Red, Blue, and the Stock Market: What History Tells Us About Midterm Elections

Well, here we are again. Election season! With the midterm elections upon us, we’re hearing more questions about what the results could mean for the stock market. Will stocks do better if Republicans maintain control of Congress? What happens if Democrats take the House or Senate? Should we be making changes to portfolios ahead of the election?

These are reasonable questions, but one of the things I find most interesting about investing is how often our expectations of what should happen in the markets differ from what actually happens. And when it comes to elections, history has some pretty interesting things to tell us.

Depending on your political preferences, you may have strong opinions about which party is better for the economy and stock market. But historically and thankfully for everyone, the stock market has performed well following midterm elections regardless of which party wins.

According to research from Horizon Investments, the S&P 500 has averaged a 15.1% return in the 12 months following midterm elections between 1950 and 2022. Perhaps even more interesting, when the president’s party lost control of at least one chamber of Congress, the market still posted positive returns in each of those eight instances, averaging 12.8%.

However, keep in mind that historical averages aren’t guarantees. Markets don’t operate in a vacuum, and plenty of economic factors and global events influence returns outside of Washington.

Still, it’s a valuable reminder that the political outcome we may be rooting for, or worrying about, doesn’t necessarily translate into the investment outcome we expect.

Markets Don’t Particularly Like Uncertainty (But When Is It Ever Certain!?) 

Another interesting pattern surrounding midterm elections is that markets have historically experienced increased volatility leading up to Election Day, followed by stronger performance in the months afterward.

One possible explanation is simply that markets don’t particularly like uncertainty… but when is it ever really certain? Before an election, investors are trying to anticipate not only who will win, but what policies might follow and how those policies could influence the economy. Once the election is over, at least one piece of that uncertainty has been resolved.

And sometimes, an outcome that sounds frustrating politically may not be particularly concerning from an investment standpoint. Take divided government, for example. While gridlock in Washington can certainly be aggravating, it can also make sweeping legislative changes more difficult, potentially creating a more predictable environment for businesses.

Of course, none of this guarantees stronger market returns, but it helps explain why a divided Congress isn’t necessarily something investors should fear.

Politics Matter, But So Does Everything Else

None of this suggests that elections don’t matter to financial markets. They absolutely can, particularly for industries affected by changes in taxes, regulation, or government spending. Healthcare, artificial intelligence, and energy infrastructure are just a few areas where future legislation could influence businesses and their profitability. But anticipating a policy change and correctly predicting how an investment will respond are two very different things.

Meanwhile, companies are still reporting earnings, consumers are still spending, and the Federal Reserve is still making interest rate decisions. Those factors don’t simply disappear because we’re having an election. This is where I think investors can start to diverge from the plan. Making significant portfolio changes based on an anticipated election outcome requires correctly predicting who will win, what policies will actually be implemented, and how the markets will respond. That’s an awful lot to get right!

Instead, we believe a well-diversified portfolio that reflects the goals in a financial plan should be designed to weather a variety of political and economic environments. For someone nearing retirement, questions about liquidity, income, and risk should carry far more weight than who controls Congress. For someone with decades to go until retirement, staying invested through changing market environments is likely to be much more important than the outcome of any single election.

Our job is to look beyond the headlines and evaluate whether developments actually change the long-term investment outlook or the financial plans we’ve built with our clients. Sometimes changes are warranted, and other times the best decision is simply to stay the course.

A Little Perspective on Election Day

There will undoubtedly be plenty of headlines, predictions, and opinions about what the election results mean for the markets over the coming days. Some will prove accurate, others won’t, and we’ll probably all be ready for a break from political advertisements.

In the meantime, I’ll leave you with a picture of our dog, who recently found himself on the receiving end of my kids’ creativity. He clearly had no say in the matter, doesn’t appear particularly pleased with the outcome, and is probably wondering how he got dragged into this in the first place.

Come to think of it, he may have more in common with the average American voter than I realized.

Whatever happens on Election Day, we hope the markets fare a little better than his dignity did!