By James Quackenbush
The Daily Record Newswire
There has been a strong connection between the performance of the stock market and the November congressional midterm elections since WWII. Stocks have historically performed favorably after a midterm election, posting above-average returns for the final months of the year and for the following calendar year.
If this historic trend is any indicator of what is in store for the markets, there is a high probability that stocks will perform strongly and the next leg of a bull market rally may be on horizon. While this might be very optimistic thinking since the markets have already rallied over 65 percent since the March 9, 2009 low and unemployment is still over 9.8 percent, post-midterm election data may prove otherwise.
When you analyze the performance of the stock market after a midterm election, the results are incredibly positive. Midterm elections usually ignite a period of strong gains for stocks and they have typically performed strongly for the 90 and 200-day period after the midterm election. In fact, stocks have not had a negative year for the calendar year following a midterm election since 1939. Hopefully, this post midterm election year is no different.
While there is no guarantee that stocks will perform positively, a study of midterm elections dating back to 1922 has shown the Dow Jones Industrial Average has risen 19 out of past 22 times over the 90 trading days following a midterm election by an average of 8.5 percent. This compares with a 3.6 percent average gain during the comparable November to mid-March periods in non-election year, which is almost 5 percent more on average than a typical non-election year.
Additionally, a study of the S&P 500 has shown gains for every 200 trading day period following midterm elections since 1942. Stocks have rallied on average of 18.3 percent in those 200 days, compared to the average non-election year of 7 percent.
Will this year be different? The trend this year should continue if the historical patterns hold true. Since WWII, the only time the markets failed to rally higher for the remainder the year (November and December) after a midterm election was in 2002, where the ruling party gained seats in both the House of Representatives and the Senate. As we all know, this is not the case this year. The Democratic Party has lost control of the House to the Republicans and lost seats in the Senate, which has created gridlock.
Overall, gridlock has typically been viewed by the markets as a positive because the balance of power is restored between the two political parties, which means the two parties must work together to make compromises to pass agendas.
While the midterm elections may start a stock market rally in the final months of the year, the calendar year after the midterm election has typically been the strongest for the markets. Many contribute the presidential election theory for this trend, which happens in the third year of a president’s term (which is the calendar year following midterm election). The theory states that the market will decline for one year following the election of a new president and then rebound in the remaining three years of the president’s term, with the third year of the term being the strongest.
In fact, the DJIA had an average annual return of 16.72 percent from 1943 to 2007 for a president’s third year in office, which is significantly higher than the annual return of the period of 1941 to 2009 of roughly 7 percent.
Despite these trends and theories, which have historically indicated an upward move in the equity markets, the economy and overall marketplace undoubtedly have significant challenges to overcome.
Hopefully, the Fed’s second round of quantitative easing, as well as the recent extension of the Bush tax cuts and unemployment benefits, along with the past history of strong market performance following midterm elections will lead stock investors to a strong finish to the year and a profitable 2011.
James Quackenbush is an analyst/portfolio manager for Karpus Investment Management. He can be reached at (585) 586-4680.
