Making Sense of the Midterms Elections and the Markets

Bruce Helmer and Peg Webb are financial advisers at Wealth Enhancement Group and co-hosts of “Your Money” on WCCO 830 AM on Sunday mornings. Email Bruce and Peg at yourmoney@wealthenhancement.com. Advisory services offered through Wealth Enhancement Advisory Services LLC, a registered investment adviser and affiliate of Wealth Enhancement Group.

As Americans prepare to vote in the Nov. 3 midterm elections, investors have another question on their minds: What will the results mean for the stock market?

The answer may be less dramatic than campaign ads and fear-inducing headlines might suggest. Elections can move markets in the short term, but history offers little evidence that either political party consistently delivers better long-term investment returns.

That distinction matters. It’s tempting to assume a divided Congress will produce gridlock, or that unified control will spur economic growth. In practice, markets have delivered gains under a variety of political arrangements.

Lessons From History

Midterms traditionally serve as a referendum on the president’s first two years in office. The party in power often loses congressional seats, potentially shifting control of the House, Senate, or both. Those changes can affect tax legislation, federal spending, and regulatory priorities.

Research from Capital Group shows that, since 1931, the S&P 500 has gained an average of 4.7% during midterm election years, compared with 9.5% in other years. Markets have also experienced greater volatility during midterm years, particularly as Election Day approaches.

Uncertainty helps explain the pattern. Investors must weigh possible changes in government policy while also assessing what those changes could mean for businesses and consumers.

Investors naturally try to anticipate these decisions. Yet election outcomes are only one influence on stock prices. And averages conceal substantial differences from one election cycle to another. A historical pattern is not a trading signal, and even a correct prediction about which party will win tells investors surprisingly little about where stocks will go next.

What Happens After Election Day?

After the votes are counted the historical performance record becomes more encouraging. The S&P 500’s average return in the 12 months following midterm elections has been 15.4% since 1950, considerably higher than returns in comparable non-election periods.

One possible explanation for this phenomenon is that markets welcome the resolution of political uncertainty. With congressional control established, businesses and investors have a clearer picture of the legislative landscape and the rules under which market participants make decisions.

This points out another truism: The economy and markets do not follow the same calendar as Washington. Federal Reserve decisions, corporate investment cycles and overseas events unfold regardless of the election timetable.

Still, a sensible investor would never use this average return to forecast the coming year. Interest rates, inflation, corporate profits and geopolitical events can overwhelm any seasonal tendency. Markets may also anticipate an election outcome well before ballots are counted, leaving little room for a surprise rally.

It’s All About Earnings

The more useful question for investors is what will support corporate earnings and economic growth after November.

Inflation and interest rates deserve particular attention. Higher borrowing costs can pressure consumers, businesses and stock valuations. They can also create opportunities for investors seeking income from high-quality bonds, although longer-maturity bonds remain sensitive to changes in yields.

Recent enthusiasm for artificial intelligence has fueled investment and helped lift major stock indexes, but recent heavy levels of spending and elevated borrowing costs raise important questions about future profitability — for both large and smaller companies.

Political decisions also matter. Changes to tax rules, trade policy, energy regulations, or government spending could benefit some businesses while creating challenges for others. But proposed policies do not automatically become law (particularly when Congress is divided), and investment decisions based on campaign promises can prove costly.

What Should Investors Do?

For investors nearing retirement, election season is a useful opportunity to review portfolio risk rather than predict the next market move. Consider whether your mix of stocks, bonds and cash still reflects your expected withdrawals and ability to withstand volatility.

Families with substantial taxable accounts should be especially cautious about making politically motivated trades. Selling appreciated investments may trigger capital gains taxes without improving long-term returns.

Business owners may have additional reasons to watch Washington. Changes in tax policy or regulation could affect succession plans, capital spending and eventual business sales. Those possibilities deserve careful deliberation and scenario planning.

Reviewing estate plans and tax strategies with an adviser can also make sense when legislative control may change. Politics matter, of course, and elections have consequences. But your financial plan must be robust enough to work through many election cycles, not just the next one.

A disciplined investment strategy, grounded in your financial goals and supported by regular, thoughtful reviews, is generally a more useful response to election uncertainty than trying to guess the winners on Nov. 3.

The original article was published in Pioneer Press. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

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