Historically, the S&P 500 often experiences strong performance in the year following midterm elections, with a notable preference for periods of divided government in Washington. Despite these historical trends suggesting a ‘relief rally,’ market experts stress that critical factors like Federal Reserve policy, corporate earnings, and the ongoing AI revolution are more influential drivers of market direction.
Furthermore, geopolitical uncertainties, including the conflict in Iran and a debt crisis in France, along with bond market dynamics, continue to exert significant sway over investor sentiment, overshadowing election outcomes.
As markets hold their breath ahead of midterm elections, historical data suggests this political event often signals robust stock performance – irrespective of a 'red wave,' 'blue wave,' a split decision, or the political status quo in Washington.
A CNBC analysis of S&P 500 returns post-elections from 1980 through 2024 indicates the index typically sees an average gain of 0.2% after one day and one week across both presidential and midterm cycles. After one month, this average rises to 1.1%.
Crucially, the S&P 500 has historically delivered strong one-year gains: an average of 13.7% following midterms and 13.8% after presidential elections. Astonishingly, returns were positive in 91% of these cases, with the S&P 500 rising after all 11 midterms from 1982 through 2022. Short-term returns, particularly after presidential contests, have proven less consistent, sometimes even dipping into negative territory for one-day and one-week averages.
Ryan Detrick, a CNBC contributor and chief market strategist at Carson Group, observes, “There's some anxiousness before these elections. Once you are through it, it's a big relief and markets tend to do pretty well.”
Markets Favor Gridlock
Intriguingly, the market generally demonstrates a preference for divided government – a scenario where one political party controls the White House and the opposing party holds at least one chamber of Congress. Across 10 midterm and five presidential elections resulting in no single party dominance, the S&P 500 surged an average of 15% after one year, with positive returns in 14 out of 15 instances. In contrast, periods of single-party control saw the index gain an average of 11.5% over the subsequent year.
Detrick explains, “If you have a huge red wave or a big blue wave, markets actually kind of don't like that as much because you have too much spending one way and too much power.”
Even a scenario where Democrats retain control of Congress while a Republican occupies the White House – a potential outcome of upcoming elections – has historically been positive. A CNBC study found that after three midterms (1986, 1990, and 2006) with this configuration, the S&P 500 saw an average 0.5% decline on the immediate reaction day but rebounded to a 3.4% gain a month later and a significant 10.9% rise after a year.
However, it’s vital to acknowledge that elections often coincide with, rather than exclusively dictate, market performance. The S&P 500's sharp 22.1% drop in the year following the 2000 elections, for instance, was primarily due to the dot-com bust. Conversely, the market’s best post-election year saw a 38.3% gain after the 2020 elections, propelled by a massive recovery from the COVID-19-induced selloff.
According to Société Générale, investors should primarily focus on Federal Reserve policy and the corporate earnings cycle, which ultimately carry more weight than election results. The market’s decline after the 2018 midterms, when Democrats took the House during President Donald Trump's term, was largely influenced by the Fed’s decision to raise interest rates four times that year. Despite the S&P 500 ending that year down 6.2%, it was up 11.7% a year after the election.
Currently, the artificial intelligence (AI) sector represents a major swing factor. Detrick suggests that as long as the AI trend remains robust and economic growth persists, the current bull market likely remains intact. Conversely, a potential Democratic sweep of both the House and Senate could exert pressure on AI infrastructure development, possibly leading to market retrenchment.
Further complicating the outlook are global bond market jitters, with rising yields and a nascent debt crisis in France. Geopolitical tensions, particularly the potential for escalation in the war involving Iran, also loom large post-election, depending on policy shifts. Jim Reid, Deutsche Bank’s global head of macro and thematic research, cautions, “Seasonality isn't destiny, and worries around Iran, AI and France won't mysteriously vanish.”
While historical patterns might suggest a post-midterm 'Santa rally' and S&P 500 gains, the market remains primarily driven by AI advancements, intertwined with the critical influences of geopolitics, Federal Reserve actions, and the bond market dynamics.
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