With more than nine months to go, midterm elections are already top of mind for politicians and voters alike. And with good reason. Capital Group’s (who run American Funds) political economist Matt Miller believes 2022 could be one of the more consequential midterm elections in U.S. history.
“Make no mistake, every move in Washington right now is being carefully calculated with the midterms in mind,” Miller says.
But while control of Congress may be at stake, do midterm elections have any effect on equity markets?
To find out, we examined more than 90 years of data and found that the answer is yes, markets have behaved differently during midterm election years. Here are the five key lessons you need to know about investing in this political cycle:
1. The president’s party typically loses seats in Congress
Midterm elections occur at the midpoint of a four-year presidential term and usually result in the president’s party losing ground in Congress. Over the past 22 midterm elections, the president’s party has lost an average 28 seats in the House of Representatives and four in the Senate. Only twice has the president’s party gained seats in both chambers.
2. Market returns tend to be muted until later in midterm years
Markets don’t like uncertainty, and that adage seems to apply here. Earlier in the year there is less certainty about the election’s outcome and impact. But markets tend to rally when results are easier to predict in the weeks before an election, and they continue to rise after the polls close.
3. Midterm election years have had higher volatility
Elections can be tough on the nerves. Candidates often draw attention to the country’s problems, and campaigns regularly amplify negative messages. Policy proposals remain uncertain but often target specific industries or companies.
So it may not be surprising that market volatility is higher in midterm election years, especially in the months leading up to Election Day. Since 1970, midterm years have had a median standard deviation (a measurement of volatility) of returns of nearly 16%, compared with 13% in all other years.
4. Market returns after midterm elections have been strong
The silver lining for investors is that after such bouts of volatility, markets tend to rebound strongly in subsequent months. And the rally that often starts shortly before Election Day isn’t just a short-term blip. Above-average returns are typical for the full year following the election cycle. Since 1950, the average one-year return following a midterm election is 15%. That’s more than twice the return of all other years during a similar period.
5. Stocks have done well regardless of the makeup of Washington
There’s nothing wrong with wanting your preferred candidate to win, but investors can run into trouble when they place too much importance on election results. That’s because, historically, elections have had very little impact on long-term investment returns. I can’t emphasize this enough!
What’s the bottom line for investors?
There is a good chance of higher volatility in 2022, but no need to fear it. Smart investors would be wise to look past the short-term highs and lows and maintain a long-term focus.
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