Elections How U.S. midterm elections may affect markets

1. The president’s party typically loses seats in Congress — and markets know it.

Midterm elections occur at the midpoint of a presidential term in November, and they usually result in the president’s party losing ground in Congress. Over the past 23 midterm elections, the president’s party lost an average 27 seats in the House of Representatives and three in the Senate. Only twice has the president’s party gained seats in both chambers.

This tends to happen for two reasons. First, supporters of the party not in power — in this case, the Democratic Party — usually are more motivated to boost voter turnout. Second, the president’s approval rating typically dips during the first two years in office, as it has with President Trump, which can influence swing voters and frustrated constituents.

Republicans currently control both the Senate and House by slim margins. Losing either chamber would effectively end any chance to pass ambitious Republican-sponsored legislation over the next two years, and it would put Trump on the defensive for the remainder of his term in office, according to Capital Group political economist Matt Miller.

Since losing seats is so common, it’s usually priced into the markets early in the year. But the extent of a political power shift and resulting policy impacts remain unclear until later in the year, which can explain other interesting trends.

2. Market returns tend to be muted in midterm years.

Since markets have typically gone up over long periods of time, the average stock movement during an average year should steadily increase. But we found that in the initial months of midterm election years, stocks have tended to generate lower average returns and often gained little ground until shortly before the election.

Markets don’t like uncertainty — and that adage seems to apply here. At the start of the year there is less certainty about the election’s outcome and impact. But markets have tended to rally in the weeks before an election then continue to rise after the polls close.

Despite election-related uncertainty, investors should consider the cost of sitting on the sidelines or trying to time the market. Historically speaking, staying invested has been the smartest move.

The path of stocks varies greatly each election cycle, but the overall long-term trend of markets has been upward. Since 1931, the S&P 500 Index has seen an average return of 4.7% in midterm election years, about half the 9.5% average for all other years but positive all the same.

3. Volatility has been elevated in midterm election years.

There is no question that election season can be tough on the nerves. Candidates often draw attention to the country’s problems, and campaigns regularly amplify negative messages. Policy proposals may be unclear and often target specific industries or companies.

If you suspect that this contributes to increased market volatility, then you’re right. Once again, election year uncertainty seems to translate directly into higher volatility. This is especially true in the months just prior to an election.

Since 1970, midterm years have a median standard deviation of returns of nearly 16%, compared with 13% in all other years. Interestingly, the volatility in presidential election years has been very similar to non-election years, pointing to midterm elections as truly an outlier.

4. Markets usually bounced back strongly after elections.

The silver lining for investors is that markets have tended to rebound strongly after Election Day. As we have seen, markets typically rally shortly after midterm elections. History also shows that this isn’t just a short-term blip: Above-average returns are typical for a full year following the election cycle. Since 1950, the average one-year return following a midterm election was 15.4%. That’s nearly twice the return of all other years during a similar period.

Of course, every cycle is different, and elections are just one of many factors influencing market returns. For example, investors will need to weigh the potential impacts of oil prices, tariffs, inflation, and interest rates, as well as global economic growth and geopolitical conflicts.

5. Control of Congress has had little impact on investment returns.

There’s nothing wrong with wanting your preferred candidates to win, but investors can run into trouble if they place too much importance on election results. That’s because, historically, elections have had little impact on long-term investment returns. Going back to 1933, markets have averaged double-digit returns during various scenarios, including when a single party controlled the White House and both chambers of Congress as a “unified government,” a split Congress, and when a president’s opposing party controls Congress.

Although midterm election years have exhibited these trends in aggregate over long periods, it is important to remember that each year follows its own path. Midterm elections — and politics as a whole — generate a lot of noise and uncertainty. But the reality is that long-term equity returns are generated by the value of individual companies over time. A prudent investor should look past the short-term volatility spikes that elections can bring and maintain a long-term focus.