How Will the Midterm Elections Affect Stocks, Anyway?

They usually go up after the vote, with the uncertainty over. But maybe not this year, warns Schwab’s Liz Ann Sonders and some other Wall Street savants.

The historical stats tell us that stocks do well after midterm elections. Reason: no more uncertainty about who is in charge of what part of the government. But despite such balming sentiments, there’s a discordant buzz that all the bad news – strong inflation and a highly anticipated 2023 recession – will counteract political history.

First, the happy side, courtesy of historical precedent. Stocks have gained an average 2.7% in the October of midterm years since 1950, according to an analysis by George Smith, a portfolio strategist at LPL Financial. The fourth quarter has long been the best, and especially in a midterm year, with the final period averaging 6.5%. What’s more, one year after the election, stocks had advanced an average 15%. Year 3 of a new president’s term (that would be 2023 here) was the best of any.

What about when a midterm election overlapped a bear market, which we certainly are in now? It’s also good, going back to 1945, per a report from Sam Stovall, senior investment strategist at research shop CFRA

The S&P 500 (and its predecessor) logged an ultimate bottom in October four of five times, and recorded an average gain of 5.6% for the month, going up 60% of the time, Stovall says. After that, the index climbed an average 6.2% through December 31, rising in price 100% of the time.

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Well, maybe that was then. Some financial thinkers don’t buy that we are destined to follow the rosy past, with so much having gone wrong in the world.

To Liz Ann Sonders, chief investment strategist at Charles Schwab, a host of economic and geopolitical troubles have a good chance of overwhelming the historical pattern. “The combination of high inflation, the war in Ukraine, and a lingering pandemic has already made this cycle unlike prior midterm years,” she writes in a report. “With so many other forces at play in the market, I wouldn’t put much weight in historical midterm-year performance.”

And it all is leading toward what Americans dread most: the R word. “Today, it is inflation, the Fed’s response to elevated inflation, and resulting risk of recession, that will be what determines the market’s direction over the coming quarters,” Seema Shah, chief global strategist at Principal Asset Management, wrote in a recent research note.

“A major question now is whether higher wage costs are hurting the bottom line for companies,” says Rob Haworth, senior investment strategist, U.S. Bank Wealth Management, in a research note. “Companies have been able to maintain earnings levels to date because they could push through price increases,” he goes on. “Can they continue to do that? It will tell us a lot about how earnings hold up through the year.”

One outcome of the election – divided government, with a Democratic White House and the GOP in control of one or two congressional chambers – could end up a boon. “The market tends to like gridlock,” Nadia Lovell, senior U.S. equity strategist at UBS Global Wealth Management, told Reuters. “I think it’s fair to say a split government is what investors right now expect and are positioned for.”