surprise to see them rebound when bad news – a bad earnings report, international conflict – pops up on the radar.

Historically, stock markets have oscillated wildly during midterm election years, and much like bad returns, stocks have been most volatile during the second and third quarters of a midterm election year. -mandate.

An analysis by financial services giant Capital Group found stocks had a median standard deviation of return of 15% since 1970, two percentage points higher than any other year.

“The volatility of presidential election years was very similar to non-election years, indicating that the midterm elections were truly the outlier,” reads a Capital Group report.

This trend was evidenced when the Dow Jones Industrial Average (DJIA) plunged about 1,000 points on May 7, 2010, before rebounding to close nearly 350 points, or more than 3%. During this midterm election year, a major debt crisis in Europe saw the International Monetary Fund (IMF) bail out the Greek government, which was drowning in bad debt, punishing the European economy.

Stock markets tend to rebound after midterm elections

After trying spells before the midterm elections, the stock market tends to calm down and recover for months afterwards.

Data from Stovall reveals that the S&P 500 returns 6.1% in the fourth quarter of election years, then offers a gain of 7.5% in the first quarter and 4.2% in the second quarter of the following year. Investors spend much of the midterm election news cycle worrying about the outcome, then relax when they find the world hasn’t ended after the election.

These discoveries are also not random. A study published in the Spring 2019 edition of the Journal of Wealth Management found that, “looking at the quarterly total returns of the S&P 500 Index between 1954 and 2017, [the authors] show that nine times out of 10 the index was positive in the fourth quarter of a midterm election year and the following two quarters.

Moreover, the study found that neither changes in the Federal Reserve nor congressional spending could explain this effect.

In 1990, stocks fell almost 14% over the summer as the country grappled with a recession, high unemployment and a painful oil shock. The first Gulf War was starting and consumers were losing confidence.

Just three months later, however, shares rose 8.5% and then jumped another 15% over the following three months. The Dow Jones Industrial Advantage hit 3,000 soon after. Investors were encouraged by the Federal Reserve’s interest rate cut to help get the economy back on track.

What to watch for in the 2022 midterm elections

This year’s political and economic trends are sending mixed signals. Democratic political candidates and economists have been singing the praises of the economy for much of the past year. The unemployment rate is down, employers are adding jobs and workers are finally getting big raises.

Economic growth has been robust, even with the Omicron variant of Covid-19, so much so that the Federal Reserve will almost certainly raise rates this spring.

At the same time, Republican candidates have hammered rampant inflation as one of their main talking points, with price increases hitting four-decade highs. Many Americans are spending more than usual on groceries, gas, and electric bills; in fact, the average worker has seen his wages increase less than prices in general.

That’s why consumer sentiment toward the economy, particularly in the latest Forbes Advisor-Ipsos Consumer Confidence survey, appears so weak.

Add to that four or five potential Fed interest rate hikes, slowing economic growth and continued supply chain shortages, and it’s no surprise that Americans feel so rotten.

These blues, according to a recent article by Paul Whiteley and Harold Clarke on the London School of Economics website, could lead to the ruling party – the Republicans – winning enough elections to secure a majority in the House of Representatives, and maybe even in the Senate.

If that happens, any faint hope President Biden has of rekindling interest in his Build Back Better plan will be all but extinguished, while Congress could turn to issues that enjoy bipartisan support, like the politics of retirement and…….

How to position your portfolio?

However, each midterm election has its own peculiarities. Although stocks fell in 2018, much of that decline took place at the end of the year, which is why you shouldn’t rely on historical trends to try to time the market.

Ozanne said he’s been getting more calls than usual from customers asking for information about this year’s midterm elections, which he attributes to concerns about potentially higher taxes if the Democrats stay in power. .

He cautions, however, that while investors need to be sensitive to potential swings in stocks and bonds during midterm election years, you need to hold steady to avoid making rash decisions before November.

“We’re talking about a period of weeks and months,” Ozanne said. “Over the long term, the midterm elections have no bearing on investment portfolios.”

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Julio V. Miller