Interactive Investor

This US midterm election investing trick has worked 100% of the time

8th November 2022 13:17

Graeme Evans from interactive investor

With more than 100 million American casting their vote today, we investigate one of the best historic buy signals for equities there is.

A perfect record for the S&P 500 index in the year after every midterm election means investors have one of their surest “buy” signals as Americans head to the polls today.

Since the Second World War, the US benchmark has risen 19 out of 19 times and delivered an average increase of about 15% in the 12 months following the midterms.

One of the reasons for this remarkable unbroken run is the fact that the winner of the presidency two years earlier tends to lose seats in a midterm election, resulting in political gridlock that prevents disruptive policy changes.

That scenario may be the case again this year as Republicans are poised to win the House of Representatives and possibly the Senate, dealing a blow to Joe Biden’s plans.

Today’s election involves every seat in the lower chamber of the US House of Representatives and a third of seats in the Senate, as well as governorships in 36 states. The possibility of runoffs means the final outcome may not be clear for a few days.

The S&P 500 is down 20% so far in 2022 following a quickfire round of bumper US interest rate rises, although the benchmark has rallied in the past fortnight. This recent improvement mirrors the findings of recent research by Oxford Economics, which found that the S&P 500’s midterm rallies usually started a few weeks prior to the election.

Deutsche Bank strategist Jim Reid added: “When it comes to markets, it’s no exaggeration to say that midterm elections are one of the best historic buy signals for equities we have.

“In fact, in the 19 midterm elections since the Second World War, the S&P 500 has always been higher one year after the vote. Whether any of those cycles had to contend with the macro tsunami that's coming in the next 12 months is a moot point but it shows the underlying technicals.”

The prospect of further Federal Reserve monetary policy tightening means the usual post-election tailwind for US markets is far from guaranteed, threatening the post-war record. Facebook owner Meta Platforms (NASDAQ:META) and Google parent Alphabet (NASDAQ:GOOGL) have recently signalled disappointing earnings trends and US Treasury yields are giving recession warnings.

There’s also the danger that gridlock could mean inaction at a time when the US economy needs strong leadership, reigniting fears of a US debt default in the process.

Some US stocks have already shown signs of benefiting from investor positioning ahead of the midterms, including in the healthcare and biotech sectors after valuations were earlier squeezed by Democrat legislation forcing lower prescription drug prices.

A Republican result may underpin oil stocks if it means more policies in favour of greater energy production. Chevron Corp (NYSE:CVX) and Exxon Mobil (NYSE:XOM) are already up 55% and 79% this year, but a stronger-than-expected result for the Democrats is likely to put pressure on these gains and benefit clean energy stocks.

For defence stocks such as Lockheed Martin (NYSE:LMT) and Raytheon (NYSE:RTX), however, geopolitical tensions mean they are likely to be supported regardless of the outcome of midterm elections.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.