The most common question that I have been asked over the past few weeks is: “If the Republicans lose control of either the House or the Senate in November, what impact do you think that will have on the markets?”   How much the stock market may go up or down in the days leading up to or directly after the midterm elections, regardless of the result, is anyone’s guess.  But if we use history as a guide, investors will probably realize that this situation is not uncommon, and there is probably less to worry about than investors think. 

A Shift In Power Is Not Uncommon

If we look back at every midterm election going back to 1934, on average, the president’s party has lost 30 seats in the House and 4 seats in the Senate during a midterm election year.  There are only three years in history that the president’s party actually gained seats due to a midterm election:  1934, 1998, and 2002.  So if the Republican’s lose seats in Congress in November that would really be the norm instead of the exception to the rule.  If it is in fact the norm, investors have to ask themselves, “how much of that shift in power is already priced into the market?” 

How Does The Stock Market React During Midterm Election Years?

In attempting to answer this question there are two components: volatility and return.  As many would guess, during midterm election years volatility typically rises leading up to the elections. Looking at the S&P 500 Index going all the way back to 1970, the volatility levels in the stock market are typically 10%+ more volatile when compared to the levels of volatility in the S&P 500 when there are no midterm elections.

From a return standpoint, the results speak for themselves.    Below is a bar chart that shows the return of the S&P 500 Index 12 months following the midterm elections 1950 – 2015:

12 months after a midterm elections the S&P 500 Index averages a 15.1% annual return.  In all other years the stock market averages a 6.8% annual return.

But What About A Flip In Control

It’s one things to lose seats in Congress but do we have to worry more because it’s not just about losing seats this year, it’s about a shift in power within Congress?  Again, using history as a guide, let’s look at what has happened in the past.  The House majority switched parties as a result of midterm elections in 1994, 2006, and 2010.  In all three of those years where a shift in power was in the cards, the stock market was either down or flat leading up the midterm elections in November.   However, in all three of those years the stock market was significantly higher 12 months after the midterm elections. See the chart below: 

The Stock Market Cares More About The Economy

If you asked me which environment I would choose to invest in:

A)  Stable political environment and bad economy

B)  Unstable political environment and good economy

I would probably choose “B” because at the end of the day the stock market is historically driven by the economy.    While politics have the power to influence the economy, if we end up in a gridlock situation after the November elections, that is also the norm.  Going back to 1948, we have had a “divided government” 61% of the time.  As we get closer to the elections, there is a very good chance that the level of volatility in the markets will increase because the stock market doesn’t like uncertainty.  But if we use history as our guide, the 12 months following the midterm elections may reward investors that stay the course.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.