American heads to the polls in under a month on November 8 2022 for midterm elections. Researchers at the University of Canterbury think this might be a very good thing for a stock market that could use a jolt of positive momentum after a terrible 2022 so far.
The Impact Of Midterm Elections
Historically, returns from October of a midterm election year to June of the following year have seen above average returns for markets. This is documented in ‘Midterm Elections’ Stock Market Surge – An Unintentional Gift From US Politicians’ from researchers at the New Zealand’s University of Canterbury as published in 2018 and recently updated, as well as being validated by other research papers in recent years.
The results are good. They find that 9 times out of 10 between 1954 and 2017 the U.S. markets have delivered a positive return over the October to June midterm period and that compounded returns over those three quarters are around 25% broadly speaking. And to provide a recent update the results after the 2018 midterms with this strategy were below average, but still positive.
Of course, this trend may not repeat in 2022 and the U.S. market has historically risen on average, but still these are promising numbers. The relevant period for these midterms this time applying the same research would be from October 2022 until June 2023.
In fact, should the midterm effect continue to be hold these are argued to be some of the strongest effects of the political cycle on the markets. Surprisingly, the midterms may matter more than Presidential elections do for markets.
Perhaps a reason for this is that U.S. midterm elections can often lead to political gridlock, or divided government. That occurs when multiple political parties share power. Currently the Democrats control the the U.S. House of Representatives, the Senate (by a single vote) and the Presidency.
That may be a risk for markets, as legislation could occur that is bad for firms’ profits, or at least makes the future more risky. Note that this argument applies regardless of whether Republicans or Democrats hold power, so it doesn’t favor either party.
However, after the upcoming elections, polls currently give a 7 in 10 chance that Republicans will likely take control of the U.S. House of Representatives, but about the same chance that the Democrats hold on to the U.S. Senate. Of course, anything could happen and those estimates will change as the election nears, but gridlock is a likely outcome as it has been in many prior U.S. elections.
Gridlock is often viewed as good for markets. It can mean that fewer laws are passed, and those laws that are passed are often less controversial. That leads to predictability and fewer surprises, something that markets typically favor.
It’s worth noting that some argue political gridlock is a most recent trend in U.S. politics, since the 1980s. Previously, parties sharing power in earlier decades would be more likely to pass legislation.
Given that the positive market data goes back to 1957, it may be that it’s possible to overstate the positive reaction of markets to economic gridlock and something else is going on with the impact of midterms on markets.
Compensation For Risk?
Some argue this is just compensation for the greater risks associated with electoral uncertainty. That means that yes, the markets do rise after the midterms, but the midterms are a risky event and could cause the markets to fall, even though that hasn’t happened too often in recent history.
Therefore, the rise in markets potentially reflects compensation for the risk associated with midterm elections. After drilling into the data an update to the research from last month by the same University of Canterbury research team, finds that the trend is broad-based, with no advantage to specific sectors or investing styles.
So it may also be that elections are highly uncertain regardless of their outcome, regardless of whether gridlock results. It’s unclear what will happen until after election results are announced, so elections remove risk.
The Current Environment
Of course, there’s a lot to worry about in this current bear market. Still, the historical track record of the markets around midterms gives some welcome reason for a bit optimism.
Maybe the midterms elections will result in legislative gridlock, and perhaps that will prove a boost to markets, or perhaps some other effect is occurring. History suggests the odds of a favorable outcome for markets are pretty good here, we won’t have too long to wait to find out.