Here in Arkansas, the primary election was held earlier this month. The mid-term general election will be held in November across the country. In this week’s Fastest 4 Minutes in Finance, a look at what history tells us about the stock market in a mid-term election year.

Investor Psychology vs Fundamentals During Election Years

First off, when we look at how elections impact the stock market, we are really talking less about fundamentals and more about investor psychology. It’s not so much the election itself that impacts the markets, but often it’s the political campaigns. So, perspective matters.

Historical Election Trends and Market Expectations

According to Chris Fasciano, chief market strategist at Commonwealth, and a guest writer for the LPL Research blog, only three times has the incumbent President’s party picked up seats in the House of Representatives during midterm elections. It happened in 1934 with Franklin Roosevelt, 1998 under Bill Clinton, and 2002 when George W Bush was in office.

So, it is much more common to expect the opposition party to pick up seats in Congress. But, the market doesn’t tend to respond favorably to that likely outcome.

Midterm Election Year Returns and Market Volatility

Here’s a chart of the S&P 500 returns since 1931.

The blue line represents the average return during a midterm election year. The gray line is the average return in all other years. Midterm election years have average returns that are roughly 5 percentage points lower than the other three years of a presidential term. Fasciano also tells us volatility increases in the six months prior to the election.

Post Midterm Election Market Performance and Recovery

But, here’s the good news. Once the dust settles, the stock market performance is historically very good. Here’s a chart showing the S&P 500 Index price return one year following the midterm election, really the 3rd year of a presidential term.

The red bars are Republican presidents, and the blue bars represent Democrat presidents. The average one- year return after the midterms is 15.4%. It’s 7.8% in all other years.

Market Returns Regardless of Political Party Control

It’s also worth pointing out that the market has produced those returns, regardless of which party controls the White House, the Senate, or the House. Fasciano theorizes that after the fallout of a midterm election, the presidential administration tends to pivot toward pro-growth polices, either to support re-election, cement their legacy, or strengthen their parties for the next election.

Investment Strategy During Election Years: Focus on Your Plan

There are always other factors involved in any given year that impact the stock market as well. Bottom line, we should expect volatility this year, and every year, but major portfolio changes shouldn’t be made over fear or hope of election results. Fasciano writes, “Well-constructed portfolios are designed to participate in market upside, while managing risk during periods of weakness. We believe the best investment strategy during an election year is to vote in the booth, not in your portfolios.”

Focus on your plan, not politics.

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