By Fidelity Investments
Here’s why the U.S. elections season could help stocks recover from their recent pullback.
September lived up to its reputation as the worst month of the year for the stock market, and October hasn’t been much better. After reaching an all-time high of 2,011 on September 18, the S&P 500 lost its upward momentum. And the downturn continued into October, with the index falling below 1,900 for the first time since last May.
But there may be silver lining. With the forthcoming midterm elections, there may be a reason for optimism for the rest of the year.
Friendly part of the calendar
November and December are normally strong months for the market—especially after midterm elections.
Indeed, since 1928, October, November, and December have historically produced the highest average quarterly returns. By contrast, July, August, and September have typically produced the lowest returns by quarter.
Of course, these returns simply represent averages. The variability of returns within each quarter can be significant, with minimums and maximums that differ dramatically from the average.
Looking at these average returns, you might be thinking this October has been just as rocky as September. Well, history says that’s not unusual.
October tends to be quite volatile, acting as a sort of bridge month between the historically bearish month of September and the bullish months of November and December.
While there have been a number of geopolitical factors that have resulted in the numerous triple-digit swings for the Dow Jones Industrial Average—both up and down—this month, the historical tendency for heightened market volatility in October may be due, at least in part, to this seasonal pattern.
Impact of midterm elections
So, why exactly does this calendar trading pattern occur? Some stock market historians, such as Yale Hirsch, attributed this calendar effect to the process of electing a U.S. president every four years. He dubbed this effect the “presidential cycle” theory.
In addition to the potential impact that electing a U.S. president might have on markets, midterm elections have been found to be significant as well, according to Jeff Hirsch, son of Yale Hirsch, and chief editor of the Stock Trader’s Almanac, which his father founded. Could the upcoming elections be playing some role in the recent market action, as uncertainty leading up to the vote contributes to the volatility?
There is a tendency for the period following midterm elections to deliver positive returns in the final months of the year. In fact, markets tend to go up regardless of the winner—perhaps because the uncertainty is removed.
The 12-month period following midterm elections has seen positive returns in every case, dating back to 1950, and quite significantly so in some cases.
The 12 months after midterm elections has been positive since 1947, with an average return of 16.1%. Since 1950, equity markets are up on average about 4.5% from the October lows during the final two months of the year.
The last leg of an incumbent presidency
We are currently near the end of year two of President Obama’s second term. Typically, this is the beginning of the most bullish segment of the presidential cycle: On average, the S&P 500 has resulted in a 22.1% return from September of year two of the incumbent presidential term through July of year three of the presidential term.
A note of caution
Of course, it is unreasonable to expect that the market will routinely follow cycle norms. David Keller, CMT, director of technical research at Fidelity and former president of the Market Technicians Association, says that it is critical to look at each cycle individually.
“You have to remember that the presidential cycle happens in the context of larger structural market trends, and that secular moves in equities can either enhance or minimize the effect of something like a four-year market cycle,” Keller says.
Right now, slowing global growth, low inflation, and expectations that the Federal Reserve will “normalize” interest rates are among the primary factors for there having been an increase in market volatility. These drivers may continue to drive market action in the coming weeks and months.
Yet the U.S. continues to appear healthy relative to the world. And history suggests that midterm elections could be a springboard for stocks to recover off their recent lows.
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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
