Will The US Midterm Elections Be Good For Stocks?

Will The US Midterm Elections Be Good For Stocks?
Luke Suddards

over 1 year ago4 mins

  • Polling indicates Republicans are highly likely to win a majority in the House of Representatives and stand a fair chance of winning one in the Senate. Popular political betting website PredicIt places a 75% probability for a “red wave” win of Congress.

  • Goldman Sachs’ research shows that over the past 90 years, the S&P 500 has generated a median return of 3% through year-end after midterm elections and 17% during the 12 months after the vote. However, this booster effect tends to fade when the Fed is hiking rates.

  • If history repeats, then at an index level the iShares Core S&P 500 ETF would be expected to gain. On a sector basis, you might consider the iShares US Healthcare Providers ETF or the iShares S&P 500 Information Technology Sector UCITS ETF.

Polling indicates Republicans are highly likely to win a majority in the House of Representatives and stand a fair chance of winning one in the Senate. Popular political betting website PredicIt places a 75% probability for a “red wave” win of Congress.

Goldman Sachs’ research shows that over the past 90 years, the S&P 500 has generated a median return of 3% through year-end after midterm elections and 17% during the 12 months after the vote. However, this booster effect tends to fade when the Fed is hiking rates.

If history repeats, then at an index level the iShares Core S&P 500 ETF would be expected to gain. On a sector basis, you might consider the iShares US Healthcare Providers ETF or the iShares S&P 500 Information Technology Sector UCITS ETF.

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The US midterm elections are upon us – and historically the months that follow the vote tend to be good ones for stocks. So, before the ballots are counted, let’s look at how things are expected to play out, which sectors typically rally after the midterms, and what might temper any gains this year.

What do the polls say?

Midterms are seen as a litmus test of the popularity of the president and the president’s party during their first two years in charge. All 435 members of the House of Representatives are up for reelection, after all, and about a third of the 100 members of the Senate. Historically, the party that holds the White House tends to lose some seats in Congress at this midway point. Currently, the Democrats control Congress – both the House and the Senate. From an economic and political perspective, that means more policies are likely to pass.

The current polling (from a variety of reputable sites) shows a very high probability that the Republicans will become the majority party in the House of Representatives. FiveThirtyEight puts it at an 85% probability and PredictIt, the popular political betting site, puts it at 90%.

The Senate, however, is a much closer call. Republicans need just one seat to win back control of the Senate from Democrats. FiveThirtyEight’s model sees a 55% probability that they’ll get it, while PredictIt puts those odds at 74%.

PredictIt has also done the odds on which party is more likely to control both chambers: it puts the probability at 75% for Republicans. So, it’s looking like we could see a red wave, which may set the stage for further political wrangling, and potentially halt progress on future economic policy.

Implied probabilities of different Congress outcomes from PredictIt. Source: Macrobond, Nordea & PredictIt.
Implied probabilities of different Congress outcomes from PredictIt. Source: Macrobond, Nordea & PredictIt.

The economic backdrop is likely to be a motivating factor for voters. Consumers’ incomes are being squeezed by eye-wateringly high inflation, and with the S&P 500 down more than 20% this year, many Americans are feeling less well-off than they did before.

How will all of this affect my stock portfolio?

Stocks typically perform well after midterm elections, as political uncertainty fades and as the shifting balance of power reduces the likelihood that new regulations or other laws might pass. Goldman Sachs’ research shows that over the past 90 years, the S&P 500 has generated a median return of 3% through year-end in midterm years, and 17% in the 12 months that follow the vote. And returns were a full two percentage points higher when Congress was controlled by a party other than the president’s. Indeed, stocks have gained after all but one of the 22 most-recent midterm election years – falling only in 1939 (the start of the Second World War).

Swiss-based investment firm Pictet Group, meanwhile, has looked at the past 60 years to see how the S&P 500 has performed in the 12 months after a midterm election, comparing what happens when the Federal Reserve is hiking interest rates (gray line) – as it is now – and when it’s not (red line). And it found that when interest rates are rising, this midterm rally effect fades.

Historical returns during a Fed hiking cycle and excluding hiking cycles. Source: Pictet.
Historical returns during a Fed hiking cycle and excluding hiking cycles. Source: Pictet.

There’s a buffet of things going on, from escalating geopolitical risks and “hawkish” central banks raising interest rates, and this may make averages from the past, which were based on more docile conditions, less useful in the present.

So let’s take a look under the hood of the S&P 500 at the specific sectors that historically have notched post-midterm gains. Since 1974, healthcare and information technologies (upper right) have been the strongest performers in the two months after midterms, while consumer staples and financials have been the weakest.

Returns via sector pre- and post-midterms. Source: Goldman Sachs.
Returns via sector pre- and post-midterms. Source: Goldman Sachs.

Further down the road, if we do end up with a gridlocked government, then fiscal support packages to help in the event of a downturn in growth (recession), could be smaller, delayed, or blocked. This could exacerbate the contraction. As a result, the burden could be shifted from fiscal support to monetary via the US Federal Reserve. Lower fiscal spending and a deeper economic contraction could lead to more dovish expectations for the Fed’s benchmark rate (pivot), perversely causing stocks to rally and the dollar to decline.

What’s the opportunity then?

If you think history will repeat and stocks will rally, there are a few ways to skin this cat. First, the stock standard iShares Core S&P 500 ETF (ticker: IVV; expense ratio: 0.03%). On a sector basis, you could look at the iShares US Healthcare Providers ETF (IHF; 0.39%) or the iShares S&P 500 Information Technology Sector UCITS ETF (IUIT; 0.15%). Zooming in even further, healthcare stocks Johnson & Johnson (JNJ), AbbVie (ABBV), and Regeneron Pharmaceuticals (REGN) have been underperformers and could be due for a change in direction.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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