October 2018 Newsletter
The 2018 midterm elections are two weeks away. This month we look at some of the market and financial implications of the results and some historical context on stock market performance in mid-term years.
People like to forecast. Attempting to make sense of the world and predict how interacting factors will ultimately play out is in our human nature. Sometimes these trends and forecasts are accurate, other times; not so much (looking at you 2016). It is important to keep this in mind when engaging in the sort of prognostication we will be doing here this month. At the end of the day, a 1% chance is still a chance, and nothing in politics or in the markets is certain.
First, let’s look at some of the historical context. Rarely are midterm elections kind to the political party of the sitting president, especially in the first term’s election. Going back to Truman, only George W. Bush gained seats in the House of Representatives in the first term, and this was likely due to the exogenous shock of September 11th, and a consequent rallying around the president and the Republican party at a time when we were heading to war.
Figure 1: The President’s Party Often Loses Seats at the First Midterm
The Senate has held up better to the opposition party, while the House has consistently saw seats shift in the midterm election during a president’s first term in office. It is also important to note that Donald Trump’s approval rating has since rallied to 47% in the latest composite poll. (Source: 538politics 10.23.18)
Turning to the 2018 midterms, the odds that Republicans maintain their majority in the Senate, according to the 538 politics model, stands at about 80%, while the odds are flipped in the house where Democrats have an 85% chance at retaking the majority there.
Figure 2: Forecasting the Race for the Senate
Of the 35 seats up for election in the Senate, only 9 of them belong to Republicans. The map for the Democrats to take control of the upper chamber is not favorable. (Source: 538politics 10.23.18)
Figure 3: Forecasting the Race for the House
In the House however, all 435 seats go up for election every two years, and the momentum this time around has clearly been on the side of the Democrats.
The most likely scenario is that Republicans will maintain or widen their majority in the Senate and the Democrats will win control of the House with a relatively slim majority. Obviously, this can all shake out differently on election day but the preponderance of data would point to this being the most probably outcome. With that in mind, we can turn our attention to what that could mean for the market and economy.
Figure 4: Markets Still Tend to Perform Well, Regardless of Outcome after an Election
The historical trends suggest a positive surge in the market in the year after a midterm election.
Figure 5: Midterm Election Year Composite Returns vs. All Other Years
Midterm election years have shown a tendency for flat to negative returns leading up to the election, and a surge in performance afterwards, regardless of outcome. By the end of the second quarter of the following year, the midterm composite shows outperformance of more than 5%.
Figure 6: Volatility Typically Picks up in the Month’s Leading Up to a Midterm Election
This pattern has held up well this year. A significant uptick in volatility over the last several months is consistent with the historical trend for a midterm election year.
Now to the present. I don’t think anyone would characterize our current political environment as normal, on trend, or in line with historical precedent. In a normal environment, market participants generally like the gridlock that comes from a divided Washington. It provides a measure of certainty that basically nothing will get done from a policy perspective and provides some continuity in financial projections and the regulatory environment. However, as a note from Société Générale recently said in a Marketwatch article, “a change in the ruling party of either house could have serious market and economic consequences, such as potentially more frequent government shutdowns, impeachment considerations, and general uncertainty.”
On a more granular level, a Democratic House would likely put any full repeal of the Affordable Care Act on hold until at least 2020 and could perhaps result in a bipartisan (!) bill to stabilize the healthcare law; either way a likely net positive for the Healthcare sector. However, leading up to the 2020 presidential election, you can expect terms like ‘Medicare-for-all’ and ‘lower drug prices’ to be mentioned early and often, the headlines of which could cause volatility in that sector.
Infrastructure investment appears to have broad support, and any increase in spending there could provide a tailwind to industrials and materials.
One important area to keep an eye on post-election will be around tariffs, trade, and the effect on the dollar. Regardless of whether Democrats take the House, the president will have the power to act with relative unfettered discretion on trade and tariff policy, something which could draw even more of his attention should his domestic agenda become logjammed. This could have significant effects on the outlook for global growth.
Despite all of this, history has generally offered us data to confirm that the current political climate should be a lightly-weighted factor when considering investment decisions.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine what is appropriate for you, consult a qualified professional.
Investing involves risk, including possible loss of principal.
Securities offered through LPL Financial, member FINRA/SIPC.
Investment advice offered through Private Advisor Group, a registered investment advisor. Private Advisor Group and The Philadelphia Group are separate entities from LPL Financial.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly.