As the country gears up for midterm elections, many investors are wondering how the results could affect the stock market. Midterm elections can introduce uncertainty and turmoil to the stock market. A change in power in Congress could lead to policy and regulatory changes that could impact the economy and corporate profits. As such, investors will be watching to see which party wins control of Congress and the implications for the stock market.
Historically, the stock market has underperformed leading up to midterm elections and bounced back in the year following the elections. Many investors use this historical precedent to predict how midterms will affect the stock market in the future. However, past performance is not indicative of future results. The midterm elections may be less important on the stock market than other economic factors, like high interest rates, inflation, and rising energy costs.
What are the Midterm Elections?
As the name suggests, midterm elections occur in the middle of a presidential term. Midterm elections are when voters elect every member of the House of Representatives and about one-third of the members of the Senate. The results of the midterm elections determine which political party controls the House and Senate, which could determine the future of economic policy that may affect the stock market.
History of Midterm Elections Results
Historically, the president’s party loses ground in Congress during the midterm elections. Of the 22 midterm elections since 1934, the president’s party has lost an average of 28 seats in the House of Representatives and four in the Senate. The president’s party gained seats in both the House and the Senate only twice over this period.
The flip in power during the midterm elections occurs, in part, because the president’s approval rating usually declines during the first two years in office, which can influence voters to vote against the party in power or not show up to the polls. Additionally, voters of the party not in control are often more motivated to vote during these elections, boosting voter turnout that can help the opposition party outperform the president’s party.
Stock Market Performance During Year of Midterm Elections
Leading up to the midterm elections, the stock market tends to underperform. According to U.S. Bank, since 1962, the average annual return of the S&P 500 Index in the 12 months before midterm elections is 0.3%. In contrast, the historical average return of the S&P 500 is an 8.1% gain.
This underperformance during the midterm year follows the Presidential Election Cycle Theory, which implies that the first two years of a president’s term tend to be the weakest for the stocks.
However, it’s unclear whether this downbeat performance and stock volatility in the year preceding the midterms is a function of investors’ views of potential election outcomes and subsequent policy changes.
Some analysts say that the underperformance occurs due to uncertainty about the election’s outcome and impact, and investors don’t like uncertainty. But others say that the more critical impact on the stock market is the state of the economy; factors like the Federal Reserve’s monetary policy, energy prices, inflation, and the state of the labor market are more important to the stock market.
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Stock Market Performance Following Midterm Elections
Even though the stock market, as measured by the S&P 500, has historically underperformed leading up to the midterm elections, stocks have tended to overperform in the post-election environment. Since 1962, the 12 months after midterm elections, the S&P 500 has had an average return of 16.3%.
The gains in stocks following the midterm elections have occurred due to no single factor. One reason may be that investors prefer the certainty of knowing the makeup of the federal government and potential policy changes.
Moreover, some believe that because the president’s party typically loses ground in the midterm elections, it reduces the likelihood of policy changes that could have a negative impact on the economy. This, in turn, can provide a tailwind for stocks. The potential for gridlock, rather than sweeping policy and regulatory changes, is usually welcomed by investors.
How Could the 2022 Midterm Elections Affect the Stock Market?
It is difficult to say how the 2022 midterm elections might affect the stock market, as many factors can affect the market, and it is hard to predict the future. However, the most obvious way the midterm elections could impact the markets is that if one party or the other gains control of Congress, that could influence economic policy and the country’s direction. This could lead to tax policy, regulation, and spending changes that could impact businesses and the stock market.
Another potential impact of the midterm elections is that if there is a change in control of Congress, that could lead to more investigations and subpoenas of businesses and individuals, which could create uncertainty that investors and the markets may not like.
However, the impact of the 2022 midterm elections on the stock market may be muted, regardless of the outcome. Going into 2023, investors may be more concerned with the potential of a recession and declining corporate profits in the face of high inflation, rising energy prices, the Russia-Ukraine war, and a global economic slowdown. These factors may affect the stock market more than any political and policy outcome following the midterm elections.
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The Takeaway
The history of midterm elections is one of cycles: the party in power typically loses ground during midterm elections, and the opposition party typically gains ground. And these cycles are also evident in the performance of the stock market, with muted stock gains in the year of a midterm election and substantial gains the year following the elections. But despite these historical trends, no one can say for sure how the midterm elections will impact the stock market. And investors shouldn’t necessarily rely on these trends when making investing decisions. Instead, investors should maintain a long-term view to reach financial goals, avoiding the short-term noise and uncertainty of elections and politics. Investors should continue to focus on asset allocation, risk tolerance, and the time horizon of a diversified portfolio to achieve financial goals.
And if you want to build your own diversified portfolio, SoFi Invest® can help. With a SoFi online brokerage account, you can trade stocks, exchange-traded funds (ETFs), cryptocurrencies, and IPOs with no commissions for as little as $5.
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