As we are drafting this newsletter article, the midterm elections haven’t been held yet. The pundits put the chance of the Republicans keeping the Senate at about 71% and the chance of the Democrats taking the House at a slightly lower percentage, but still likely. Of course, there are many recent examples where these kinds of predictions not only missed the mark, but missed spectacularly.
“…Few can claim the ability to reliably predict elections – look no further than the Brexit vote and the 2016 US presidential election…,” Mike Ryan, Chief Investment Officer for the Americas, UBS Global Wealth Management pointed out. In fact, some pundits projected a 5% to 20% decline in U.S. markets if Trump was elected. As we know, predictions grabbed headlines, but those declines didn’t materialize.
By the time you read this, we will all know the outcome but the question we should be asking ourselves is, “Does it matter?” when it comes to the financial markets.
Market volatility comes from uncertainty
For weeks, we all heard that the November 2018 midterms would be the “most important” of our lifetimes. We hear that same admonishment before virtually every opportunity to vote – whether it is a primary, general, runoff, special or mid-term election that is coming. However, elections have had little to no longer-term effect on the market; it’s uncertainty, poor corporate performance, wars, and natural and man-made disasters that drive fluctuations in the market.
You might be surprised to learn that underperformance in the markets leading up to a midterm election is the norm. In fact, a typical midterm election year has experienced a market correction in the months prior to the election itself. Looking at election cycles since 1950, the intra-year decline or lowest point in a mid-term election year has actually averaged a decline of 17%. The last two decades of market performance show that the S&P 500 routinely experienced an average decline of 3% in the second and third quarters of election years and generally approached the mid-term elections with a market roughly flat compared to the beginning of the year. Performance this year follows the pattern of past decades remarkably closely.
Outperformance on the way?
But is that the whole story? Definitely not! Following these declines, the rebound in those same years averaged 31%. If we look at the months of November and December together, the average return has been over 2% total. In addition, equities’ gains around midterm elections have outpaced the average returns seen in all other years, according to UBS analyst Keith Parker. According to another study by Federated, the return of the S&P 500 in the third year of a president’s term has averaged over 16%, making the third year in a term the highest returning year of all four.
While that’s encouraging for market bulls, analysts caution that history is only a guide; uncertainties are not the only factors driving this performance. For example, Binky Chadha, chief strategist at Deutsche Bank, noted that S&P 500 returns around midterms have produced a 76% correlation with changes in the Institute for Supply Management’s activity index in the six-month period surrounding Election Day. “This suggests growth, and not the midterm elections per se, was the key driver of the rallies,” he said.
To the financial markets, the days leading up to elections and those after the voting are just days. Losses and gains happen no matter what the outcome is, or which parties gain or lose seats. Simply put, policies don’t change overnight just because of a gain or loss of seats in Congress.
Uncertainty, not politics, causes market fluctuation. “It does not matter which party was in charge before or after the midterm election. ”The removal of uncertainty and of constant media attention allows markets to resume focusing on fundamentals,” noted analyst Craig Holke.
As many of us remember, perhaps too well, September 17, 2001 saw the largest single-day decrease (7.1%) in the history of the Dow Jones Industrial Average. While this decline was largely associated with the September 11 terrorist attacks in the United States, it really signaled, not a single event, but a more pervasive sentiment – uncertainty about the future. In the final analysis, uncertainty continues to be the greatest driver of market moves, and it’s one that investors can largely overcome with a sensible investment strategy.
Savvy investors know that market realities, not election results or even the news of the day, drive market movement:
- Watch the fundamentals of growth, earnings and valuations – not the news.
- Take a long-term view.
- Plan for uncertainty.
- Don’t “join the herd,” making moves based on emotion.
If you find you are riding the emotional rollercoaster of headline news and predictions of doom, please reach out to your advisor today for help putting the “news of the day” into context with your financial plan and goals for the future. History shows us how extraordinarily difficult it is to “time” the markets, and how dire the consequences can be of getting it wrong. When properly planned and executed, a financial investment strategy should be more closely resemble the turtle – not the hare. Slow and steady won that race. Our entire team at AFA is dedicated to helping you win your “race,” whatever the goal is. Please reach out with any questions or concerns. We are here to serve you.