U.S. Mid-term Elections
U.S. elections are different from many other democracies regarding rules and customs. The Mid-term elections occur every four years, coinciding with the halfway or the second year of a U.S. president's term.
It encompasses numerous election contests, from congressional seats to local mayoral races, county legislature, and county sheriffs. The most important of these contests are the high-profile contests to decide the upper chambers of the Senate and the lower chamber of the House of Representatives.
Tomorrow, 11/8/22, is another critical Mid-term election year, as the outcome will help decide who will control Congress. Currently, the Republicans and the Democrats are split evenly within the Senate between 50 Republican senators and 48 Democrats/2 Independents. The party breakdown for the House of Representatives currently favors the Democrats, but only by a slim lead of 222 Democrats to 212 Republicans.
Mid-term Elections offer voters a chance to weigh in on President Biden’s performance during his two years in office. If voters are unhappy with the president and his policies, there may be a shift in the balance of power in Congress.
Crucial races to decide who controls the two chambers are almost always closely monitored. State and local races typically go unnoticed. The races to determine the governors, big-city Mayors, and local lawmakers can sometimes serve as a litmus test of current policies. With the thin margins the Democrats hold in the House and Senate, there may be a broad shift in power soon after the Mid-terms elections.
Will Mid-term Elections affect the stock market?
History says yes. Major political events such as Mid-term Elections and changes in government policies can impact businesses, which tend to influence corporate profits and stock prices.
Historically, stocks tend to perform well after Mid-term Elections. Since 1946, in 17 of the 19 Mid-term Elections, stocks performed better in the six months after the election than the six months prior.
Will a swing from the Democrats to the Republicans lead to a stock market bottom and the start of the next bull rally?
Incumbent's party loses seats during Mid-term Elections
Mid-term election trends over the past 88 years suggest the incumbent president’s party can lose an average of thirty (30) seats in the House of Representatives and four (4) seats in the Senate.
If this trend repeats in tomorrow’s mid-term election, it is reasonable to expect the incumbent’s party (Democrats) will lose control of both the House and the Senate.
Some pollsters believe the reason for the change in power in the two chambers is the party currently not in power (Republicans) is more motivated to regain control, leading to higher (Republican) voter turnout in the next mid-term election.
Others cite the president’s approval rating typically declines during the first two years in office. When a president's approval rating falls, swing voters seeking a change tend to vote for candidates from the opposite party.
Elevated market volatility and muted stock market returns
Since the U.S. stock market retains a long-term upward bias, the results of the mid-term election are not likely to impact the prevailing structural trend. However, election uncertainties coupled with the Russian/Ukraine war, rising inflation, supply bottlenecks, hawkish monetary policies, the Covid-19 resurgence, and recession fears can still lead to elevated market volatility into the end of the year.
Historical trends also suggest voters and investors are more cautious during Mid-term elections. According to the 2022 Stock Trader Almanac, starting in 1946, investors tend to be defensive, evidenced by SPX averaging gains of about 6% during Mid-term elections or 200 basis-point below the long-term SPX average annual returns of 8%.
The mid-term election stock market returns tend to be weaker when a Democratic president is in control, averaging 4% for the entire year. During the first year of a Democratic president, SPX lost -0.6% of its value, and during the second year, SPX lost an average of -2.3%.
All four scenarios (all years, Mid-term elections, first-term Mid-term elections, and the second year of a new Democratic President) show stocks tend to peak around April and achieve a low between May and October.
Mid-term Election Year Cycle Stock Market Bottoms and Recoveries
Another study by Stock Trader Almanac suggests the Mid-term Election Years (second-year of a U.S. Presidential Election year cycle) and Pre-election years (the third year) tend to lead to stock market bottoms.
Stock market corrections tend to develop during the first or the second years of a 4-year U.S. presidential term. For instance, since 1961, 9 of the 17 bear market bottoms occurred during the Midterm election years.
Also, since 1914, during Mid-term Elections, the Dow Jones Industrial Average recorded six (6) bottoms during January (1918, 1922, 1950, 1954, 1986, and 2006) and four (4) during October (1946, 1966, 1990, and 2002).
Additionally, INDU recorded Pre-Election highs in nine (9) December (1915, 1927, 1955, 1959, 1963, 1991, 1995, 1999, 2003).
On a positive note, the percentage change between the Dow Jones Industrial Average Mid-term Election year low to the Pre-election year high averaged 47.4%.
Are the October 2022 reaction lows also 4-year Mid-term Election bottoms?
October 2022 lows for popular indexes are as follows:
SPX low = 3,491.58 (10/13/22)
INDU low = 28,660.94 (10/13/22
NYA low = 13,278.56 (10/13/22)
COMPQ low = 10,088.83 (10/13/22)
NDX low = 10,440.64 (10/13/22)
MID low = 2,185.93 (9/27/22)
SML low = 1,057.91 (9/27/22)