The 2022 midterm elections matter less to equity markets than investors think

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Traders work on the floor of the New York Stock Exchange during morning trading on November 02, 2022 in New York City.

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Andrew Graham is the founder and managing partner of Jackson Square Capital

During each election season, candidates on both sides of the aisle like to suggest that a victory for their opponent will produce economic Armageddon and send the stock market crashing. And time and time again, it never quite turns out that way, regardless of the outcome.

Yes, markets and investors care about elections – but not as much as many think. Still, it’s interesting to note that stocks generally did well in the aftermath of the midterm elections. In the 12 months after Oct. 31 in every mid-year since 1962, the S&P 500 has jumped an average of 16.3%, according to data from US Bancorp Investments.

Admittedly, some of these gains are an anomaly. After all, there’s a long list of things markets care about far more than who wins an election, including the health of the economy, corporate earnings, stock valuations and interest rate policy. interest.

Will we see a rebound in the next year, like after the past elections? In the short term, this seems possible, if not probable. Looking further down the road? This is when things could get risky.

Clarity matters

To be sure, businesses and investors have political preferences, with most preferring lower taxes and fewer regulations. But they also crave certainty.

This helps explain why stocks tend to perform well after everything elections, not just mid-terms. In the 30 days following three of the last four federal elections, the S&P has jumped significantly (2.9% in 2014, 5% in 2016 and 10% in 2020). It slipped in 2018, but only by around 1.4%.

Notably, it’s hard to argue that the markets were applauding a particular outcome. Indeed, they rose when Republicans performed well in 2014 and 2016, and then again when Democrats took control of the White House and Senate in 2020.

Instead, what these elections have produced is clarity. When companies and investors know the outcome of an election – even if they may not like it – they can plan and articulate a vision, and markets tend to react favorably, at least in the short term.

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One argument for why stock market gains could be more than transitory is that this election is unlikely to produce a unified government. Most models predict Republicans will take control of at least one chamber of Congress, with analytics site FiveThirtyEight.com giving them a roughly 70% chance of winning the chamber. (The site is much less optimistic about the GOP’s chances of winning the Senate).

Such an outcome would make it unlikely that significant legislation will be passed in the next two years. While this kind of political stalemate is why many Americans hate politics, investors prefer that lawmakers step aside and let the markets do their thing.

This could be particularly relevant after this cycle. Despite all the talk about how England’s now-revised budget plans would have fueled more inflation, new government spending in the United States could do the same. Therefore, if a divided government results in fewer spending bills passing, that could be a good thing.

Lessons learned

Still, persistently high inflation – not just here, but around the world – is huge reason to believe stocks will buck the above trends and struggle in the months after the election ends. and beyond. Fed Chairman Jerome Powell has been steadfast: policymakers will do whatever it takes to stifle rising prices, even if it means “some pain” for families and businesses.

This position is likely the result of lessons learned from the 1970s, when inflation was also on the rise. At the time, the Fed under the leadership of Arthur Burn eased off prematurely, which only complicated matters. It took massive rate hikes by Paul Volcker – and two deep recessions – to fix the problem.

Powell is no doubt trying to prevent this from happening again. So expect policymakers to turn to policy tightening too aggressively and for too long.

Whether all of this means a recession is imminent is anyone’s guess, although a consensus is forming among economists that this is exactly what will happen. And while contractions may be short and shallow, any economic downturn combined with high interest rates makes betting on a booming market over the next 12 months a risky proposition.

There is a saying that has become fashionable in political circles in recent years: elections have consequences. They certainly do, impacting everything from the makeup of the Supreme Court to the heads of powerful congressional committees and regulatory agencies like the Securities Exchange Commission.

But their impact on the markets? The repercussions aren’t quite as dramatic, despite what some proponents would have you believe. Other variables matter much more. We will likely see this play out in the months to come.

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