Last Tuesday was a historic night in US politics, with a resounding victory for the Democrats in the midterm election.
The outcome was expected, but few thought the winning margins would be as strong as they were.
There was a very positive market reaction the following day, followed by an equally dramatic selloff on day two. Let’s take a step back from the daily swings and consider how markets usually react to midterm elections.
The midterm year is often a weak part of the four-year presidential cycle for the sharemarket. Uncertainty is high heading into this period and investors will often respond positively to the outcome, simply because they know where they stand. It’s also very common for the president’s party to lose support in midterm elections, which usually means a divided government. Markets often welcome gridlock, as it reduces the likelihood of major policy changes.
This year didn’t completely follow that pattern, with the S&P 500 up a very healthy 10.5 per cent just before the midterms took place. However, the market was flat in the three months leading up to polling day, despite a very strong earnings backdrop. So maybe that does point to a bit of investor nervousness.
Historically, the post midterms period has traditionally been a strong one for US shares. Looking back at all the midterm elections over the past 100 years, the market has been up in the following 12 months 23 out of 25 times.
To go along with that 92 per cent hit rate, the average return has been 13.6 per cent, with a median gain of 14.5 per cent. That’s much better than the typical 12-month period since the late 1920s, which has seen a positive return 69 per cent of the time for an average gain of 6.8 per cent (excluding dividends).
The last time we saw a post-midterms market decline was in 1938, while the other example was following the 1930 midterms. Those periods were in the Great Depression era, when the US was grappling with banking failures, deflation and the impact of the Smoot-Hawley tariffs of 1930. That was an extreme period, and in the 21 midterm elections since then (from 1942 to 2022) the S&P 500 has been up over the next year.
That’s a very strong record, although there are still plenty of risks which might break this streak. The situation in the Middle East is arguably the key one. That directly impacts oil prices, inflation and the cost of living, which was a key reason voters pushed back so hard against the incumbent Republicans. This will also have an impact on what the Federal Reserve does from here, in terms of further rate hikes. Longer-term US bond yields will also remain in focus, and even if we see an oil price reprieve markets will be interested to see how the Democrats approach America’s fiscal challenges.
Then there’s AI, which has been a major driver of economic growth (not to mention a rising sharemarket) in recent years. Will we see more regulation, and will a Democratic Congress clamp down on data centre growth?
We also shouldn’t forget about the man in the White House. With the Democrats in control of the House of Representatives and the Senate, President Trump will struggle to execute his domestic agenda. However, he still has room to move on things like tariffs and foreign policy.
The 2028 presidential election is less than two years away, so the clock is ticking. His wounded Republican colleagues will be hoping he uses the remainder of his presidency to help stabilise the party and give it a chance for a comeback. We’ll see.
History says the US sharemarket is likely to be higher a year from now, with the average gain after the midterms double that of a normal 12-month period.
However, the US market is more concentrated now than it was in any of these historical examples. That means the extension of this winning run might come down to how a small group of mega-cap tech stocks performs.
Original Article by:
Mark Lister, Investment Director