How midterm elections affect the stock market

October 11, 2022 | Market news

Key takeaways

  • The 2022 midterm elections will influence the legislative agenda of the next Congress and could impact fiscal policy, including taxation and spending priorities.
  • Does history provide any guide for investors on what the outcome of midterm elections might mean for the markets and economy?

The 2022 midterm elections take place on November 8. Though typically garnering less attention than a presidential election, midterm elections are important because they could lead to a change in control of the U.S. Senate and House of Representatives. This can have a significant impact on policy, laws and foreign relations. But how do these elections affect the stock market? And how does that affect you and your investments?

To better understand, U.S. Bank analysts studied Bloomberg market data from the past 60 years (and the 15 midterm elections held during this period) to identify midterm election cycle patterns. While past market performance is no guarantee of future results, analyzing historical data offers insights into how midterm elections might affect the market and your investment portfolio in the coming year and beyond.

Stock market performance in midterm election years

Stock market performance during midterm election years can be separated into two categories: pre-midterm election and post-midterm election.

  • Pre-midterm election stock market performance. The S&P 500 Index has historically underperformed in the year leading up to midterm elections. The average annual return of the S&P 500 in the 12 months before a midterm election is 0.3%—significantly lower than the historical average of 8.1%.1
  • Post-midterm election stock market performance. The post-midterm election period is a very different story. The S&P 500 has historically outperformed the market in the 12-month period after a midterm election, with an average return of 16.3%. This is especially true for the one- and three-month periods following midterm elections, which historically have significantly outperformed years with no midterm election.2

Midterm election year stock market performance since 1962

Debating the causes of stock market changes before and after midterm elections

Why does the market underperform in the 12 months leading up to midterm elections and overperform the 12 months after midterm elections? One factor might be policy uncertainty. Without knowing which political party will hold majorities in Congress, it’s unclear which social and economic policies will take priority. This uncertainty resolves after the midterm election.

The problem with this theory is that the outcome of midterm elections has no noticeable impact on overall equity market performance, according to our analysis. The party or parties controlling Congress—and whether they change after a midterm election—is historically not an indicator of market performance.

The biggest stock market performance influence in midterm election years

Our analysis shows that the health of the economy is a much more important factor than midterm election results. The last time the S&P 500 Index produced negative returns during the 12 months after a midterm election was 1939—a time of tremendous economic contraction and uncertainty as the U.S. battled the Great Depression and World War II began in Europe.

This also explains why negative pre-midterm market returns dominated the 1960s and 1970s, pulling down the overall pre-midterm average. The late 1960s and 1970s were a time of slow economic growth marked by high unemployment, rising energy prices and significant inflation. If you exclude the five midterm elections in the 1960s and 1970s, the average S&P return for pre-midterm election years is 8.1%—roughly in line with average annual S&P 500 performance.

Since then, the economy has grown steadily, with accommodating central bank policy keeping inflation low. This suggests that a healthy overall macroeconomic environment carries greater weight than any policy uncertainty.

Analyzing the factors going into the 2022 midterm election

The 2022 midterm election results are unlikely to affect broad equity market performance, but we could see effects on specific sectors or industries.

If Republicans gain control of either body of Congress, we’ll likely see relative legislative gridlock. Perhaps most notably, Republicans would gain the ability to use subpoena power to pursue investigations of the White House. However, such investigations historically have little to no capital market impact. While President Biden would be limited in his ability to push through any new policies over the next two years, existing policies would likely remain in place.

If Republicans gain control of both the Senate and House, President Biden’s agenda will face a strong headwind. Again, any major policy initiatives from the Biden administration would likely be stymied. Congress, in this scenario, would only be likely to enact “must-pass” legislation such as continuing government funding or a national defense authorization act. That said, the White House could continue to pursue executive orders and rule-making that might impact specific industries.

If Democrats retain both the Senate and House, a scenario that’s considered the most unlikely outcome based on pre-election polling, it raises the potential passage of Democrats’ more sweeping policy agenda. This includes the unpassed components of the “Build Back Better” legislation. Components of that could include expanded social spending, corporate and individual tax increases, additional clean energy investments and subsidies, and raising or eliminating the cap on state and local income tax deductions.

How to structure your investment portfolio to weather the 2022 midterm election and beyond

While it’s tempting to speculate which party or parties will control the House and Senate after the 2022 midterm elections, the midterm elections shouldn’t have a significant impact on your investment portfolio or the investment strategy developed in partnership with your financial professional.

U.S. fiscal policy may change after the 2022 midterms, but it’s economic fundamentals—not election results—that historically play the greatest role in equity market performance both before and after midterm elections. Leading up to the election, it’s fair to say that economic developments could factor into voter sentiment. As November 8th draws closer, the potential outcome of the election is likely to draw greater investor scrutiny. Again, history tells us that the specific election outcome, in terms of which party controls the levers of power, will not have a direct income on capital market performance.

While investors may want to keep an eye on the political environment in 2022, other issues have so far taken center stage. Ongoing inflation concerns and a major policy shift by the Federal Reserve have been dominant market drivers this year. The Fed is “tightening” monetary policy, raising short-term interest rates and reducing its role as an owner of U.S. Treasury and mortgage-backed securities.

The Fed’s stance is aimed at slowing the pace of economic growth and ultimately stemming the tide of higher inflation and its actions are likely to contribute to ongoing capital market volatility leading to the mid-term elections. Despite the Fed’s efforts to temper economic activity, consumer and corporate balance sheets remain strong. The longer these fundamentals persist, the less likely it is that policy uncertainty related to the election outcome will impact the markets to any great extent.

Reach out to your wealth management professional if you have questions about your unique situation, and be sure to stay up to date on the latest market news and activity.

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This information represents the opinion of Wealth Management of U.S. Bank and U.S. Bancorp Investments. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their unique situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank or U.S. Bancorp Investments in any way.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.

Past performance is no guarantee of future results. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments.

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