Why the markets might be in for an upswing

Every four years, a certain high-profile event takes place that the US stock market seems to really like. Since 1950, the S&P500 has always (with one exception – thanks Black Monday) had positive returns 6, 9 and even 12 months after this event. Know which one it is?

The Midterm Effect

If you guessed the Olympics, well… you’re wrong, but I applaud your international outlook. If you guessed the presidential elections, that would technically be wrong too.

Historical data do suggest a market cycle connected to the electoral cycle – but that connection seems much stronger with the midterm elections than the presidential election itself.

Proof? Sure. Below are the historical stock market returns for each presidential term, divided into quarters starting from their election on November 5th (yes, technically a new President’s term doesn’t start until Jan. 20th – but we all know Election Day is what really matters).  

Both the best and worst market performance during a presidential term tends to happen closer to midterms

That’s a lot of little squares, I know – but notice how the best and worst quarters are more clustered in the middle? To see it more clearly:

Within a presidential term, stock market returns have historically been worst prior to midterms and best after them.

So in other words…

  • Stock market returns have historically been the worst 3-6 months before midterms.
  • Stock market returns have historically been the best right after midterms.

Granted, averages can be misleading. But crunch the numbers a bit more and sure enough, every presidential term has seen market gains in the first two quarters following the midterm. Often sizable ones:

Every presidential term has seen market gains in the first two quarters following the midterm

What does this mean?

Markets hate uncertainty and reward stability. So the prevailing theory is that once the critical midterm cycle is past, a huge degree of uncertainty is removed and markets are left to focus on fundamentals. Not so much the case after a new President comes in, and definitely not amid the political volatility of presidential elections.

Now the big question is – should I trade on this intel?

The logic side of my brain says, maybe. But my scientific background (Chemistry) says no. Even going all the way back to Eisenhower’s first term only gives us 17 midterms – not a significant enough sample size for any strong actionable conclusions.

However, if the pattern holds and the theory is supported, there may be an upswing just around the corner.

No guarantees, of course. But if you have been waiting for a good time to risk off or otherwise trim the fat in your portfolio, then definitely keep your eyes open as campaign season reaches its peak.