Midterms’ Market Impact

September 13, 2018

With midterm elections quickly approaching, you will find no shortage of headlines predicting how the markets will react. Media forecasts are all over the map and have been for weeks, so it’s easy to understand why investors are scared or confused about the future. Here are just a few examples:

  • “Investors may be understating the risk stocks face from the midterm elections”, MarketWatch, August 20, 2018
  • “Midterms: why the elections should boost stocks, 401(k)s”, USA Today, August 9, 2018
  • “Expect stocks to drop before the midterms”, Barrons, March 15, 2018
  • “Forget the September stock slump and brace for the market’s ‘best 9-month stretch’, MarketWatch, September 4, 2018

Wait a second, MarketWatch, didn’t you just tell me two weeks earlier to be concerned about upcoming risks?

The bottom line is, investors, pundits and the media seem to always have some sort of theory, some repeatable pattern — which is the answer to making gains and avoiding losses every time. From “Sell in May and Go Away” to the “Halloween Indicator”, the list is endless – but not necessarily reliable.

What are midterms?

Midterm elections in the United States are general elections held in the middle of an incumbent President’s term. They may include some members of the Senate, all seats in the House of Representatives, and other local positions. They gain a lot of attention from voters and investors alike, because the makeup of Congress can change. One party can retain control, see it shift to the other party, or end up divided depending on the outcome.

What history suggests for investors

What should investors expect come November and beyond? The truth is, it’s impossible to predict the future. As the saying goes, past performance does not indicate future results. However, it is interesting to reflect on history and see what markets have done leading up to and following the midterms.

According to a recent Morningstar article, “stocks tend to struggle “in the September of years that feature midterm elections – and other years as well” which they attribute to uncertainty. The average return of the S&P 500 in September from 1928-2017 according to DFA is -1.0%.

After the elections and the uncertainty fades, stocks have done well regardless of the outcome. Just how well? According to data from PIMCO and DFA, since 1950, the S&P 500 index has returned 15% on average in the twelve months following midterm elections, with no instances of negative performance – a period that includes 17 midterm elections.

What this all means for you

The midterm elections bring yet another uncertain element to the markets. But looking back throughout history, it’s evident that this has always been the case. Uncertainty is the one constant factor throughout time.

It’s important to remember that politics are just one variable to the equation. Multiple factors can impact performance over short periods, both positively and negatively, but it ultimately comes down to earnings and the expectation of those earnings over time. If companies make money, theoretically stocks should do well. The fact that stocks have made approximately 10% annualized per year since 1926 supports this, a period that includes a lot of midterms, and a whole lot of other ups and downs in between.

During uncertain times, a diversified approach and long-term focus remain the best defense. Doing so helps to smooth out the bumps, prevent missed opportunities and maximize the probability of achieving your goals. And if recent elections tell us anything, the expected outcome and market reaction can always go the other way, regardless of what the polls or news may say.