The stock market did not perform well in the year leading up to the midterm elections. This year’s election may only add to the global woes besetting equities.
Historically, the average annual return of the benchmark S&P 500 in the 12 months leading up to the midterm elections is 0.3%, compared to a historical average of 8.1% in non-midterm years. . In 2022, of course, with the S&P 500 down more than 20%, those historic numbers look pretty good. Unfortunately, volatility also tends to increase before and after midterm elections.
But this year is different, you might say, as we are witnessing the first European war in decades, as well as the highest rate of inflation in 40 years. And let’s not forget the persistence of the coronavirus, a pandemic whose magnitude the world has not known for more than a hundred years.
While all of this is true, it does not contradict the data. For more than a century, the second year of the four-year presidential election cycle has consistently been the weakest in terms of performance, so investors should prepare for an even worse year than most.
Consumer confidence is at rock bottom and a growing list of issues – political, social and economic – plague voters. The economy is sending mixed signals. It continues to grow, although that growth is slowing down. But right now, US GDP remains strong enough for employers to keep hiring and wages to rise – but for how long?
Two major negative factors are increasingly threatening the economy: inflation and the Fed’s determination to combat it with tighter monetary policy. These two elements have an impact on the wealth effect of American voters. Higher interest rates hurt the stock market and with it the average American’s retirement portfolio. House prices, another bright spot for homeowners, are also stabilizing as mortgage rates rise. The two combine to inflict a general sense of diminishing wealth on many households. We feel poorer.
Inflation adds to this feeling. At the gas pump and supermarket, soaring inflation has dramatically increased the cost of living for most voters. Workers note that recent wage increases do not cover the effects of inflation on the family budget. Worse still, more and more economists are beginning to fear that the Fed’s monetary tightening will ultimately lead to a recession in the near future, whether this year or next. If so, macro data will likely show it just in time for November’s midterm elections.
The makeup of Congress and the Senate adds even more uncertainty to the midterm equation. Looking at midterm elections since 1934, the president’s party has lost at least 30 seats in the House and four seats in the Senate. There are only three years in history where the president’s party has won seats. Democrats cannot afford to lose Senate seats and a few House seats if they hope to hold on to their majority. At this point, history argues against that happening.
Investors tend to dislike uncertainty and like the status quo within their governments. The stakes are high. If Democrats hold their ground in both houses of Congress, the likelihood of new legislation (and possibly new taxes) becomes higher. If Republicans win one or both chambers, deadlock becomes the likely outcome in government. In this case, investors can expect few new laws or unpleasant surprises. Either way, we can be sure that the markets will be anything but calm until November 5th.
Of course, there are a multitude of social issues, which can help determine the outcome. However, the economy usually takes precedence over everything else in the minds of voters. Either way, readers can expect politicians on both sides of the aisle to add to market volatility in the months ahead. From now on.
Bill Schmick is registered as an investment adviser representing Onota Partners Inc. in the Berkshires. He can be reached at 413-347-2401 or by email at [email protected]