The market casts its vote
11/06/18

●The market’s performance this year fits historical midterm-election-year pattern

●Historically, market has often staged a brief bounce on and after midterm election days


 

One thing that hasn’t gotten much play recently is how the US stock market’s year-to-date performance fits into the history of midterm election years. As detailed in “Midterm election year pattern” (waaay back on January 2), dating back to 1962, the S&P 500 (SPX) has, on average, tended to perform sub-par in the first 10 months of these years.

In fact, this year hasn’t even been that bad, relatively speaking. While the SPX gained ground from January through October in 77% of all years since 1960, only half of midterm election years (MTE) had positive January-October returns. And this year’s 1.4% January-October gain was a lot better than the -3.01% average return for all other midterm years:

Table 1: Midterm Elections: S&P 500 average returns (1960-2016)

Source: OptionsHouse

The upshot is that the market, overall, killed it in the 12 months following midterm elections: Since 1962, the SPX has never failed to rally from October 31 of a midterm election year to the following year’s October 31. The win rate for all other years was 84%, so yes, we’re talking about an improvement over some already bullish stats, not a 180-degree trend reversal. But the 16.57% average SPX return for the midterm election October-October periods was twice that of the 8.27% average October-October return for all other years.

But talk a few minutes to your friends, neighbors, and relatives and you’re sure to come up with a dozen reasons why this time may be different—and you could be right. But there’s another aspect of the election to consider: What may be in store the next several days.

Yesterday’s mostly quiet trading day was par for the course—it’s the same wait-and-see stance the market often takes before an FOMC announcement, a jobs report, or some other piece of juicy news. Here are a few other things the SPX has tended to do around midterms over the past 56 years:

●Rally on election day: The SPX closed higher 75% of the time on midterm election days.

●Flipped a coin the next day: The day after election day, the SPX closed higher than its closing price the day before election day just 50% of the time.

●Closed higher five days later: The SPX was up five days after a midterm election in 10 of 14 instances (71% of the time), with a median 0.94% return.

The following table summarizes the SPX’s performance on midterm election day and the next five days:

Table 2: S&P 500 returns, midterm elections (1962-2014)

Source: OptionsHouse

It’s fair to argue that the more common post-election-bounce scenario would depend on the market getting the result it expected. In this case, the vast majority of polls have the Democrats gaining a majority in the House and Republicans holding on to the Senate.1 And reports show the financial industry has funneled 63% of its campaign contributions to Dems, suggesting the Street is anticipating this flip.2

But it’s also easy to make the case that a “surprise” Republican victory in the House would be received favorably by the Street. The only outcome likely to be received negatively by the market is be a Democratic takeover of the Senate, which many peg as a long shot, but you only have to look back two years to remember how wrong polls and forecasts can be.

Basically, the dynamic at work could be summed up as a tendency for a “relief” bounce as the market gets the election out of the way, after which it can get back to worrying about (or shrugging off) things like trade wars, interest rates, and “peak earnings.”

 

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1 FiveThirtyEight.com. Forecasting the race for the House. 11/5/18.

2 CBSNews.com. Wall Street's campaign contributions are flowing mostly to Democrats. 10/31/18.