Democrats are expected to gain several House seats this year
Midterm elections are a week away and you would expect them to have an important effect on stocks. This week I'm comparing Election Day -- the day after the first Monday in November -- in midterm years, presidential election years, and off years. I'm curious about how stocks tend to behave leading up to the elections and thereafter. Not only performance-wise, but volatility-wise, too.
A Week Before Election Day
The table below summarizes the S&P 500 returns in the week before Election Day going back to 1950. Investors seem enthusiastic whenever there's an election coming up. Whether it's a presidential election or a midterm election, the index has performed very well in the preceding week. Volatility, however, looks muted in election years. Off years have a higher standard deviation of returns and a bigger magnitude of average positive and negative.
After Election Day
Now we'll look at whether investors' giddiness before elections is justified. This table shows how the S&P 500 has initially reacted the day after Election Day. The reaction has been positive after midterm elections, averaging a gain of 0.57%, with 76.5% of the returns positive.
The reaction has been the opposite after presidential elections. After those elections, stocks have tended to fall an average of 0.45%, with just 41.2% of the returns positive. In off years, the S&P 500, on the day after the first Monday of November, has been positive slightly more times than negative, but the average return is still negative.
Now let's look a little longer term. Stocks have done well for the rest of the year in midterm election years. The percentage of S&P positive returns in all three circumstances are similar -- between 64% and 74%. After midterm elections, however, the average return is better than the other two conditions. This outperformance is due to higher returns to the upside. When the S&P 500 has been positive for the rest of the year after midterm elections, the index averages a gain of more than 6%. Other years, the index has an average positive below 4.5%.
Looking out even further, this has been an extremely bullish time to be in long stocks. In the six months after midterm elections, the S&P 500 has been up every single time. That's a streak of 17 straight times, averaging a gain of almost 15%. Historically speaking, now is a very good time to buy stocks.
Change in House Seats
According to fivethirtyeight.com, the Democrats are expected to gain around 40 seats in the House of Representatives. The party in the White House generally loses seats in the midterm elections, but that would be a bigger loss than normal. The chart below plots how the S&P 500 has fared for the rest of the year based on the change in House seats for the party that controls the presidency.
You can tell from the chart that there isn't a whole lot of correlation between the change in the number of seats and the rest-of-year returns. The R-squared on the chart says statistically that 6.4% of the variance in the S&P 500 return is explained by the change in House seats.
If I wanted to strain, however, to draw some conclusions from the data, I could note that the market tends to struggle the rest of year when there's a change of at least 40 seats. When the change is greater than 40, the S&P 500 has fallen in three of five instances. The last time a Republican White House lost more than 40 House seats was in 1974, during President Gerald Ford’s reign. After that, the S&P dropped 8.7% heading into 1975.
Also, the trendline on the chart is upward-sloping, suggesting the more seats that the party of the president can hold at midterms, the better for stocks the rest of the year. This, of course, is only looking at the party in control of the White House and doesn't consider whether the presidency is held by a Democrat or Republican… or Donald Trump.
