The following article is an excerpt from the April 30, 2018, Wells Fargo Investment Institute report Midterms and the markets.
By Chris Haverland, CFA Global Asset Allocation Strategist
With trade, taxes, and volatility dominating headlines this year, the looming U.S. midterm elections have received less coverage. That is likely to change as the elections near and political advertisements begin.
Currently, Republicans control the presidency, the Senate, and the House of Representatives (through a majority) — and they’ve promoted a pro-market agenda of tax reform and deregulation.
Yet, polls at the time of this writing show a greater likelihood of a Democratic takeover in the House of Representatives following the midterm elections, and they suggest Republicans likely will maintain a hold on a Senate majority.1
Historically, political uncertainty leading up to midterm elections has led to greater market volatility, and this year has been no exception.
Midterm elections and S&P 500 trends
In previous midterm election years, the S&P 500 Index has experienced a sell-off early in the year — and, on average, ends the first three quarters flat to slightly lower (as of this writing, the S&P 500 Index price is nearly unchanged year to date).
Equity markets have tended to rally in the fourth quarter of midterm election years as election results become clearer. Since 1962, fourth-quarter returns for the S&P 500 Index during midterm election years have averaged 7.5% (with October being the best month).
As the chart shows, equity-market corrections during midterm election years historically have turned out to be great buying opportunities.
- Since 1962, the average peak-to-trough S&P 500 Index decline during these years was 19%, although the past three midterm election years averaged closer to a 10% drop (the correction in February 2018 was approximately 10%).
- In all instances, the index was higher one year after the trough, with an average return of 31%.
- Furthermore, once the midterm election takes place, the index has been higher one year later every time since 1946. This could be partly due to the markets preferring a greater balance of power or the anticipation of additional fiscal stimulus in a president’s third year in office.
Although a Republican majority in Washington, D.C., historically has been accompanied by strong equity-market performance, a potential split in Congress is unlikely to derail the U.S. equity bull market (in our view).
The average annualized return for the S&P 500 Index when Republicans were in control was a robust 15.1%. If Democrats win a majority in the House of Representatives this November, history tells us U.S. equity-market returns have been lower under this scenario, but they still have been double-digit returns (on average).
Average S&P 500 Index returns by political party control: 1933 – 20162
(President/Senate/House of Representatives)
|S&P 500 Return||15.1%||13.6%||13.0%||10.8%||9.3%||4.9%|
Source: Strategas, as of April 20, 2018. Returns are average annual S&P 500 Index returns between 1933 and 2016, and reflect relative political party control.
A turning point
Historical analysis suggests the midterm election cycle is traditionally a turning point for equity markets, regardless of the shift in power.
Not unlike today, volatility often picks up as investors digest shifting political winds that could impact fiscal and monetary policy, the economy, and corporate earnings.
We believe the year-to-date market movement is normal, and we expect equity markets to end 2018 higher than where they are today.
If markets continue to experience greater volatility, it likely will present an opportunity to lean into some of the asset classes we view favorably.
In particular, we continue to see strong fundamentals and reasonable valuations in U.S. equities, and favor cyclically oriented sectors such as Consumer Discretionary, Financials, and Industrials, along with Health Care.
- U.S. midterm elections will be held this fall, and these elections historically have signaled some clear patterns for equity markets.
- Midterm election years have had higher volatility in the past, but also have offered some compelling buying opportunities.
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2. Charts are for illustrative purposes only. There is no certainty that the S&P 500 Index will perform similarly in the 2018 midterm election year as it has in past midterm election cycles or in future midterm elections or produce similar returns as shown above relative to political party control. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.