INVESTMENT PERSPECTIVES

Can midterm elections move markets? 5 charts to watch

Briefcase

Added To Briefcase

Midterm elections are top of mind for politicians and voters alike in the fall of 2018. And while control of Congress and influence over future policies may be at stake, do midterm elections have any effect on equity markets?

To find out, we examined over 85 years of S&P 500 data, and it turns out that stock markets do exhibit some unique characteristics during midterm election years. While a variety of other factors influence stocks in any given year, after digging deeper into midterm election history we’ve identified five key takeaways as illustrated in the charts below.

1. The president’s party typically loses seats in Congress.

Midterm elections occur every four years at the midpoint of a four-year presidential term, and they usually result in the president’s party losing representation in Congress. Over the past 21 midterm elections, the president's party has lost an average 30 seats in the House of Representatives and an average four seats in the Senate. Only twice has the president’s party gained seats in both chambers.

Net change in House seats controlled by president’s party after a midterm election

Source: “Seats in Congress gained/lost by the president’s party in midterm elections.” The American Presidency Project.

Why is this the case? First, supporters of the party not in power usually are more motivated to boost voter turnout. In addition, a president’s approval rating typically dips during the first two years in office, which can influence swing voters and frustrated constituents to seek change.

Since losing seats is so common, it’s usually priced into the markets early in the year. But the extent of a political power shift and the resulting policy ramifications remain uncertain until later in the year, which can explain some of the trends we see in the following charts.

2. Market returns tend to be muted until later in midterm years.

Since markets rise over long periods, it makes sense that the price chart of an “average” year would also steadily increase. However, isolating just the midterm election years highlights that these periods are different from others. In such instances, markets tend to move sideways for most of the year, gaining little ground until shortly before the election.

S&P 500 Index average cumulative return (1931-present)

Sources: Capital Group, RIMES, Standard & Poor’s. As of 8/31/18.

The adage that markets don’t like uncertainty seems to apply here. Earlier in the year there is less certainty about the election’s outcome and its policy impact. But markets tend to rally when results are easier to predict in the weeks before an election, and continue to rise after the polls close and winners are declared.

3. Volatility is elevated in midterm election years.

If you think midterm election years would be more prone to market volatility, then you’d be right. Once again, election year uncertainty seems to translate directly into higher volatility. This is especially true in the months leading up to an election.

S&P 500 Index annualized monthly volatility since 1970

Sources: Capital Group, RIMES, Standard & Poor’s. As of 8/31/18. Volatility is calculated using the standard deviation of daily returns for each individual month. The median volatility for each month is then displayed in the chart on an annualized basis. Standard deviation is a measure of how returns over time have varied from the mean. A lower number signifies lower volatility.

Since 1970, midterm years have a median standard deviation of returns of 15%, compared with 13% in all other years. Interestingly, the volatility in presidential election years has been very similar to non-election years, pointing to midterm elections as truly an outlier.

4. Markets usually bounce back strongly after elections.

The silver lining for investors is that after such bouts of volatility, markets tend to rebound strongly in subsequent months. As we saw previously, markets typically rally shortly after midterm elections. History also shows that this isn’t just a short-term blip: above-average returns are typical for a full year following the election cycle. Since 1950, the average one-year return following a midterm election is 15%, more than double that of all other years during a similar period.

S&P 500 Index price return one year after a midterm election

Sources: Capital Group, RIMES, Standard & Poor’s. Calculations use Election Day as the starting date in all election years, and November 5 as a proxy for the starting date in other years. Only midterm election years are shown in the chart.

5. Even when the House flips control, markets have similar patterns.

The consensus among most polls this year is that not only will Republicans lose seats in the House, it likely will be enough to give Democrats the majority. If this comes to fruition, would markets react differently than in a year where the majority simply lost its edge but remained in control?

S&P 500 Index return in years that House majority switched parties(Indexed to 0% on November 5)

Sources: Capital Group, RIMES, Standard & Poor’s.

The House has lost its majority during midterm elections only three times in the past 60 years, but those three years showed patterns similar to what we’ve described above — choppy markets early in the year and rising stocks around Election Day. Although no strong conclusions can be drawn from such a small sample size, history seems to indicate that a change of control in the House is not necessarily a negative market event.

So what’s the bottom line for investors?

While midterm election years have exhibited these trends in aggregate over long periods, it is important to remember that each year is different and follows its own path. Midterm elections — and politics as a whole — generate a lot of noise and uncertainty. But the reality is that long-term equity returns are generated by the value of individual companies over time. A prudent investor should look past the short-term volatility spikes that elections can bring and maintain a long-term focus.

The S&P 500 Composite Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2018 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC.
 


 

Sign up today

Get industry-leading RIA insights delivered to your inbox

*Required field
YOU MAY ALSO LIKE

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.

American Funds Distributors, Inc., member FINRA.

This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.