Effect of midterm elections on the stock market

The US midterms will take place on November 8, 2022, and while Biden is not the one on the ballot, the results will greatly impact his ability to implement policies in the second half of his term in office.

What are interim tests?

Midterms are the House of Representatives elections that fall in the middle of a presidential term. House elections are held every two years, so there’s one in the election year and one halfway through the term. There are also often votes in the Senate seat that fall mid-term, as senators hold their positions for six years.

During the 2022 midterms, all 435 seats in the House will be elected and 35 seats in the Senate up for grabs.

Midterm elections are important because they ultimately affect the current president’s ability to pass policies. Biden already finds it difficult to pass policies on gun control, climate change and reproductive rights, as Democrats only have a slim majority in both the House and Senate.

They have 221 seats in the Republican House of 208, with six seats open. The Senate is split 50/50 – but the tiebreaker vote is given to Vice President Kamala Harris, so you can guess which way she votes. For example, the Senate passed groundbreaking legislation on climate change and health care that would yield the largest investment in history — the result was evenly split, but Harris cast the decisive vote.

This means that if the Democrats lose even a few seats in the House or Senate, we could see Biden’s grip slip even more. The GOP needs five seats to win a majority in the House and one seat in the Senate. The states that could determine whether we see a flip are Pennsylvania, Wisconsin, Arizona, Georgia and Florida.

Will the Democrats win the midterms?

Whether Biden and the Democrats will win the midterms is still up in the air. But it wouldn’t be unusual for them to lose control of the House.

Midterm elections are often seen as a way for voters to pass judgment on the current government. If they are not satisfied with the policies they have followed, the primaries are a good way to express their views and shift power away from the current party.

For example, Democrats lost the House in 2010 halfway through Barack Obama’s presidency, and Republicans lost the House after two years with Donald Trump.

How have stock markets responded to midterms in the past?

Stock markets have historically been at their weakest during midterm election years. In fact, the second year of a president’s term has been (more often than not) the worst year for the stock market for more than 100 years, according to a report by Ned Davis Research.

We don’t see real declines every two years, but the annualized return is smaller. The Presidential Cycles report used the Dow Jones to demonstrate this:

  • 12.7% for year 1
  • 3.1% for year 2 (the interim year)
  • 14.8% for year 3 (pre-election year)
  • 7.4% for year 4 (the election year)

For Biden’s second year, the stock market is already in decline amid tightening financial conditions brought on by the ongoing impact of the coronavirus pandemic, soaring inflation and the war in Ukraine. In fact, the S&P 500 is down 4.08% this year, and the Dow is down more than 7.3%.

Using Trump’s second year as a comparison, the GOP had just passed a huge package of tax cuts and consumer confidence had soared to new heights. But by the middle of the year, stocks still fell 6.2% as the Fed raised interest rates and increased tensions between the US and China.

The theory suggests that after the decline in yields and volatility, the market will recover late in the year and into the following year – with stocks rising in the two quarters following the end of the midterm elections. A study in the Journal of Wealth Management 2019 states:

“…by examining the quarterly total returns on the S&P 500 index between 1954 and 2017, [the authors] show that nine times out of ten the index was positive in the fourth quarter of a midterm election and the following two quarters.”

While these patterns exist, it’s important to remember that every year is different. The above data was recorded before the pandemic, so many different factors are now at play.

This year we will likely continue to see the Federal Reserve attempt to curb inflation and avoid a recession, which could further dampen investor confidence. In addition, many US stocks also started the year with quite expensive valuations, which has caused volatility in their stock prices anyway.

These market moves can be daunting for investors, but over the longer term, the impact of midterms tends to self-limit. But for traders, medium-term volatility creates an interesting environment to go both long and short on US stocks and indices.

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What Happens To Stock Markets When Republicans Take Over Congress?

If Republicans enter Congress in the upcoming midterm elections, Biden will likely lose any chance of enacting policy, but US stocks could actually gain ground.

According to historical records, a Democratic president from 1901 combined with Republican control of both houses of Congress has provided the Dow Jones with an annualized real stock return of 8%. The average return of the S&P 500 in years when Democrats have held the presidency and both houses of Congress is 10.5%, compared to a 13.6% return during a divided Congress.

POLITICAL SCENARIO

S&P 500 AVERAGE RETURN

years

united government

11.2%

31

democratic president

10.5%

23

Republican President

12.9%

8

united congress

7.4%

32

Democratic press. / Republican Congress

13.0%

10

Republican Pres. / Democratic Congress

4.9%

22

Split Congress

8.6%

14

democratic president

13.6%

4

Republican President

7.3%

10

ssource: Forbes and CFRA Research, based on S&P 500 data from 1944 – 2021

For example, when Barack Obama faced a divided Congress from 2010 to 2014 — with the GOP holding the House and Democrats in the Senate — the S&P 500 rose nearly 70%.

The idea that a split cCngress is a good thing is somewhat surprising, as we generally think that markets like certainty and strong governments. But given that it will be harder for Biden to raise the federal minimum wage and raise corporate taxes, it’s not surprising that investors will benefit from a split congress.

However, it would also lead to lower government spending, which the markets have enjoyed over the past year. Biden has passed bills aimed at boosting the economy and domestic industries, such as:

  • A $1.2 trillion infrastructure bill, pushing the S&P 500 up 26% in 12 months
  • A $52.7 billion CHIP bill intended to boost domestic semiconductor manufacturing – the iShares Semiconductor ETF rose 4.66% in the week after its announcement

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