Financial Professionals

October 26th, 2022

How Will Midterm Elections Impact the Market?

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Equity investors looking for positive signs on the horizon may find one in an unlikely place: the U.S. midterm elections.

The first point worth mentioning is that the lead-up to midterm elections has historically proven very volatile for the stock market, a pattern that matches what we’ve seen in 2022. Going back the last 60 years, the average drawdown for the S&P 500 in the leadup to a midterm has been a stout -19% – a sizable correction close to in line with 2022’s declines.1

It is also true, however, that stocks have staged strong rebounds in the months and years following a midterm election, with positive performance far more than just a seasonal or statistical quirk. Case-in-point: since 1950, there have been 18 midterm elections, and stocks have gone up the following year 100% of the time. And not only do stocks go up, but they also tend to go up by a lot. From 1950 to 2018, here are the forward returns for the S&P 500 following a midterm election:

I think it’s more than just chance that stocks tend to behave this way leading up to and following the midterms. In the run-up to the election, there is usually an increased chance that the party in power will attempt to squeeze legislation through before the balance of power shifts, which adds uncertainty to the business and economic environment. As a rule of thumb in equity markets, uncertainty drives volatility.

But once the midterm elections take place and markets can digest how the balance of power has shifted, the uncertainty fades and corporations (stocks) have a clearer sense of what to expect from Congress in the coming two years. The ideal outcome for markets, in my view, is gridlock – split power in Congress and between Congress and the executive branch significantly lowers the likelihood of sweeping legislation, which reduces uncertainty for businesses when it comes to tax and investment planning.

Gridlock looks like a distinct possibility in this cycle. Since 1946, when a president has had lower than 50% job approval, the party has lost an average of 37 seats. With President Biden’s approval rating closer to 40% and Republicans needing only 5 net seats to regain control of the House, Republicans appear poised to take at least one chamber of Congress. Gridlock may provide a tailwind for stocks.

To be fair, there is one key caveat to the 2022 midterm election cycle that we have not seen in years past. This may come as a surprise, but the U.S. economy has never had a recession in year three of a presidential cycle, going back to 1929. This long-standing trend could break in 2023, as leading economic indicators are pointing to a mild recession either now or in the not-too-distant future. The upshot, however, is that bull markets tend to start during recessions, and stocks also historically rally when CPI peaks and comes down. I think these conditions will appear in the year following the midterm election, which only adds to the historical bull case presented above.

Bottom Line for Investors

Stocks are rarely influenced by a single factor like midterm elections, and past returns do not influence future returns. But there is a multitude of other factors working in tandem with the midterm elections that I think should give investors hope looking forward.

The risk of recession has risen with falling profit margins, a weakening housing market, and leading economic indicators that have turned slightly negative. While that does not seem like good news on its face, it is important to remember that bull markets typically start during a recession, around 6-9 months before a trough in earnings. Equity markets have also done very well once CPI peaks and come down, and also when growth is weak but improving (rather than when it is strong but slowing). In my view, we may be closer to reaching these conditions than most appreciate, just as a midterm election is about to take place.

Disclosure

1 Forbes. October 2, 2022. https://www.forbes.com/sites/michaelcannivet/2022/10/02/the-stock-market-has-risen-after-every-midterm-election-since-1950/?sh=11220dd27c48


DISCLOSURE

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by other parties. Zacks Investment Management does not assume any responsibility for the accuracy or completeness of such information. Further, no third party has assumed responsibility for independently verifying the information contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are based upon opinions or assumptions that Zacks Investment Management considers to be reasonable. Any investment inherently involves a high degree of risk, beyond any specific risks discussed herein.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor. An investor cannot invest directly in an index.

The Russell 1000 Growth Index is a well-known, unmanaged index of the prices of 1000 large-company growth common stocks selected by Russell. The Russell 1000 Growth Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

Nasdaq Composite Index is the market capitalization-weighted index of over 3,300 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks, as well as limited partnership interests. The index includes all Nasdaq-listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debenture securities. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Dow Jones Industrial Average measures the daily stock market movements of 30 U.S. publicly-traded companies listed on the NASDAQ or the New York Stock Exchange (NYSE). The 30 publicly-owned companies are considered leaders in the United States economy. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Bloomberg Global Aggregate Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

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