Mid-term Elections and the Market – Q3 2018 Newsletter

The mid-term elections are right around the corner. That means that the phone is ringing with questions about how the elections could impact the stock market. Generally, we prefer to keep politics and investing separate, but we grudgingly accept that they can influence one another in the short run.

By way of background, we have a number of conservative clients who were very upset when Barack Obama was first elected back in 2008. After all, they reasoned, his policies were socialistic, he had no economic experience, and he was antagonistic to business interests. Under his watch, the stock market did nothing but go up.

On the other hand, we have more than a few liberal clients who were beside themselves when Donald Trump was elected two years ago. After all, they argued, he’s going to get us into a war, he’s antagonistic to large parts of the population, and he’s just plain nuts. So far, under his watch, the stock market has done nothing but go up.

Economic cycles may be exacerbated or mitigated by political policies, but the business cycle is largely going to play out regardless of who is in office. That said, markets can certainly react to political events, and the mid-term elections could be a short-term driver of markets.

There have been many studies showing how the market performed under various political regimes. For example, the Democrats have long boasted that the stock market has performed best when their candidate is in the Oval Office. That is indeed true. Since 1926, the stock market has averaged returns of 14.9% under Democratic presidents versus 8.9% under Republican presidents.

However, the results shift when you look at government as a whole. The best-case scenario, over the full period we studied, was for a Republican president and a Republican Congress. The annualized returns were 16.1%. This was just slightly better than the 15.9% earned on average with a Democratic president and Republican Congress (see table below).

President / CongressSince 1926Since 1950Since 1980
Rep / Dem11.0%11.0%14.8%
Dem / Rep15.9%18.5%18.5%
Rep / Rep16.1%19.1%16.4%
Dem / Dem14.5%14.3%17.1%

 

Of course, the dirty little secret that articles in the financial media tend to ignore is that these numbers mean nothing. The relationships are not statistically significant, which means they could just be a random coincidence. Indeed, looking at subperiods, the results are not consistent.

So, with nothing to back us up other than a bit of common sense (which you could quibble with) and too much self-assurance, here is what we think could happen to the market in November.

Scenario A: The Republicans keep the House and Senate

While this outcome seems unlikely, it probably is the best-case scenario for the stock market. Love him or hate him, The Donald’s economic policies have been popular with investors. The trade spat (not really a trade war yet) could get out of control, but otherwise lower corporate taxes and less regulation have proven strong fuel to keep the market cooking. If the Republicans remain in power, expect more economically-focused and business-friendly policies, including an extension of the tax cuts.

Scenario B: The Republicans keep the Senate but lose the House

Since this is the consensus outcome at this point, there likely isn’t much impact to the market. There could be a short-term, knee-jerk reaction down, but don’t expect any lasting effect. There will be a lot of talk of impeachment, and Trump could actually be impeached. However, it is unlikely that he would be removed from office, and we find it hard to image he would resign. The uncertainty of that process could cause further short-term market ups and downs. The President’s agenda will probably still move forward through executive order under this scenario. These will mostly be challenged in court, resulting in very little getting accomplished, which historically has been good for stocks.

Scenario C: The Democrats take control of both the House and Senate

This scenario could be bad for the market, first because it is unexpected. Secondly, because it creates uncertainty around the economic policies that have recently been put in place. Emboldened Democrats could try to roll back the new lower corporate tax rates, and propose new legislation with tighter regulations. There would undoubtedly be gridlock with a split government, but the Democrats would have enough influence to try to enact some of their own policies, possibly by tying future debt ceiling increases to policy concessions.

There is, of course, a social agenda that accompanies either party, and we’ve intentionally limited this discussion to only economic issues. From an economic perspective, there is much to be optimistic about. As noted in a nearby article, the current economic expansion could still have a long way to run. The economy is strong and there aren’t too many signs of a slowdown. Regardless of what happens in November, and the market’s knee-jerk reaction to it, the markets could keep marching higher for some time.

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