How Elections Affect the Stock Market

Will a Republican victory in the upcoming congressional elections help the stock market? Or will the market fare better if Democrats hold on to Congress and continue their much-criticized efforts to fix the struggling economy?

Guess what? It probably won’t matter -- at least not to investors. The stock market simply wants election day to be behind us: Stocks have rallied after every mid-term election since 1942.

Stocks surge, on average, by a whopping 18.3% in the 200 trading days after mid-term elections, according to the Leuthold Group, a Minneapolis-based investment-research firm. Standard & Poor’s 500-stock index chalked up its biggest 200-day gain, 30.5%, in 1942, as the tide began to turn in World War II. The puniest gain, 3.9%, came in 1946, as investors fretted that the economy would sink into another depression.

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In the 11 mid-term elections between 1942 and 1982, control of one or both houses of Congress flipped just twice. But in more- recent elections, a majority of Americans have expressed their unhappiness with the party in power. Voters have ousted the party in power in Congress four times in the past six elections. The polls show that the pattern likely will be repeated in this year’s election, with the GOP regaining control of the next House of Representatives.

The market has essentially been neutral about such changes. In the elections in which control of Congress didn’t switch, the S&P 500 rose an average of 17.9% over the 200 trading sessions after election day. That compares with an 18.3% gain for all mid-term elections -- a difference of less than one half of one percentage point.

Because investors hate uncertainty, what matters most is simply getting the election over with. Indeed, since 1942, the S&P has tended to lag in the 200 days before mid-term elections. On average, stocks have gained 2.6% during that period. Starting in early October, however, stocks have tended to stabilize and then rise -- probably because Wall Street starts to anticipate how the election will turn out. "Changes in congressional majority power in mid-term elections appear to have little to do with causing the strong performance of equities following the election," Leuthold’s Eric Bjorgen says. "It doesn’t matter if power shifts to the other party or not. It’s knowing what’s going to happen, knowing how policy will be formulated. It’s a clearing up of the clouds of uncertainty."

The presidential cycle

The "presidential cycle" historically has also been a good predictor of stock performance. The thinking is that presidents try to make tough economic decisions during the first two years of their tenure, and that often leads to lousy stock-market performance. Then, as presidential elections near, the incumbents do everything possible to ignite the economy so that they and their party will hold the White House for another term.

Since 1940, the S&P has returned a cumulative 9.3%, on average, in the first two years of presidential terms -- slightly more than a third of the 25% cumulative return in the second two years.

But the presidential-cycle indicator has fallen on its face of late. Through October 11, the S&P 500 has risen 6.2% so far in 2010, the second year of President Obama’s term. It surged 26% last year.

President George W. Bush couldn’t make it work, either. After gaining ground in the first two years after his re-election in 2004, the market rose a mere 5% in 2007, then plunged 37% in 2008.

The bottom line: Even presidents can’t control the economy, and forecasting the market based on the presidential election cycle doesn’t look as reliable as it once did.

Although the mid-term election-rally effect appears to be holding fast, you shouldn’t bank on that either. Markets, alas, often find a way to upset our preconceived notions.  

Steven T. Goldberg (bio) is an investment adviser.

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Steve has been writing for Kiplinger's for more than 25 years. As an associate editor and then senior associate editor, he covered mutual funds for Kiplinger's Personal Finance magazine from 1994-2006. He also authored a book, But Which Mutual Funds? In 2006 he joined with Jerry Tweddell, one of his best sources on investing, to form Tweddell Goldberg Investment Management to manage money for individual investors. Steve continues to write a regular column for Kiplinger.com and enjoys hearing investing questions from readers. You can contact Steve at 301.650.6567 or sgoldberg@kiplinger.com.