Get ready for the Americans

If you’re like most people, you might think that US midterm elections mean one thing for stock markets: Volatility followed by investor-friendly upswings. 

In reality, however, the situation is far more convoluted. Here’s a quick primer on why.

Do the Midterms Really Matter?

Post-midterm stock market upswings enjoy a long history, although some analysts disagree whether the trend dates back to 1946 or 1939. Either way, watchers seem to concur on one fundamental idea: After an election, anxious stock investors have less to worry about, which has made for healthier markets since World War II.

Having a single party definitively gain – or retain – power tends to generate less politically driven instability, but this isn’t the only factor. Research suggests that for whatever reason, events like bear markets, recessions, and armed conflicts tend to occur during the first two years of a presidential term.

This last point brings up an interesting idea: Maybe the midterms don’t matter, or at least they aren’t the primary driving factor everyone assumes they are.

Some financial professionals go as far as to declare that investors shouldn’t bother changing their portfolios in the run-up to the big (election) day or even after. To many of these experts, the overall market valuation and financial outlook ultimately outweigh whatever happens at the polls.

The Reality Is More Nuanced

Analysts are likewise quick to point out that looking at historical trends is an imprecise science. Not only do the predictions vary based on how you slice the data, but also there are plenty of outliers, and some believe that 2022 will be the year that bucks the trend no matter who wins.

Take a look at tech companies, which during one particularly dismal week before the election lost $1 trillion in valuation. Although the gridlock that usually follows midterms ironically helps markets by keeping legislators from passing new bills, it’s hard to argue that it can completely negate such huge downswings. Also, the potential for a recession doesn’t make the outlook feel any more favourable.

With all that said, the market could see some immediate – if not long-lasting – changes depending on who wins. For instance, if Republicans regain one chamber, leading to a split Congress, the healthcare industry might benefit from reduced regulation. On the other hand, if Democrats stay in control of both the Senate and the House, sectors like renewable energy and infrastructure – passion issues for the party – would probably get a boost.

So what’s the final verdict? Well, the key takeaway is that elections have a multifaceted impact. While they can heighten uncertainty before the polls open, they ultimately remove risk once the dust has settled, which explains why the naysayers are rarely the loudest voices.

At the same time, any rally could prove short-lived, especially if a recession follows. In all likelihood, the volatility we’ve seen thus far is likely to persist, particularly if the Fed keeps its finger on the rate-hike button.

While the midterms are almost guaranteed to have some kind of impact, it’s just not clear whether it will be enough to outweigh all the other factors – suggesting that investors shouldn’t make decisions solely based on the polls.

My preference is to let the dust settle, then decide which value growth income generating good cash flow producing companies look like they will continue their upward trend.

Alpesh Patel OBE