I read an interesting article in the October 1st issue of Barron’s recently. The topic was “Midterms and Markets”, which makes sense as we’re three weeks away from the midyear elections themselves. The gist of the article was what can investors expect? Normally, the midterms are dreadful for them. Going back to 1962 the average correction in a midterm election year is minus 19%, but this year has been different.
There are sixteen quarters in a Presidential Cycle and the two worst are the second and third of a midterm year. Since WWII the S&P 500 has lost 1.5% in the second quarter and 0.9% in the third. Yet this year the S&P was up 2.9% in the second quarter and 7.20% in the third. Over 10% in the historically worst performing period.
Why are midterm election years so hard on the stock markets? It’s because they are uncertain times and stocks hate uncertainty. The president’s party loses seats in the House of Representatives and it doesn’t matter who the president is. It’s happened in 19 of the last 20 midterm elections. A shift in power means a shift in policy, and since no one knows for sure what it’s going to be, the markets get nervous.
Going a little further, The Hulbert Financial Digest found that since 1900, the two quarters before the midterms only gained 1.4%. But the six months following the election, the markets grew at an annualized rate of 21.8%. You have to ask yourself if this year will follow suit since the six months prior to the election were unusually strong, but it is based on 118 years of data.
Another positive for the markets is the economy continues it nine-year growth pattern. Unemployment was over 10% at the end of the Bush Administration but it’s 3.7% today. The lowest in 49 years. Corporate earnings are strong, incomes are rising and consumers are buying which makes investors confident.
But we care about what happens going forward and how the markets will react. What happens if the Republicans keep control of the Presidency, the House and the Senate? I suspect more of the same. Investors are used to the status quo and overlook things like tariff battles with China and massive budget deficits. These deficits increase every day due to the tax cuts, and these deficits will go on into perpetuity since Republicans want a tax cut bill 2.0 to make the current cuts permanent instead of expiring in 2025 as now written.
And what happens if the Democrats take control of the House and Senate? Well, they want to raise corporate taxes from the current 21% to 25% and take proceeds and invest in infrastructure. Also, if the Democrats get control of the House, they would get subpoena power and that would allow them to search further into things like foreign interference into our elections or the undisclosed documents from the Judge Kavanaugh hearings. Potentially market negative.
Historically, the best scenario for the markets would be a Democratic House and Senate with a Republican President or vice-versa. Since 1928, that division of power has led to an 11.9% advance in the S&P 500. If the Republicans keep control of the House and Senate plus the Presidency, historic returns are 9.8%. But if the Democrats get the House and the Republicans keep the Senate, a divided congress only returns 0.2%.
I’m a political independent so a President of one party and a House and Senate of another doesn’t bother me at all, especially if it means the markets are better that way. But it made me wonder which party in the Presidency is better for stocks. Surprisingly, since 1928, Democrats have quite a lead. The average total return of a four-year Democratic term is 57.44% which equates to an annualized return of 10.83%. Republicans, on the other hand have an average four-year total return on 16.61% equating to and annualized return of 1.71%. I don’t know how much you can read into these numbers, because you can’t conclude the returns were because a Democratic or Republican was president as opposed to the times they were president, but it makes you wonder.
Since WWII, the S&P 500 returns 15% in the twelve months following a midterm election and the third year of a presidential cycle is the best for stocks. So, you want to be in, but you want to be protected.
Until the next time, we’ll watch your money.