I have been promising to talk about the effects of Mid-term elections on the stock market and now that my research is as complete as I feel comfortable with to talk about it here is my opinion. Much of the following I found through Mitch Zacks at Zacks Investment Research and John Lynch and Ryan Dietrich at Market Signals LPL Research. Opinions are all my own.
There is never just one single factor that determines the direction of the stock market. If you have followed me for any time you will know that I put a great emphasis on corporate earnings. That is a very important factor that can really help stocks propel upward in price but it is not the only factor. There have been many times when corporations have reported great earnings and great forward looking comments yet still declined in price. Added to that, there is not just one factor or event that causes the market to go down. For example, tariffs are a very strong headwind for stocks and often can cause markets to go down. However this year the markets have continued to climb in the face of some very strong tariffs. I could site many other examples but you get the point. It is the confluence or intersections of these many factors and the weighting of each of them at any given point in time that causes the market to go up or down.
That said, one question that keeps popping up is “What effect does the Mid-term elections have on the market”? Here at Mowery Capital Management, we try not to take political sides in our investing decisions. Our concern is the policies and how they affect the economy, corporate profits and thus ultimately the markets.
Historically the markets have become much more volatile during midterm elections. Let’s look at some history:
During these four mid-term election years the market correction during thise years and market performance one year after is as follows:
2002 (Bush) mid-term correction (-34%) and performance one year later +34%
2006 (Bush) mid-term correction (-8%) and performance one year later +24%
2010 (Obama) mid-term correction (-16%) and performance one year later +21%
2014 (Obama)mid-term correction (-7%) and performance one year later +9%
(Table by Zacks)
Going back sixteen years we can see that mid-term election years have dealt some pretty strong blows to the markets. Going back even further to 1962 the average correction was a -19%. However, over that same time frame the year after the mid-terms the average return was 31%.
We believe that the markets are more volatile is because of the potential of the government flipping party’s that control the House and Senate. This creates “Uncertainty”. The markets HATE uncertainty. Will there be a policy shift or will it be more of the same policies currently in place? Once the mid-term elections have happened the uncertainty is gone and investors are more confident on how to invest their money.
Now that we have finished the period of seasonal weakness, May through August, it looks like the February low may turn out to be the low this year for the market with the S&P500 touching 2,530. Then again a close retest in April touching 2,552. The sell in May and go away crowd didn’t really materialize this year.
If the S&P ends September up it will be the sixth month in a row ending up with this summer’s rally. This was due to a lot of some very very strong fundamentals (plural) underlying this economy such as GDP growth, consumption, corporate profits, low unemployment, Leading Economic Indicators (LEI), and of course still historically low interest rates. There are many other strong fundamental factors as well.
Something that is really important to consider is the Real Rate of Interest which is the Fed Funds Rate minus inflation or 1.9% – 2.0% which ends up being slightly negative to zero. During t the average recession this rate hovers around 4.5% going back to the 60’s. I think we see by this that the FED has more room to tighten without causing any real damage.
Going back to our original question of the effect of mid-terms on the markets we find that it is not necessarily who’s in the White House and who’s in congress but the combination of the two. But a better question might be what will happen if the Republicans loose the House? Currently Republicans control it all. It is important to note that this is no way a prediction just a “what If”.
Should we get a divided congress, history tells us that markets tend to do pretty well, surprisingly. One reason that I mentioned before is that the “Unknown” is now known. Uncertainty is gone. Another reason may be that grid lock is not necessarily a bad thing. I have said it before and I will say it again, when the government does nothing I don’t get hurt. This is because it goes back to our founding fathers system of checks and balances in government.
Going back to the 1950’s, grid lock with a republican president the S&P moved higher by 15.7% and grid lock with a democratic president the S&P rose by 18.3% probably because the House controls the purse strings in government.
When you add up the strong fundamentals in our economy with historic facts backing us up with Real interest rates at or near zero we have a very bullish launching pad going into 2019.
This mid-term year we have already had two 10% corrections. But the 4th quarter is historically one of the strongest quarters in a four year presidential cycle with the first and second quarters of the next year (post mid-term election) the next strongest. So we are sitting right smack dab in front of three of the strongest quarters in a mid-term election year.
Some have said it is already built into the markets given the summer rally but I would argue that with all the strength of economy and corporate profits I definitely don’t see any near end to this bull market.
So what can go wrong? Geo-political factors are always a concern and I guess the FED could get too aggressive in raising rates and topple the yield curve into inversion where the short bonds are yielding more than the longer bonds. That said, it is unprecedented that we have a FED raising rates from ZERO. As I mentioned above they have a lot of room to move without making a mistake.
Remember the FED has two main mandates, control inflation and unemployment. Unofficially the FED is attentive to the markets stability and the strength of our dollar. We have had two recent examples of what can happen when our dollar gets too strong with the recent upheaval in Turkey and Argentina. With our dollar too strong emerging markets have trouble servicing their outstanding debt. A very strong dollar can cause a world recession. Dollar is still King but it has to be a good king.
Thanks again to those mentioned above for their research but this isn’t really something that is strange to most in this industry. This is pretty much common knowledge.
We will continue to take advantage of these times and make Hay while the sun shines.
Your Boring Money Manager,
Mowery Capital Management
We manage risks first
Then we buy quality
And only then do we seek to provide a reasonable return
At the time of this writing:
Dow Jones 26,476.80
S&P 500 2,916.92
Two Year Treasury Yield 2.827%
Ten Year Treasury Yield 3.063%
Thirty Year Treasury Yield 3.194%
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Disclosures and Notices
Sources: The Capital Group. Zacks, Seeking Alpha, CNBC, CNBC guest and contributors, Jim Cramer, Wall Street Journal, Investor’s Business Daily, and Financial Times. Special thanks to Wikipedia and MarketWatch for historical facts. If I have inadvertently missed any other sources please accept my apologies. No assurance can be made that profits will be achieved or that substantial losses will not be incurred in connection with any investment. All investments involve varying degrees of risk including loss of capital. This information should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any individual investment or strategy. PAST PERFORMANCE IS NO GUARR ANTEE OR
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