This is my last communication with you before the polls open next Tuesday morning. I’ll share the most interesting thing I’ve learned in the last couple of weeks, which has to do both with the election and the stock markets. Let me get straight to the point: stocks almost always rise strongly following the midterm elections, no matter which party wins.
This fact is particularly interesting this year since stocks have been in a downward funk over the last several weeks. Actually, it’s not unusual for stocks to fall as the midterm elections approach due to all the uncertainty – and this year is full of uncertainties about the election. The S&P 500 Index plunged about 10% from intraday high to the low in October.
But here’s the most interesting thing I’ve learned over the last couple of weeks: Since 1946, stocks have rallied strongly after every midterm election. That’s 18 elections, many of which ended up shuffling the balance of power in Congress. In midterms going back to 1946, the S&P 500 Index had an average gain of 16.7% in the 12 months after the elections.
Right now, most polls show Democrats taking control of the House in the midterm elections next Tuesday, while Republicans are likely to retain control of the Senate. One popular adage is that Wall Street likes gridlock (two-party rule) in Washington, because it creates less uncertainty and diminishes the likelihood of major legislation that could upset the markets. So why has the market been dropping lately?
As I have written recently, I believe it’s primarily because of growing fears of a trade war with China and rising interest rates. Both could be bad for US equity markets. The US trade dispute with China could undo some of the benefits of the GOP tax cuts and eventually squeeze corporate profit margins. And we all know that rising interest rates are a drag on the economy.
Another concern we should consider is the length of the current bull market in stocks. It’s now more than nine years old, the longest ever. This has many investors worried that stocks are overdue for a significant pullback.
Currently, the US economy is growing at the best clip in years, with GDP up 4.2% and 3.5% in the 2Q and 3Q, respectively. Consumer confidence remains at or near all-time record highs. Yet we are seeing more and more articles suggesting a new recession could unfold next year or in 2020 at the latest.
Despite the strong economy, history shows the president’s party typically suffers big losses in the first midterm elections after taking office. In recent history, the party holding the White House lost the majority in one or both houses of Congress in every midterm going back to 2002.
So, investors must prepare for anything. If the Democrats win control of the House, we likely face gridlock, which as pointed out above is not usually a bad thing. The stock markets typically like gridlock, as strange as that may seem.
Should Republicans remain in control of Congress, it’s likely the Trump administration will try to make the corporate and personal tax cuts included in last year’s reform package permanent. Also, on the possible to-do list if Republicans maintain control: reforming entitlements, more easing of government regulations on banks and other businesses and perhaps tackling the issue of controlling drug prices.
If the GOP somehow manages to expand its majority, there could be a push to lower capital gains taxes and enact an infrastructure spending bill.
In the scenario where Democrats regain control of the House, major policy initiatives from the White House will be dead on arrival. Democrats might find common ground with the GOP on an infrastructure bill or on legislation to control drug pricing.
Maybe so, but generally speaking analysts expect gridlock to seize Congress if the Dems retake the House. Compromise could be difficult, especially if the Democrats move to impeach Trump. In addition, it’s unlikely that even if Democrats win control of Congress they will be able to reverse the Trump tax cuts and the White House’s rollback of government regulations on businesses.
The bottom line is that stocks have rallied, usually strongly, after every midterm election since 1946 with an average S&P 500 gain of 16.7% in the 12 months following the election – regardless of which party gains ground.
So, if you have been thinking of unloading your equity portfolio due to the recent downturn, you might want to rethink that strategy based on the information I’ve provided today.
To the contrary, now may be a good time to add to your accounts while the market is down. Think about it.
I could be wrong, of course. Let’s see what the elections bring.
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