Chris Kamykowski CFA®, CFP® | Head of Investment Strategy & Research
In a year where equities are down 20% and fixed income is providing limited downside protection, investors have certainly had much to contend with in 2022. Four-decade highs in inflation, the war in Europe, and a rapid tightening of monetary conditions have all come to generate much uncertainty, which has made its mark on market valuations. Now, as we enter the fourth quarter, we can add the upcoming US mid-terms elections in early November to the list of investor concerns.
As with each election cycle, investors typically ask how mid-term results could affect their portfolio and if any changes should be made ahead of the elections. However, while it may seem comforting to enact a portfolio adjustment to “hedge” out one’s fear of the election outcome, history has shown that investors should remain steady through the elections.
In this short piece, we will recap the current state of the election expectations and why investors should remain committed to their long-term asset allocation despite the coming election drama.
Current Election Expectations
As polls stand currently, odds point to a potentially divided government following the mid-terms, with Republicans taking control of the House of Representatives. The Senate looks to be a coin-flip as to whether the Democrats retain their slender majority or Republicans regain the majority.
As seen below, the first mid-term election for a new President has usually witnessed their party losing seats; since 1934, the President’s party has seen an average net loss of 26 House seats and two Senate seats. This bodes well for Republicans, but while probabilities for a Republican sweep appeared a near certainty earlier in the year, those odds have likely fallen as voter polls have responded to recent Supreme Court rulings and falling energy prices.
Yet, Presidential approval ratings remain challenging for what some see as a referendum on the current administration; to that end, losses for the Democrats would align with the historical precedent with mid-term elections.
Markets During Mid-Term Elections
Again, the natural question for investors for any election cycle is: what does it mean for the markets and their portfolio specifically? In a year such as 2022, investors are likely skittish about any more uncertainty with losses abounding across their portfolios; therefore, providing a dose of historical perspective should help alleviate fears turning in to unnecessary actions.
When looking at the mid-terms since 1970s, you can see 2022 has generally trended similarly to the average return over those years. While 2022 has had elevated downside volatility through the first three quarters of the year, the average of past mid-terms has seen a downtrend in returns for the same period. However, the fourth quarter has typically witnessed a fairly strong recovery off the market trough in past mid-term election years.
To be sure, this does not imply 2022 will follow the same trend, but history has at least shown remaining in the market proved to be a better plan of action than exiting ahead of the elections.
Additionally, following mid-term elections, you can see that returns 12-months later have been positive for every period since 1970 and averaged 25%. While the range of outcomes has ranged dramatically from as high as 44% to as low as 5%, importantly, there has not been a negative 12-month return after a mid-term election since 1970.
In the end, political leadership of the US government is only one part of the larger equation of factors that can influence the direction of markets. Government leadership change is inevitable, and despite the various party affiliations and subsequent policies of the elected Presidents, markets have marched on through changing policy preferences as elections come and go.
Therefore, investors should continue to use their own investment objectives, risk tolerances, and liquidity needs to dictate their appropriate long-term investment allocation; avoid allowing the uncertainty of the political winds to induce large shifts in investment objectives.
Sources:
Morningstar
The American Presidency Project, UC Santa Barbara: https://www.presidency.ucsb.edu/statistics/data/seats-congress-gainedlost-the-presidents-party-mid-term-elections
Definitions:
The S&P 500 Index is a free-float capitalization-weighted index of the prices of approximately 500 large-cap common stocks actively traded in the United States.
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